**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(markone)**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|------------|-----------------------------------------------------------------------------------------------|
|       |                                                                                          |
|       | **FOR  THE QUARTERLY PERIOD ENDED JUNE 30, 2003**                                             |
|       |
| **or**     |
|       |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**Commissionfile No. 0-30066**

 

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| **SANDERS  MORRIS HARRIS GROUP INC.**                            |
|------------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)          |
|                                                             |   |   |
| **Texas**                                                        |   | **76-0583569** |
| (State or other jurisdiction of   incorporation or organization) |   | (I.R.S. Employer   Identification No.) |
|                                                             |
|                                                             |   |   |
| **600 Travis, Suite 3100****Houston,  Texas 77002**              |
| (Address of principal  executive office)                         |
|                                                             |   |   |
| **(713) 993-4610**                                               |
| (Registrant’s telephone  number, including area code)       |

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past90 days.    YES   ý            NO   o

 

Indicate by check mark whether registrant is anaccelerated filer (as defined in Rule 12b-2 of the ExchangeAct).    YES    ý            NO   o

 

The number of shares ofthe registrant’s Common Stock, par value $0.01 per share, outstanding as ofAugust 1, 2003, was 17,159,767.

 

 

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**SANDERS MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

 

# **INDEX**

 
| **PART I.**  | **CONDENSED CONSOLIDATED  FINANCIAL INFORMATION** |
|--------------|---------------------------------------------------|
|         |
|         | Item 1.                                           | Financial Statements |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Balance Sheet as of June 30, 2003 (unaudited) and December 31,  2002 |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Income for the Three and Six Months Ended June 30,  2003 and 2002 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Shareholders’ Equity for the Six Months Ended June  30, 2003 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2003  and 2002 (unaudited) |
|         |                                              |   |
|         |                                              | Notes  to Condensed Consolidated Financial Statements (unaudited) |
|         |                                              |   |
|         | Item  2.                                          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|         |                                              |   |
|         | Item  3.                                          | Quantitative  and Qualitative Disclosures About Market Risk |
|         |                                              |   |
|         | Item 4.                                           | Controls and  Procedures |
|         |
| **PART II.** | **OTHER INFORMATION**                             |   |
|         |
|         | Item 1.                                           | Legal Proceedings |
|         |                                              |   |
|         | Item  4.                                          | Submission  of Matters to a Vote of Security Holders |
|         |                                              |   |
|         | Item 6.                                           | Exhibits and  Reports on Form 8-K |
|              |                                                   |  |  |  |

 

1

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**PART I.  FINANCIAL INFORMATION**

**Item 1.  *Financial Statements***

 

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEET**

(in thousands, exceptshare and per share amounts)

