<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 24, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-19483
SOUTHWEST SECURITIES GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-2040825
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 Elm Street, Suite 3500, Dallas, Texas 75270
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 859-1800
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
As of November 3, 1999, there were 11,803,381 shares of the registrant's common
stock, $.10 par value, outstanding.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition
September 24, 1999 and June 25, l999
Consolidated Statements of Income and Comprehensive Income (Loss)
For the three months ended September 24, 1999 and September 25, 1998
Consolidated Statements of Cash Flows
For the three months ended September 24, 1999 and September 25, 1998
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 24, 1999 and June 25, l999
(In thousands, except par values and share amounts)
<TABLE>
<CAPTION>
September June
(Unaudited)
------------- -------------
<S> <C> <C>
Assets
Cash $ 13,688 $ 11,334
Assets segregated for regulatory purposes 210,939 225,736
Marketable equity securities, at market value 95,111 172,928
Receivable from brokers, dealers and clearing organizations 2,641,815 3,088,005
Receivable from clients, net 719,468 679,652
Securities owned, at market value 68,819 74,486
Other assets 46,747 41,133
------------- -------------
$ 3,796,587 $ 4,293,274
============= =============
Liabilities and Stockholders' Equity
Short-term borrowings $ 38,700 $ 2,700
Payable to brokers, dealers and clearing organizations 2,609,091 3,000,096
Payable to clients 754,730 812,559
Securities sold, not yet purchased, at market value 19,779 24,350
Drafts payable 35,491 37,013
Other liabilities 67,517 104,222
Exchangeable subordinated notes 57,500 50,000
------------- -------------
3,582,808 4,030,940
Minority interest in consolidated subsidiary 50 50
Stockholders' equity:
Preferred stock of $1.00 par value. Authorized 100,000
shares; none issued - -
Common stock of $.10 par value. Authorized 20,000,000 shares;
11,803,459 issued and outstanding at September 24, 1999;
11,805,925 issued and outstanding at June 25, 1999 1,181 1,180
Additional paid-in capital 127,765 127,278
Accumulated other comprehensive income - unrealized
holding gain, net of tax of $33,146 at September 24, 1999
and $60,374 at June 25, 1999 61,511 112,123
Retained earnings 23,361 21,896
Receivable from employees under the Employee Stock Purchase Plan (3) (7)
Deferred compensation, net 423 (186)
Treasury stock (11,334 shares, at cost) (509) -
------------- -------------
Total stockholders' equity 213,729 262,284
Commitments and contingencies
------------- -------------
$ 3,796,587 $ 4,293,274
============= =============
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income (Loss)
For the three months ended September 24, 1999 and September 25, 1998
(In thousands, except per share and share amounts)
(Unaudited)
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------
<S> <C> <C>
Net revenues from clearing operations $ 10,208 $ 8,094
Commissions 15,232 14,409
Interest 44,585 35,847
Investment banking, advisory and administrative fees 6,786 7,584
Net gains on principal transactions 4,303 3,762
Other 3,497 3,501
---------------------------------------------
84,611 73,197
---------------------------------------------
Commissions and other employee compensation 26,604 25,863
Interest 31,335 24,029
Occupancy, equipment and computer service costs 6,614 4,739
Communications 3,980 2,912
Floor brokerage and clearing organization charges 1,990 1,465
Advertising and promotional 4,428 788
Other 5,867 6,045
---------------------------------------------
80,818 65,841
---------------------------------------------
Income before income taxes 3,793 7,356
Income taxes 1,301 2,673
---------------------------------------------
Net income 2,492 4,683
Other comprehensive income (loss) - unrealized holding
gain (loss) arising during period, net of tax of ($27,228) and
$5,308 for the three month periods ended September 24, 1999
and September 25, 1998, respectively (50,612) 9,857
---------------------------------------------
Comprehensive income (loss) $ (48,120) $ 14,540
=============================================
Earnings per share - basic and diluted $ .21 $ .40
=============================================
Weighted average shares outstanding - basic 11,807,429 11,746,247
=============================================
Weighted average shares outstanding - diluted 11,976,563 11,757,449
=============================================
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended September 24, 1999 and September 25, 1998
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,492 $ 4,683
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 730 871
Provision for doubtful accounts 204 146
Deferred income taxes 538 21
Deferred compensation expense 503 -
Decrease (increase) in assets segregated for regulatory purposes 14,797 (108,968)
Net change in broker, dealer and clearing organization accounts 55,185 (20,342)
Net change in client accounts (97,849) 129,889
Increase (decrease) in securities owned 5,636 (3,294)
Increase in other assets (5,886) (890)
Increase (decrease) in securities sold, not yet purchased (4,571) 8,541
Decrease in drafts payable (1,522) (4,016)
Decrease in other liabilities (9,959) (4,141)
------------ ------------
Net cash provided by (used in) operating activities (39,702) 2,500
------------ ------------
Cash flows from investing activities:
Purchase of furniture, equipment and leasehold improvements (732) (639)
Sale of marketable equity securities 9 -
------------ ------------
Net cash used in investing activities (723) (639)
------------ ------------
Cash flows from financing activities:
Proceeds from short term borrowings 36,000 -
Proceeds from issuance of exchangeable subordinated notes 7,500 -
Debt issue costs (242) -
Net change in receivable from employees for Employee
Stock Purchase Plan 4 (28)
Proceeds from employees for Stock Purchase Plan 250 -
Proceeds from exercise of stock options 34 -
Proceeds related to Deferred Compensation Plan 509 -
Purchase of treasury stock (509) -
Payment of cash dividend on common stock (767) (610)
Proceeds from issuance of stock of consolidated subsidiary - 100
------------ ------------
Net cash provided by (used in) financing activities 42,779 (538)
------------ ------------
Net increase in cash 2,354 1,323
Cash at beginning of period 11,334 13,706
------------ ------------
Cash at end of period $ 13,688 $ 15,029
============ ============
</TABLE>
See accompanying Notes to the Consolidated Financial Statements.
<PAGE>
SOUTHWEST SECURITIES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
GENERAL AND BASIS OF PRESENTATION
The interim consolidated financial statements include the accounts of Southwest
Securities Group, Inc. ("Parent") and its consolidated subsidiaries listed below
(collectively, the "Company"):
Southwest Securities, Inc. "Southwest"
SWS Financial Services, Inc. "SWSFS"
Mydiscountbroker.com, Inc. "MDB"
Southwest Clearing Corporation "Clearing"
Westwood Management Corporation "Westwood"
Westwood Trust "Trust"
SW Capital Corporation "Capital"
Southwest Investment Advisors, Inc. "Advisors"
SWS Technologies Corporation "Technologies"
Southwest, SWSFS, MDB and Clearing are registered broker/dealers under the
Securities Exchange Act of 1934 ("1934 Act"). Clearing became a registered
broker/dealer on June 29, 1999, but has not yet begun operations. Effective
August 6, 1999, the Company sold all of its shares in NorAm Investment Services,
Inc. for $478,788. Advisors and Westwood are registered investment advisors
under the Investment Advisors Act of 1940. All significant intercompany
balances and transactions have been eliminated.
The consolidated financial statements as of September 24, 1999, and for the
three month periods ended September 24, 1999 and September 25, 1998, are
unaudited; however, in the opinion of management, these interim statements
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the financial position, results of
operations and cash flows. These financial statements should be read in
conjunction with the audited consolidated financial statements and related notes
as of and for the year ended June 25, 1999 filed on Form 10-K. Amounts included
for June 25, 1999 are from the audited consolidated financial statements as
filed on Form 10-K.
CASH FLOW REPORTING
Cash paid for interest was $29,323,000 and $36,420,000 for the three month
periods ended September 24, 1999 and September 25, 1998, respectively. No cash
was paid for income taxes in the first quarter of fiscal 2000. Cash paid for
income taxes was $3,075,000 in the comparable period of the prior year.
ASSETS SEGREGATED FOR REGULATORY PURPOSES
At September 24, 1999, the Company had reverse repurchase agreements of
$20,491,000 and U.S. Treasury securities with a market value of $190,448,000
segregated in a special reserve bank account for the exclusive benefit of
customers under Rule 15c3-3 of the 1934 Act. The reverse repurchase agreements
were collateralized by U.S. Government securities with a market value of
approximately $192,894,000. At June 25, 1999, the Company had U.S. Treasury
securities with a market value of $28,465,000 and reverse repurchase agreements
of $197,271,000 in this account. The reverse repurchase agreements were
collateralized by U.S. Government securities with a market value of
approximately $198,298,000 at June 25, 1999.
MARKETABLE EQUITY SECURITIES
The investment in Knight/Trimark Group, Inc. ("Knight") common stock is
classified as marketable equity securities available for sale, and the
unrealized holding gains (losses), net of tax, are recorded as a separate
component of stockholders' equity on the consolidated statements of financial
condition. The Knight shares are subject to the provisions of Securities and
Exchange Commission Rule 144. The
<PAGE>
following table summarizes the cost and market value of the investment in Knight
at September 24, 1999 and June 25, l999 (in thousands):
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Market
Cost Gains Losses Value
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
September
Marketable equity securities $ 423 94,688 - $ 95,111
=================================================================================
June
Marketable equity securities $ 432 172,496 - $ 172,928
=================================================================================
</TABLE>
The "specific identification" method is used to determine the cost of marketable
securities sold. In the first quarter of fiscal 2000, the Company sold 70,000
shares of Knight, with realized gains totaling approximately $3 million.
RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS
At September 24, 1999 and June 25, l999, the Company had receivable from and
payable to brokers, dealers and clearing organizations related to the following
(in thousands):
<TABLE>
<CAPTION>
September June
----------------------- ----------------------
<S> <C> <C>
Receivable
Securities failed to deliver $ 23,424 $ 27,505
Securities borrowed 2,550,447 2,987,910
Correspondent broker/dealers 43,545 47,805
Clearing organizations 2,462 1,444
Other 21,937 23,341
----------------------- ----------------------
$ 2,641,815 $ 3,088,005
======================= ======================
Payable
Securities failed to receive $ 42,437 $ 23,634
Securities loaned 2,541,628 2,945,007
Correspondent broker/dealers 12,413 15,273
Other 12,613 16,182
----------------------- ----------------------
$ 2,609,091 $ 3,000,096
======================= ======================
</TABLE>
SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
At September 24, 1999 and June 25, l999, the Company held securities owned and
securities sold, not yet purchased as follows (in thousands):
<TABLE>
<CAPTION>
September June
--------------------- ---------------------
<S> <C> <C>
Securities owned
Corporate equity securities $ 8,972 $ 35,671
Municipal obligations 15,109 19,391
U.S. Government and Government agency obligations 15,397 9,470
Corporate obligations 20,737 4,114
Other 8,604 5,840
--------------------- ---------------------
$ 68,819 $ 74,486
===================== =====================
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
September June
--------------------- ---------------------
<S> <C> <C>
Securities sold, not yet purchased
Corporate equity securities $ 9,957 $ 14,972
Municipal obligations 359 6,184
U.S. Government and Government agency obligations 5,203 2,491
Corporate obligations 3,593 372
Commercial paper 405 -
Other 262 331
--------------------- ---------------------
$ 19,779 $ 24,350
===================== =====================
</TABLE>
SHORT-TERM BORROWINGS
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $192,500,000. These lines of credit are used primarily to
finance securities owned, securities held for Correspondent broker/dealer
accounts and receivables in customers' margin accounts. These lines may also be
used to release pledged collateral against day loans. These credit arrangements
are provided on an "as offered" basis and are not committed lines of credit.
These arrangements can be terminated at any time by the lender. Any outstanding
balance under these credit arrangements is due on demand and bears interest at
rates indexed to the federal funds rate. At September 24, 1999, the amount
outstanding under these secured arrangements was $38,700,000 which was
collateralized by clients' securities valued at $31,798,000 and by marketable
equity securities owned valued at $52,245,000. There was $2,700,000 outstanding
at June 25, 1999 on these credit arrangements which was collateralized by
securities held for firm accounts valued at $29,724,000.
In addition to the broker loans lines, the Company has a $20,000,000 unsecured
line of credit that is due on demand and bears interest at rates indexed to the
federal funds rate. There were no amounts outstanding under this line of credit
at September 24, 1999 and June 25, l999.
At September 24, 1999 and June 25, l999, the Company had no repurchase
agreements outstanding.
EXCHANGEABLE SUBORDINATED NOTES
In July 1999, the Company issued an additional $7.5 million of 5% Exchangeable
Subordinated Notes (132,304 Derivative Adjustable Ratio Securities(SM),
"DARTS(SM)") as the underwriters exercised their over-allotment option. These
DARTS have the same terms as the DARTS issued in June 1999. The Company received
proceeds of $7.3 million, net of underwriters fees. The Company recorded
additional debt issue costs of $242,000 which will be amortized over the life of
the DARTS. In the first quarter of fiscal 2000, the Company recorded interest
and amortization expense related to the DARTS of $702,000 and $98,000,
respectively.
NET CAPITAL REQUIREMENTS
The broker/dealer subsidiaries are subject to the Securities and Exchange
Commission's Uniform Net Capital Rule (the "Rule"), which requires the
maintenance of minimum net capital. Southwest has elected to use the
alternative method, permitted by the Rule, which requires that it maintain
minimum net capital, as defined in Rule 15c3-1 under the 1934 Act, equal to the
greater of $1,500,000 or 2% of aggregate debit balances, as defined in Rule
15c3-3 under the 1934 Act. At September 24, 1999, Southwest had net capital of
$121,788,000, or approximately 14.7% of aggregate debit balances, which is
$105,251,000 in excess of its minimum net capital requirement of $16,537,000 at
that date. Additionally, the net capital rule of the New York Stock Exchange,
Inc. (the "Exchange") provides that equity capital may not be withdrawn or cash
dividends paid if resulting net capital would be less than 5% of aggregate debit
items. At September 24, 1999, Southwest had net capital of $80,445,000 in
excess of 5% of aggregate debit items.
Clearing also follows the alternative method. At September 24, 1999, Clearing
had net capital of $1,268,000, which is $1,018,000 in excess of its minimum net
capital requirement of $250,000 at that date.
<PAGE>
SWSFS and MDB follow the primary (aggregate indebtedness) method under Rule
15c3-1, which requires the maintenance of minimum net capital of $250,000. At
September 24, 1999, the net capital and excess net capital of these companies
was as follows:
<TABLE>
<CAPTION>
Net Capital Excess Net Capital
---------------------------------------------------------
<S> <C> <C>
SWSFS $ 317,000 $ 67,000
MDB 599,000 349,000
</TABLE>
Trust is subject to the capital requirements of the Texas Department of Banking,
and has a minimum capital requirement of $1,000,000. Trust had total
stockholder's equity of approximately $2,726,000, which is $1,726,000 in excess
of its minimum capital requirement at September 24, 1999.
DEFERRED COMPENSATION PLAN/TREASURY STOCK
In July 1999 the Company implemented a Deferred Compensation Plan ("Plan") for
eligible officers and employees to defer a portion of their bonus compensation
and commissions. Contributions to the Plan consist of employee pre-tax
contributions and the Company's matching contributions up to a specified limit.