 
|                                                                                                                  |   | **June 30,  2003**  |    | **December 31,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|------------------------|------------|
|                                                                                                                  |   | **(unaudited****)** |    |                   | ** ** |
| **ASSETS**                                                                                                            |   |                |    |                   |       |
| Cash and cash  equivalents                                                                                            |   | $                   | 34,431  |                   | $          | 34,890 |   |
| Receivables, net  of allowance of $400 and $295, respectively                                                         |   |                |    |                   |       |
| Broker-dealers                                                                                                        |   | 700                 |    | 641                    |       |
| Customers                                                                                                             |   | 2,972               |    | 2,026                  |       |
| Related parties                                                                                                       |   | 5,843               |    | 4,489                  |       |
| Other                                                                                                                 |   | 406                 |    | 719                    |       |
| Deposits with  clearing brokers                                                                                       |   | 1,003               |    | 1,000                  |       |
| Securities owned                                                                                                      |   | 20,474              |    | 16,995                 |       |
| Securities  available for sale                                                                                        |   | 2,692               |    | 3,064                  |       |
| Furniture and  equipment, net                                                                                         |   | 3,944               |    | 4,021                  |       |
| Deferred income  taxes                                                                                                |   | 76                  |    | 638                    |       |
| Other assets                                                                                                          |   | 2,086               |    | 1,167                  |       |
| Goodwill, net of  accumulated amortization of $4,268                                                                  |   | 49,399              |    | 47,673                 |       |
| Total assets                                                                                                          |   | $                   | 124,026 |                   | $          | 117,323 |   |
|                                                                                                                  |   |                |    |                   |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                        |   |                |    |                   |       |
|                                                                                                                  |   |                |    |                   |       |
| Liabilities:                                                                                                          |   |                |    |                   |       |
| Accounts payable  and accrued liabilities                                                                             |   | $                   | 14,683  |                   | $          | 15,308 |   |
| Securities sold,  not yet purchased                                                                                   |   | 276                 |    | 93                     |       |
| Other  liabilities                                                                                                    |   | 215                 |    | 190                    |       |
| Total  liabilities                                                                                                    |   | 15,174              |    | 15,591                 |       |
|                                                                                                                  |   |                |    |                   |       |
| Commitments and  contingencies                                                                                        |   |                |    |                   |       |
|                                                                                                                  |   |                |    |                   |       |
| Minority  interests                                                                                                   |   | 204                 |    | 421                    |       |
|                                                                                                                  |   |                |    |                   |       |
| Shareholders’  equity:                                                                                           |   |                |    |                   |       |
| Preferred stock,  $0.10 par value; 10,000,000 shares authorized; no shares issued and  outstanding                    |   | —              |    | —                 |       |
| Common stock,  $0.01 par value; 100,000,000 shares authorized; 17,882,270 and 17,439,743  shares issued, respectively |   | 179                 |    | 174                    |       |
| Additional  paid-in capital                                                                                           |   | 112,711             |    | 109,959                |       |
| Receivables for  shares issued                                                                                        |   | (1,050              | )       | (705                   | )          |
| Retained  earnings (accumulated deficit)                                                                              |   | 1,217               |    | (3,367                 | )          |
| Accumulated  other comprehensive loss                                                                                 |   | (158                | )       | (243                   | )          |
| Unearned  compensation                                                                                                |   | (968                | )       | (1,392                 | )          |
| Treasury stock  at cost, 722,503 and 702,849 shares, respectively                                                     |   | (3,283              | )       | (3,115                 | )          |
| Total  shareholders’ equity                                                                                      |   | 108,648             |    | 101,311                |       |
| Total  liabilities and shareholders’ equity                                                                      |   | $                   | 124,026 |                   | $          | 117,323 |   |

 

The accompanying notes are an integral part of thecondensed consolidated financial statements.

 

2

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF****INCOME**

(in thousands, exceptshare and per share amounts)

(unaudited)