Participants can invest in the Company's common stock or a variety of mutual
funds. The Company stock is carried at cost and is held as treasury stock, with
an offsetting deferred compensation liability in the equity section of the
statement of financial condition. In the first quarter of fiscal 2000,
approximately $1,415,000 was invested into the Plan. Funds totaling $509,000
were invested in 11,334 shares of the Company's common stock, with the remainder
being used to purchase mutual funds. Approximately $188,000 of compensation
expense was recorded related to the Plan. The trustee of the Plan is Trust.
EARNINGS PER SHARE
A reconciliation between the weighted average shares outstanding used in the
basic and diluted EPS computations is as follows at September 24, 1999 and
September 25, 1998 (in thousands, except share and per share amounts):
<TABLE>
<CAPTION>
1999 1998
----------------------------------------------
<S> <C> <C>
Net income $ 2,492 $ 4,683
==============================================
Weighted average shares outstanding - basic 11,807,429 11,746,247
Effect of dilutive securities:
Assumed exercise of stock options 169,134 11,202
----------------------------------------------
Weighted average shares outstanding - diluted 11,976,563 11,757,449
==============================================
Earnings per share - basic and diluted $ .21 $ .40
==============================================
</TABLE>
At September 24, 1999, the Company had two stock option plans, the Southwest
Securities Group, Inc. Stock Option Plan (the "1996 Plan") and the Southwest
Securities Group, Inc. 1997 Stock Option Plan (the "1997 Plan"). At September
24, 1999, there were approximately 728,000 options outstanding under the 1996
Plan and approximately 26,000 options outstanding under the 1997 Plan. The
Company also had approximately 17,000 options outstanding that were granted in
conjunction with the acquisition of Barre & Company, Inc. ("Barre Options"). As
of September 24, 1999, all outstanding options were dilutive and were included
in the calculation of weighted average shares outstanding - diluted, except
approximately 293,750 shares under the 1996 Plan and 264 shares under the 1997
Plan.
<PAGE>
SEGMENT REPORTING
The Company operates two principal segments within the financial services
industry: the Broker/Dealer Group and the Asset Management Group. There have
been no changes in the basis of segmentation or in the basis of measurement of
segment profit or loss since last reported.
<TABLE>
<CAPTION>
Consolidated
Asset Other Southwest
Broker/Dealer Management Consolidated Securities
(in thousands) Group Group Entities Group, Inc.
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Three months ended September 24, 1999
Net revenues from external sources $ 80,980 $ 3,235 $ 396 $ 84,611
Net intersegment revenues -- 241 1219 --
Income before income taxes 3,690 713 (609) 3,794
Three months ended September 25, 1998
Net revenues from external sources $ 70,127 $ 2,754 $ 316 $ 73,197
Net intersegment revenues -- 206 541 --
Income before income taxes 7,597 589 (830) 7,356
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
From time to time, Southwest Securities Group, Inc. (the "Parent") and
subsidiaries (collectively, the "Company") may publish "forward-looking
statements" within the meaning of section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended,
(the "Acts") or make oral statements that constitute forward-looking statements.
These forward-looking statements may relate to such matters as anticipated
financial performance, future revenues or earnings, business prospects,
projected ventures, new products, anticipated market performance and similar
matters. The Private Securities Litigation Reform Act of 1995 provides a safe
harbor for forward-looking statements. In order to comply with the terms of the
safe harbor, the Company cautions readers that a variety of factors could cause
the Company's actual results to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
These risks and uncertainties, many of which are beyond the Company's control,
include, but are not limited to (1) transaction volume in the securities
markets; (2) volatility of the securities markets; (3) fluctuations in interest
rates; (4) changes in regulatory requirements which could affect the cost of
doing business; (5) general economic conditions, both domestic and foreign; (6)
changes in the rate of inflation and related impact on securities markets; (7)
competition from existing financial institutions and other new participants in
the securities markets; (8) legal developments affecting the litigation
experience of the securities industry; (9) successful implementation of
technology solutions; and (10) changes in federal and state tax laws which could
affect the popularity of products sold by the Company. The Company does not
undertake any obligation to publicly update or revise any forward-looking
statements.
The Company's discussion of the issues surrounding the Year 2000 contain
forward-looking statements as defined in the Acts. These forward-looking
statements could relate to, but are not limited to (1) the financial impact of
the Year 2000 project; (2) the Company's estimated timetables for completion of
each phase of the project; (3) the Company's estimates of the availability of
vendor software upgrades and consulting services; (4) the readiness of third-
party service providers; and (5) contingency plans. The Company cautions that
many factors, including those outside of the control of the Company, could cause
actual results to be materially different than those anticipated and expressed
in the forward-looking statements.
<PAGE>
GENERAL
The Company is primarily engaged in securities execution and clearance,
securities brokerage, investment banking, securities lending and borrowing and
trading as a principal in equity and fixed income securities. All of these
activities are highly competitive and are sensitive to many factors outside the
control of the Company, including volatility of securities prices and interest
rates; trading volume of securities; economic conditions in the regions where
the Company does business; income tax legislation; and demand for investment
banking and securities brokerage services. While revenues are dependent upon
the level of trading and underwriting volume, which may fluctuate significantly,
a large portion of the Company's expenses remain fixed. Consequently, net
earnings can vary significantly from period to period.
RESULTS OF OPERATIONS
During the first quarter of fiscal 2000, net income totaled $2,492,000, a
decrease of $2,191,000, or 47%, from the first quarter of fiscal 1999.
The following is a summary of increases (decreases) in categories of net
revenues and operating expenses for the three month periods ended September 24,
1999 and September 25, 1998 (dollars in thousands):
<TABLE>
<CAPTION>
Amount Percent
---------------------------
<S> <C> <C>
Net revenues:
Net revenues from clearing operations $ 2,114 26%
Commissions 823 6%
Net interest 1,432 12%
Investment banking, advisory and administrative fees (798) (11%)
Net gains on principal transactions 541 14%
Other (4) -
---------------------------
4,108 8%
---------------------------
Operating expenses:
Commissions and other employee compensation 741 3%
Occupancy, equipment and computer service costs 1,875 40%
Communications 1,068 37%
Floor brokerage and clearing organization charges 525 36%
Advertising and promotional 3,640 462%
Other (178) (3%)
---------------------------
7,671 18%
---------------------------
Income before income taxes $ (3,563) (48%)
===========================
</TABLE>
Net Revenues from Clearing Operations. Net revenues from clearing increased
primarily as a result of a increase in total transaction volumes in the three
month period ended September 24, 1999 over the same period in the prior year.
Total transactions processed in the first quarter of fiscal 2000 increased 196%
to approximately 9.2 million from approximately 3.1 million in the first quarter
of fiscal 1999. The rate of increase in transactions processed has outpaced the
increase in revenues from clearing, because, in recent years, the Company has
increased the number of high-volume trading Correspondents in its customer base,
and a substantial portion of the increase in transactions processed were related
to these Correspondents. These customers use a relatively low level of clearing
services and, accordingly, are charged substantially discounted clearing fees
from the Company's standard clearing schedule. As transaction volumes increase,
revenue per clearing transaction tends to decrease as Correspondents take
advantage of volume discounts.
<PAGE>
Net Interest Income. The Company's net interest income is dependent upon the
level of customer and stock loan balances as well as the spread between the rate
it earns on those assets compared with the cost of funds.
The components of interest earnings are as follows for the three month periods
ended September 24, 1999 and September 25, 1998 (in thousands):
<TABLE>
<CAPTION>
1999 1998
----------------------------------------
<S> <C> <C>
Interest revenue:
Customer margin accounts $ 13,487 $ 11,812
Assets segregated for regulatory purposes 2,481 1,929
Stock borrowed 26,618 20,085
Other 1,999 2,021
--------------- ---------------
44,585 35,847
--------------- ---------------
Interest expense:
Customer funds on deposit 7,791 7,502
Stock loaned 22,550 16,127
Other 994 400
--------------- ---------------
31,335 24,029
--------------- ---------------
Net interest $ 13,250 $ 11,818
=============== ===============
</TABLE>
In the three month period ended September 24, 1999, net interest income
accounted for 25% of the Company's net revenue. Net interest income was 24% of
net revenue in the three month period ended September 25, 1998.
Interest revenue from customer margin balances and interest expense from
customer funds on deposit have fluctuated in relation to average balances over
the three month periods ended September 24, 1999 and September 25, 1998.
Average customer balances and average balances from securities lending
activities are as follows for the three month periods ended September 24, 1999
and September 25, 1998 (in thousands):
<TABLE>
<CAPTION>
1999 1998
----------------------------------------
<S> <C> <C>
Average customer margin balances $ 684,000 $ 530,000
Average customer funds on deposit 736,000 599,000
Average stock borrowed 2,728,000 2,058,000
Average stock loaned 2,718,000 2,040,000
</TABLE>
Rates on customer margin balances and funds on deposit are influenced by changes
in leading market interest rates and competitive factors. Spreads on securities
lending transactions are influenced by the types of securities borrowed or
loaned, market conditions and counterparty risk. Securities lending activities
are conducted out of the Company's New York office using a highly specialized
sales force. Competition for these individuals is intense and there can be no
assurance that the Company will be able to retain these individuals.
Investment Banking, Advisory and Administrative Fees. Investment banking,
advisory and administrative fees include revenues derived from the underwriting
and distribution of corporate and municipal securities, unit trusts and money
market and other mutual funds. Investment banking, advisory and administrative
fees decreased in the first quarter of fiscal 2000 when compared to the same
period in fiscal 1999 due to decreases in fees from municipal finance business.
This decrease was, however, offset
<PAGE>
slightly by increased fees from investment advisory services in the first
quarter of fiscal 2000 over the first quarter of fiscal 1999. Advisory fees
earned on investment management increased as assets under management averaged
$3.4 billion for the quarter ended September 24, 1999 averaged $3.0 billion for
the same quarter a year ago.
Net Gains on Principal Transactions. For the quarter ended September 24, 1999,
$3 million in net gains on principal transactions represents gains realized on
the sale of Knight common stock (see Advertising and Promotional below).
Excluding the gains from the sale of Knight, net gains from principal
transactions were $1.3 million versus $3.8 million in the first quarter a year
ago due to a difficult trading environment in both the equity and fixed income
markets. Revenue in this area can fluctuate significantly from quarter to
quarter based on market conditions.