 
|                                                                                         |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                         |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
| Revenues:                                                                                    |   |                              |   |                            |   |   |   |   |   |
| Commissions                                                                                  |   | $                                 | 13,321 |                            | $      | 11,372 |   | $ | 25,633 |   | $ | 21,032 |   |
| Principal  transactions                                                                      |   | 3,939                             |   | 612                             |   | 5,949 |   | 5,395 |   |
| Investment  banking                                                                          |   | 6,797                             |   | 4,087                           |   | 10,201 |   | 7,763 |   |
| Fiduciary,  custodial and advisory fees                                                      |   | 2,527                             |   | 1,927                           |   | 4,281 |   | 3,640 |   |
| Interest and  dividends                                                                      |   | 684                               |   | 461                             |   | 1,209 |   | 887 |   |
| Other income                                                                                 |   | 351                               |   | 750                             |   | 1,277 |   | 1,315 |   |
| Total revenues                                                                               |   | 27,619                            |   | 19,209                          |   | 48,550 |   | 40,032 |   |
|                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Expenses:                                                                                    |   |                              |   |                            |   |   |   |   |   |
| Employee  compensation and benefits                                                          |   | 16,714                            |   | 12,463                          |   | 30,429 |   | 25,885 |   |
| Floor brokerage,  exchange and clearance fees                                                |   | 1,470                             |   | 1,064                           |   | 2,900 |   | 1,987 |   |
| Communications  and data processing                                                          |   | 1,408                             |   | 900                             |   | 2,738 |   | 1,905 |   |
| Occupancy                                                                                    |   | 1,635                             |   | 1,152                           |   | 2,882 |   | 2,198 |   |
| Other general  and administrative                                                            |   | 2,592                             |   | 2,046                           |   | 4,652 |   | 3,949 |   |
| Total expenses                                                                               |   | 23,819                            |   | 17,625                          |   | 43,601 |   | 35,924 |   |
|                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Income before  equity in income of limited partnerships, income taxes and minority interests |   | 3,800                             |   | 1,584                           |   | 4,949 |   | 4,108 |   |
| Equity in income  of limited partnerships                                                    |   | 1,985                             |   | 193                             |   | 2,853 |   | 817 |   |
|                                                                                         |   | 5,785                             |   | 1,777                           |   | 7,802 |   | 4,925 |   |
| Provision for  income taxes                                                                  |   | (2,365                            | )      | (670                            | )      | (3,194 | ) | (1,832 | ) |
| Minority  interests in net income of consolidated companies                                  |   | (25                               | )      | (7                              | )      | (24 | ) | (23 | ) |
|                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Net income                                                                                   |   | $                                 | 3,395  |                            | $      | 1,100 |   | $ | 4,584 |   | $ | 3,070 |   |
|                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Earnings per  share:                                                                         |   |                              |   |                            |   |   |   |   |   |
| Basic                                                                                        |   | $                                 | 0.20   |                            | $      | 0.07 |   | $ | 0.27 |   | $ | 0.19 |   |
| Diluted                                                                                      |   | $                                 | 0.19   |                            | $      | 0.07 |   | $ | 0.26 |   | $ | 0.18 |   |
|                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Weighted average  common shares outstanding:                                                 |   |                              |   |                            |   |   |   |   |   |
| Basic                                                                                        |   | 17,115,147                        |   | 16,613,928                      |   | 16,981,008 |   | 16,541,655 |   |
| Diluted                                                                                      |   | 17,641,257                        |   | 16,886,188                      |   | 17,526,008 |   | 16,748,502 |   |

 

The accompanying notes are an integral part of the condensedconsolidated financial statements.

 

3

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY**

**For thesix months ended June 30, 2003**

(in thousands, exceptshares)

(unaudited)

 
|                                                                    |   | **Amounts** |        |       |   | **Shares** |           |
|-------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|------------|----------------|
|                                                                    |   |        |        |       |   |       |           |
| **Common  stock**                                                       |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | 174         |       |   |       | 17,439,743     |   |
| Stock issued  pursuant to employee benefit plan                         |   | 5           |        |       |   | 442,527    |           |
| Balance, end of  period                                                 |   | 179         |        |       |   | 17,882,270 |           |
| **Additional  paid-in capital**                                         |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | 109,959     |       |   |       |           |   |
| Stock issued  pursuant to employee benefit plan                         |   | 3,788       |        |       |   |       |           |
| Dividends                                                               |   | (1,036      | )           |       |   |       |           |
| Balance, end of  period                                                 |   | 112,711     |        |       |   |       |           |
| **Receivables  for shares issued**                                      |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (705        | )          |   |       |           |   |
| Issuance of  restricted stock                                           |   | (729        | )           |       |   |       |           |
| Amortization of  notes receivable                                       |   | 384         |        |       |   |       |           |
| Balance, end of  period                                                 |   | (1,050      | )           |       |   |       |           |
| **Retained  earnings (accumulated deficit)**                            |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (3,367      | )          |   |       |           |   |
| Net income                                                              |   | 4,584       |        | 4,584      |   |       |           |
| Balance, end of  period                                                 |   | 1,217       |        | 4,584      |   |       |           |
| **Accumulated  other comprehensive loss**                               |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (243        | )          |   |       |           |   |
| Net change in  unrealized depreciation on securities available for sale |   | 135         |        | 135        |   |       |           |
| Income tax  benefit on change                                           |   | (50         | )           | (50        | )      |       |           |
| Balance, end of  period                                                 |   | (158        | )           | 85         |   |       |           |
| **Comprehensive  income**                                               |   |        |        | 4,669      |   |       |           |
| **Unearned  compensation**                                              |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (1,392      | )          |   |       |           |   |
| Net issuance of  restricted stock                                       |   | (57         | )           |       |   |       |           |
| Amortization of  unearned compensation                                  |   | 481         |        |       |   |       |           |
| Balance, end of  period                                                 |   | (968        | )           |       |   |       |           |
| **Treasury  stock**                                                     |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (3,115      | )          |   |       | (702,849       | ) |
| Acquisition of  treasury stock                                          |   | (168        | )           |       |   | (19,654    | )              |
|                                                                    |   |        |        |       |   |       |           |
| Balance, end of  period                                                 |   | (3,283      | )           |       |   | (722,503   | )              |
| **Total  shareholders’ equity and common shares outstanding**      |   | **$**       | **108,648** | ** ** |   |       | **17,159,767** | ** ** |

 

4

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF CASH FLOWS**

**For thesix months ended June 30, 2003 and 2002**

(in thousands)

(unaudited)

 
|                                                                                         |                                                   | **2003** |       | **2002** |       |
|----------------------------------------------------------------------------------------------|--------------------------------------------------------|----------|------------|----------|------------|
|                                                                                         |                                                   |     | ** ** |     | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                       |                                                   |     |       |     |       |
| Net income                                                                                   |                                                   | $        | 4,584      |     | $          | 3,070 |   |
| Adjustments to  reconcile net income to net cash (used in) provided by operating activities: |                                                   |     |       |     |       |
| Realized gain on  securities available for sale                                              |                                                   | (9       | )          | (21      | )          |
| Depreciation                                                                                 |                                                   | 567      |       | 399      |       |
| Provision for  bad debts                                                                     |                                                   | 160      |       | 180      |       |
| Compensation  expense related to amortization of notes receivable and unearned compensation  |                                                   | 864      |       | 522      |       |
| Deferred income  taxes                                                                       |                                                   | 512      |       | 161      |       |
| Minority  interests in income of consolidated companies                                      |                                                   | 24       |       | 23       |       |
| Changes in  operating assets and liabilities:                                                |                                                   |     |       |     |       |
| Increase in  receivables                                                                     |                                                   | (2,040   | )          | (632     | )          |
| Increase in  securities owned                                                                |                                                   | (3,479   | )          | (744     | )          |
| Increase in  other assets                                                                    |           | (965     | )          | (417     | )          |
| Increase  (decrease) in securities sold, not yet purchased                                   |                                                   | 183      |       | (27      | )          |
| Increase  (decrease) in other liabilities                                                    |                                                   | 25       |       | (46      | )          |
| Increase  (decrease) in accounts payable and accrued liabilities                             |                                                   | (476     | )          | 984      |       |
| Net cash (used  in) provided by operating activities                                         |                                                   | (50      | )          | 3,452    |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                       |                                                   |     |       |     |       |
| Capital  expenditures                                                                        |                                                   | (460     | )          | (1,563   | )          |
| Acquisition, net  of cash acquired of $142 and $0, respectively                              |                                                   | (1,608   | )          | —   |       |
| Purchase of  securities available for sale                                                   |                                                   | (784     |  )    | (2,307   | )          |
| Proceeds from  sales and maturities of securities available for sale                         |                                                   | 1,302    |       | 431      |       |
| Net cash used in  investing activities                                                       |                                                   | (1,550   | )          | (3,439   | )          |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                       |                                                   |     |       |     |       |
| Purchase of  treasury stock                                                                  |                                                   | (168     | )          | (582     | )          |
| Collection of  receivable for shares issued                                                  |                                                   | —   |       | 48       |       |
| Proceeds from  shares issued                                                                 |                                                   | 2,130    |       | 777      |       |
| Investment by  minority interest                                                             |                                                   | 38       |       | 50       |       |
| Distributions to  minority interests                                                         |                                                   | (344     | )          | —   |       |
| Payments of cash  dividends                                                                  |                                                   | (515     | )          | (419     | )          |
| Net cash (used  in) provided by financing activities                                         |                                                   | 1,141    |       | (126     | )          |
| Net decrease in  cash and cash equivalents                                                   |                                                   | (459     | )          | (113     | )          |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                            |                                                   | 34,890   |       | 30,410   |       |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                                  |                                                   | $        | 34,431     |     | $          | 30,297 |   |
|                                                                                         |                                                   |     |       |     |       |
| Noncash  investing and financing activities:                                                 |                                                   |     |       |     |       |
| Cash paid for  income taxes                                                                  |                                                   | $        | 1,514      |     | $          | 1,665 |   |