Occupancy, Equipment and Computer Service Costs. Occupancy, equipment and
computer service costs increased for three month period as the Company continued
to increase the resources allocated to the implementation of its new brokerage
software, Comprehensive Software Systems, Ltd. ("CSS") (see YEAR 2000 discussion
below).
Communications. Communications expense increased primarily due to increased
quotations expense during the first quarter of fiscal 2000 due to the expansion
of the equity trading area, as well as the growth of MDB.
Floor Brokerage and Clearing Organization Charges. Floor brokerage and clearing
organization charges increased due to higher volume in the institutional trading
area.
Advertising and Promotional. Advertising and promotional expenses increased
primarily due to the national advertising campaign launched by MDB in the first
quarter of fiscal 2000. The Company sold 70,000 shares of its investment in
Knight to fund the advertising commitment for the quarter.
FINANCIAL CONDITION
The Parent owns approximately 3.3 million shares of Knight. The shares are
classified as marketable equity securities available for sale, and the
unrealized holding gain, net of tax, is recorded as a separate component of
stockholders' equity on the consolidated statements of financial condition in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities."
LIQUIDITY AND CAPITAL RESOURCES
The Company's assets are substantially liquid in nature and consist mainly of
cash or assets readily convertible into cash. These assets are financed by the
Company's equity capital, short-term bank borrowings, interest bearing and non-
interest bearing client credit balances, Correspondent deposits and other
payables. The Company maintains an allowance for doubtful accounts which
represents amounts, in the judgment of management, that are necessary to
adequately absorb losses from known and inherent risks in receivables from
clients, clients of Correspondents and Correspondents.
The Company has credit arrangements with commercial banks, which include broker
loan lines up to $192,500,000. These lines of credit are used primarily to
finance securities owned, securities held for Correspondent broker/dealer
accounts and receivables in customers' margin accounts. These credit
arrangements are provided on an "as offered" basis and are not committed lines
of credit. Outstanding balances under these credit arrangements are due on
demand, bear interest at rates indexed to the federal funds rate and are
collateralized by securities of the Company and its clients. At September 24,
1999, the amount outstanding under these secured arrangements was $38,700,000
which was collateralized by clients' securities valued at $31,798,000 and by
marketable equity securities owned valued at $52,245,000. In the opinion of
management, these credit arrangements are adequate to meet the short-term
operating capital needs of the Company.
In addition to the broker loan lines, the Company also has a $20,000,000
unsecured line of credit that is due on demand and bears interest at rates
indexed to the federal funds rate. There were no amounts outstanding at
September 24, 1999 under this unsecured line of credit.
<PAGE>
The Company has issued $57.5 million of 5% Exchangeable Subordinated Notes (the
"Notes") due June 30, 2004. At maturity, the principal of the notes will be
paid in shares of the Class A common stock of Knight or, at the option of the
Company, their cash equivalent. The Notes, which are in the form of DARTS(SM)
(or, "Derivative Adjustable Ratio Securities(SM)"), were issued in denominations
of $56.6875, the closing bid price of Knight on June 10, 1999. At maturity,
Noteholders are entitled to one share of Knight common stock for each DARTS if
the average price for the 20 days immediately preceding the Note's maturity is
equal to or less than the DARTS issue price. Noteholders are entitled to .833
shares of Knight common stock for each DARTS if the average price of Knight's
common stock is 20% or more greater than the DARTS' issue price. If the average
price of the Knight common stock is between the Note's issue price and 20%
greater than the issue price, the exchange rate will be determined by a formula.
Net cash used in operating activities during the three month period ended
September 24, 1999 was $39,702,000. The use of cash was due to the increase in
securities owned and was adequately financed by the short-term borrowings
mentioned above.
The Company's broker/dealer subsidiaries are subject to the requirements of the
Securities and Exchange Commission relating to liquidity, capital standards and
the use of client funds and securities. The Company has historically operated
in excess of the minimum net capital requirements.
MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in value of a financial instrument as a result of fluctuations
in interest rates, equity prices, and changes in credit ratings of the issuer.
The Company's exposure to market risk is directly related to its role as a
financial intermediary in customer-related transactions and to its proprietary
trading activities.
Interest Rate Risk. Interest rate risk is a consequence of maintaining
inventory positions and trading in interest-rate-sensitive financial
instruments. The Company does not maintain material positions in interest-rate-
sensitive financial instruments. The Company's fixed income activities also
expose it to the risk of loss related to changes in credit spreads. Credit
spread risk arises from the potential that changes in an issuer's credit rating
or credit perception could affect the value of financial instruments.
Equity Price Risk. The Company is exposed to equity price risk as a result of
making markets in equity securities. Equity price risk results from changes in
the level or volatility of equity prices, which affect the value of equity
securities or instruments that derive their value from a particular stock, a
basket of stocks or a stock index.
Credit Risk. Credit risk arises from the potential nonperformance by
counterparties, customers or debt security issuers. The Company is exposed to
credit risk as a trading counterparty to dealers and customers, as a holder of
securities and as a member of exchanges and clearing organizations.
Managing Risk Exposure. The Company manages risk exposure through the
involvement of various levels of management. Position limits in trading and
inventory accounts are well established and monitored on an ongoing basis.