 

The accompanying notes are an integral part of the condensedconsolidated financial statements.

 

5

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**Sanders Morris Harris Group Inc. andSubsidiaries**

**Notes to Condensed ConsolidatedFinancial Statements**

**(unaudited)**

 

### **1.**              BASIS OFPRESENTATION

 

###### *Nature ofOperations*

 

Through its operating subsidiaries Salient CapitalManagement (“Salient/PMT”), Sanders Morris Harris Inc. (“SMH”) and SMH CapitalAdvisors (“SMCA”), the Company provides a broad range of financial services,including institutional, prime and retail brokerage, investment banking, otherinvestment banking services,  merchantbanking, financial advisory, trust related services, investment management andfinancial planning. The Company serves a diverse group of institutional,corporate and individual clients.

 

The Company merged with and acquired its operatingsubsidiaries in 2003, 2001, 2000 and 1999. The acquisitions were accounted for using the purchase method.  All of the operating subsidiaries are 100%owned, (either directly or indirectly) by the Company, except Salient/PMT whichis 50% owned by the Company.

 

###### *Consolidation*

 

The unaudited condensed consolidated financialstatements of the Company include the accounts of its wholly owned subsidiaries.All material intercompany transactions and balances have been eliminated inconsolidation.

 

In management’s opinion, the unaudited condensedconsolidated financial statements include all adjustments necessary for a fairpresentation of our consolidated financial position at June 30, 2003, ourresults of operations for the three and six months ended June 30, 2003 and2002, and our cash flows for the six months ended June 30, 2003 and 2002.  All adjustments are of a normal recurringnature. Interim results are not necessarily indicative of results for a fullyear.

 

These consolidated financial statements and notesshould be read in conjunction with the Company’s annual report on Form 10-K forthe year ended December 31, 2002.

 

###### *Effects ofRecently Issued Accounting Standards*

 

In January 2003, the FASB issued Interpretation No.46, *Consolidation of Variable InterestEntities, an interpretation of ARB No. 51. *This Interpretation addresses the consolidation by businessenterprises of variable interest entities as defined in theInterpretation.  The Interpretationapplies immediately to variable interests in variable interest entities createdafter January 31, 2003, and to variable interests in variable interest entitiesobtained after January 31, 2003.  Forpublic enterprises, such as the Company, with a variable interest in a variableinterest entity created before February 1, 2003, the Interpretation is appliedto the enterprise no later than the beginning of the first annual or interimreporting period beginning after June 15, 2003.  The application of this Interpretation is not expected to have amaterial effect on the Company’s consolidated financial statements.  The Interpretation requires certaindisclosures in financial statements issued after January 31, 2003 if it isreasonably possible that the Company will consolidate or disclose informationabout variable interest entities when the Interpretation becomeseffective.  The Company has identifiedone entity that would require consolidation under this Interpretation.  The Company expects consolidation of thisentity to increase the Company’s assets and liabilities by approximately$100,000 and have an insignificant affect on other basic consolidated financialstatements.

 

###### *Compensation*

 

Statement of Financial Accounting Standards (SFAS) No.148, *Accounting for Stock-Based Compensation– Transition and Disclosure – an Amendment to FASB Statement No. 123,*wasissued in December 2002.  SFAS No. 148amends SFAS No. 123, *Accounting forStock-Based Compensation,*to provide alternative methods fortransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, SFAS No 148 amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financialstatements about the 

 

6

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method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results.  The Companyhas adopted the disclosure provisions included on SFAS No. 148 in the notes tothe consolidated financial statements contained herein.

 

The Company applies the intrinsic value-based methodof accounting prescribed by Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees,*andrelated interpretations including FASB Interpretation No. 44, *Accounting for Certain Transactions involving StockCompensation an Interpretation of APB Opinion No. 25,*issued inMarch 2000, to account for its fixed plan stock options.  Under this method, compensation expense isrecorded on the date of grant only if the current market price of theunderlying stock exceeded the exercise price.

 

The following table illustrates the effect on netincome as if the Company had applied the fair value recognition provisions ofSFAS No. 123 as amended by SFAS No. 148:

 
|                                                                                                                                                |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                                                                                |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Net income as  reported                                                                                                                             |   | $                                | 3,395  |                           | $      | 1,100 |   | $ | 4,584 |   | $ | 3,070 |   |
| Deduct:  Total stock based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |   | (36                              | )      | (334                           | )      | (86 | ) | (471 | ) |
| Pro forma net  income                                                                                                                               |   | $                                | 3,359  |                           | $      | 766 |   | $ | 4,498 |   | $ | 2,599 |   |
|                                                                                                                                                |   |                             |   |                           |   |   |   |   |   |
| Earnings per  share                                                                                                                                 |   |                             |   |                           |   |   |   |   |   |
| Basic-as  reported                                                                                                                                  |   | $                                | 0.20   |                           | $      | 0.07 |   | $ | 0.27 |   | $ | 0.19 |   |
| Basic-pro forma                                                                                                                                     |   | $                                | 0.20   |                           | $      | 0.05 |   | $ | 0.26 |   | $ | 0.16 |   |
|                                                                                                                                                |   |                             |   |                           |   |   |   |   |   |
| Diluted-as  reported                                                                                                                                |   | $                                | 0.19   |                           | $      | 0.07 |   | $ | 0.26 |   | $ | 0.18 |   |
| Diluted-pro  forma                                                                                                                                  |   | $                                | 0.19   |                           | $      | 0.05 |   | $ | 0.26 |   | $ | 0.16 |   |

 

*Reclassifications*

 

Certain reclassificationshave been made to the 2002 condensed consolidated financial statements toconform them with the 2003 presentation.   The reclassifications had noeffect on retained earnings (accumulated deficit), results of operations orcash flows as previouslyreported.

 

### **2.**              ACQUISITIONS

 

On May 2, 2003,the Company acquired a 50% ownership interest in the Salient companies.  Additionally, the Company acquired a 23.15%profits interest in The Endowment Fund, a related entity.  The former owners of Salient and TheEndowment Fund received cash payments totaling $1.75 million and may laterreceive an additional $250,000 cash payment and up to 1,200,000 commonshares.   The Salient companies and PinnacleManagement & Trust Company (“PMT”) were contributed to Salient CapitalManagement (“Salient/PMT”), which entity’s Class A limited partner units arejointly owned by the Company and the former owners of Salient.  Additionally, the Company received Class Blimited partner units of Salient/PMT, which in the event of a liquidation orsale of Salient/PMT entitle the Company to first receive proceeds equal to thenet asset value of PMT as of May 2, 2003, (approximately $4.4 million) with theremaining proceeds to be divided equally among the owners of the Class Aunits.  The Salient companies provideinvestment advisory services to individuals and institutions.  The Endowment Fund is a diversified fund offunds using hedge fund managers that specialize in a variety of investmentapproaches.  The acquisitions wereaccounted as a 

 

7

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purchase, andaccordingly, the financial information of the Salient companies and TheEndowment Fund has been included in the Company’s consolidated financialstatements from May 2, 2003.  Thepurchase price of approximately $1.8 million exceeded the fair market value ofidentifiable net assets by approximately $1.7 million, which has been recordedas goodwill.  The Company uses theconsolidation method to account for its investment in Salient/PMT.