Current and proposed underwriting, banking and other commitments are subject to
due diligence reviews by senior management, as well as professionals in the
appropriate business and support units involved. Credit risk related to various
financing activities is reduced by the industry practice of obtaining and
maintaining collateral. The Company monitors its exposure to counterparty risk
through the use of credit exposure information, the monitoring of collateral
values and the establishment of credit limits.
Market Risk Analysis. The Company has performed an analysis of the Company's
financial instruments and has assessed the related risk and materiality in
accordance with the rules. Based on this analysis, in the opinion of
management, the market risk associated with the Company's financial instruments
at September 24, 1999 will not have a material adverse effect on the
consolidated financial position or operating results of the Company.
<PAGE>
YEAR 2000
The widespread use of computer programs that rely on two-digit date programs to
perform computations and decision-making functions may cause information
technology ("IT") systems to malfunction in the Year 2000 and may lead to
significant business delays in the U.S. and internationally. The Year 2000
problem has the potential to impact the securities industry since information is
moved to and from the exchanges and trading partners on a real-time basis from
computer system to computer system with little human interaction. In addition
to potential problems from computer systems, potential problems could arise from
equipment with embedded chips, such as fax machines, elevators and other non-IT
systems.
The Company has defined a Year 2000-compliant system as one capable of correct
identification, manipulation and calculation when processing data in connection
with the year change from December 31, 1999 to January 1, 2000. A Year 2000-
compliant system is also capable of correct identification, manipulation and
calculation using leap years both alone and in conjunction with other dates.
The Company's systems are compliant under the above definition. The Company
addressed issues with regard to Year 2000 compliance as described below.
In the first stage, the Company prepared an inventory of all IT and non-IT
systems, as well as equipment that could have embedded chips, whether or not
critical to the operation of the business. The Company also compiled a listing
of material relationships with third parties. These relationships include
various exchanges, clearing houses, banks, telecommunications companies and
public utilities. This stage of the Year 2000 process is 100% complete. The
Company continually reviews areas of the business to address any new items added
since the initial inventories.
In stage two, results from the inventory discussed above were assessed to
determine the Year 2000 impact and what actions needed to be taken to obtain
Year 2000 compliance. For the Company's internal systems, actions needed ranged
from obtaining vendor certification of Year 2000 compliance, remediation of
internal systems or replacement of systems and equipment that could not be
remediated. This stage is 100% complete. The Company has determined a course
of action for remediation or replacement of all critical internal systems. The
Company continues surveying and obtaining information about Year 2000 readiness
of its material third-party relationships. Contingency plans have been
developed for those third parties who cannot satisfactorily demonstrate Year
2000 compliance. The plans are continually refined, updated and tested as
changes in third-party readiness occurs.
The third stage includes the repair, replacement or retirement of systems. This
stage of the Year 2000 process is complete. The Company has upgraded packaged
software throughout the organization. Desktop system upgrades and upgrades of
the communications infrastructure are finished. The main telephone switch and
critical branch office switches have been upgraded where necessary, and upgraded
network operating systems have been loaded into place. The rollout of the Year
2000 compliant version of the BRASS(R) Equity Trading System has also been
completed.
The primary financial system used for financial reporting purposes for the
Company was replaced during fiscal 1998 to prepare for Year 2000 as well as to
derive other benefits from the financial reporting system. Updates to this
system were installed in the second quarter of fiscal 1999 and testing was
completed in the third quarter of fiscal 1999. The financial system itself is
certified by the vendor as Year 2000 compliant.
The Company's primary operational system is the Securities Industry Software
("SIS") application, which provides both front- and back-office services to
Correspondents, customers and our internal users. For several years, the
Company has self-supported the SIS application. The Company has been pursuing a
replacement strategy for SIS and is implementing a new client-server based
information system ("CSS"). CSS is being developed by Comprehensive Software
Systems, Ltd., an entity in which several securities firms own interests,
including the Company, which owns an 8.18% interest.
While replacement of the SIS system with CSS was our primary solution for Year
2000 issues associated with the SIS system, in September 1998 the Company
engaged an independent consulting firm to begin remediation of the SIS system.
As of June 30, 1999, 100% of the code was remediated by the consulting firm,
tested by the Company and installed in the production environment.
<PAGE>
The Company has been working on the CSS project since 1992, as implementation of
this system was in process before the Company began assessment of critical Year
2000 issues. In fiscal 1997, the Company accelerated the pace of the CSS
project so that it would be available as the Year 2000 solution for the SIS
system. Through fiscal 1997 and 1998, costs associated with the joint
venture, including personnel, hardware, software and related costs, were
approximately $4 million. During fiscal 1997 and 1998, the Company incurred an
additional $1 million in costs related to the Year 2000 project primarily
related to compensation and benefits, software upgrades and hardware replacement
for financial and other systems. In fiscal 1999, the Company incurred an
additional $8.4 million in expenses related to the CSS project and other Year
2000 initiatives. Implementation of the CSS system should result in the
reduction of certain existing hardware and software lease, maintenance and
licensing costs.
The Company has incurred approximately $398,000 in Year 2000 related expenses in
the first quarter of fiscal 2000. In the second quarter of fiscal 2000, the
Company expects to incur an additional $400,000 related to Year 2000 project
costs. These costs will be funded out of working capital and substantially all
will be expensed. The budgeted expenditures include compensation and benefits
for IT and other operational staff.
The Company is also heavily dependent upon the power and telecommunications
infrastructure within the United States and would be subject to business
interruptions as a result of the failure of those systems. Additionally, the
Company would experience disruption in certain of its businesses if the various
exchanges, clearing houses or banks used by the Company reported a system
failure. The Company is communicating with these third parties in order to
obtain assurances regarding Year 2000 readiness. The Company's contingency
plans also address potential failure of these systems.
The last stage of the implementation process includes testing all of the changes
implemented individually and integrating those changes with all of the Company's
systems and those of its customers and trading partners. Testing takes on
various forms depending on the type of change implemented. Each upgrade, to the
extent economically feasible, is run through a test environment before it is
implemented. It is then tested to see how well it integrates into the Company's
overall IT environment. The Company has also engaged in point-to-point testing
with various exchanges, clearing houses and utilities and has established a
future date environment for testing the CSS and SIS applications. The Company
participated in the Securities Industry Association's industry-wide testing
which occurred over a series of weekends in March and April 1999 and simulated
the first trading cycle to settle in the Year 2000. The Company successfully
completed each phase of the testing. Additional tests have continued with
vendors not included in the industry-wide test as well as with Correspondent
customers. There were no material unresolved Year 2000 testing exceptions.
The Company has prepared contingency plans that deal with a variety of failures
that could potentially be caused by Year 2000 or other problems. These plans
range from global issues like the loss of a major stock exchange or utility, to
infrastructure issues like the loss of the primary data communications carrier
or regional electrical power supplier, to failures within the Company's
facilities like the loss of an owned telephone switch or the failure of an
internally maintained application. The Company will continue to refine and test
these plans up through the Year 2000 as the various exchanges and utilities
update their plans for different kinds of failures. Testing related to
contingency plans will focus on those failures we assume are more likely to
occur because of incomplete work or inadequate information on the part of
mission critical vendors. As a part of the contingency planning process, the
Company is preparing a formal command center at both the primary and backup
facilities.
Although the Company's mission critical systems are Year 2000 compliant, there
are many factors beyond the Company's control that could have an adverse effect.
The Company continues to work diligently to minimize the potential impact of
such external forces on its Year 2000 readiness.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is incorporated in Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations under
the caption Market Risk.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None Reportable (229.103)
Item 2. Changes in Securities and Use of Proceeds
None Reportable (Per Instructions to Form 10-Q)
Item 3. Defaults upon Senior Securities
None Reportable (Per Instructions to Form 10-Q)
Item 4. Submission of Matters to a Vote of Security Holders
None Reportable (Per Instructions to Form 10-Q)
Item 5. Other Information
None Reportable (Per Instructions to Form 10-Q)
Item 6. Exhibits and Reports on Form 8-K
EXHIBITS
10.1 Executive Compensation
The information required by this item regarding Executive compensation is
incorporated by reference to the definitive Proxy Statement for the Company's
1999 Annual Meeting of Stockholders filed with the Commission pursuant to
Regulation 240.14a (6) (c) within 120 days after the Company's fiscal year end
is incorporated herein by reference.
27 Financial Data Schedule
REPORTS ON FORM 8-K
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Southwest Securities Group, Inc.
--------------------------------
(Registrant)
November 8, 1999 /S/ David Glatstein
- ---------------- -------------------
Date (Signature)
David Glatstein
President and Chief Executive Officer
(Principal Executive Officer)
November 8, 1999 /S/ Stacy M. Hodges
- ---------------- ------------------------
Date (Signature)
Stacy M. Hodges
Treasurer and Chief Financial Officer
(Principal Financial Officer)
November 8, 1999 /S/ Laura Leventhal
- ---------------- -------------------
Date (Signature)
Laura Leventhal
Controller
(Principal Accounting Officer)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUN-26-1999
<PERIOD-END> SEP-24-1999
<CASH> 13,688
<RECEIVABLES> 3,361,283
<SECURITIES-RESALE> 190,164
<SECURITIES-BORROWED> 2,550,447
<INSTRUMENTS-OWNED> 68,819
<PP&E> 11,361
<TOTAL-ASSETS> 3,796,587
<SHORT-TERM> 38,700
<PAYABLES> 3,363,821
<REPOS-SOLD> 0
<SECURITIES-LOANED> 2,541,628
<INSTRUMENTS-SOLD> 19,779
<LONG-TERM> 57,500
0
0
<COMMON> 1,181
<OTHER-SE> 212,548
<TOTAL-LIABILITY-AND-EQUITY> 3,796,587
<TRADING-REVENUE> 4,303
<INTEREST-DIVIDENDS> 44,585
<COMMISSIONS> 15,232
<INVESTMENT-BANKING-REVENUES> 6,786
<FEE-REVENUE> 10,208
<INTEREST-EXPENSE> 31,335
<COMPENSATION> 26,604
<INCOME-PRETAX> 3,793
<INCOME-PRE-EXTRAORDINARY> 3,793
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,492
<EPS-BASIC> .21
<EPS-DILUTED> .21
</TABLE>