 

### **3.**              SECURITIES OWNED AND SECURITIES SOLD, NOTYET PURCHASED

 

Securities owned and securities sold, not yetpurchased as of June 30, 2003 were as follows:

 
|                                                |   | **Owned**          |       | **Sold, Not Yet  Purchased** |   |
|-----------------------------------------------------|--------|--------------------|------------|------------------------------|--------|
|                                                |   | **(in thousands)** | ** ** |
| Marketable:                                         |   |               |       |                         |   |
| Corporate stocks  (cost $222)                       |   | $                  | 185        |                         | $      | 276 |   |
| Corporate bonds  and commercial paper (cost $1,593) |   | 1,832              |       | —                       |   |
|                                                |   | 2,017              |       | 276                          |   |
| Not readily  marketable:                            |   |               |       |                         |   |
| Partnerships  (cost $5,433)                         |   | 12,197             |       | —                       |   |
| Corporate stocks  and warrants (cost $5,976)        |   | 6,260              |       | —                       |   |
|                                                |   | $                  | 20,474     |                         | $      | 276 |   |

 

Securities not readily marketable include investmentsecurities (a) for which there is no market on a securities exchange or noindependent publicly quoted market, (b) that cannot be publicly offered or soldunless registration has been effected under the Securities Act of 1933, or (c)that cannot be offered or sold because of other arrangements, restrictions, orconditions applicable to the securities or to the Company.  Not readily marketable securities consist ofinvestments in limited partnerships, equities, options and warrants.  The investments in limited partnerships areaccounted for using the equity method, which approximates fair value, andprincipally consist of Environmental Opportunities Fund, L.P., EnvironmentalOpportunities Fund II, L.P., Environmental Opportunities Fund II(Institutional), L.P., Corporate Opportunities Fund, L.P., CorporateOpportunities Fund (Institutional), L.P., Sanders Opportunity Fund, L.P.,Sanders Opportunity Fund (Institutional), L.P., Tactical Opportunities HighYield Fund, L.P., and Life Sciences Opportunity Fund, L.P., and Life SciencesOpportunity Fund (Institutional), L.P.

 

### **4.**              SECURITIES AVAILABLE FOR SALE

 

Securities available for sale at June 30, 2003 were asfollows:

 
|                                    |   | **Amortized******  |       | **Gross Unrealized** |   | **Estimated****** |   |
|-----------------------------------------|--------|--------------------|------------|----------------------|--------|-------------------|--------|
|                                    |   | **Cost**           |       | **Gains**            |   | **Losses**        |   | **Fair Value** |   |
|                                    |   | **(in thousands)** | ** ** |
|                                    |   |               |       |                 |   |              |   |   |   |
| U.S. Government  and agency obligations |   | $                  | 1,301      |                 | $      | 19                |   | — |   | $ | 1,320 |   |
| Marketable  equity securities           |   | 1,641              |       | 11                   |   | (280              | )      | 1,372 |   |
| Total                                   |   | $                  | 2,942      |                 | $      | 30                |   | $ | (280 | ) | $ | 2,692 |   |
|                                         |        |                    |            |                      |        |                   |        |  |  |  |  |  |  |

 

8

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The contractual maturities of debt securities available for sale atJune 30, 2003, were as follows:

 
| Due before 5  years |   | $ | 1,320 |   |
|---------------------|--------|---|-------|--------|

 

Gross gains on sales of securities available for salewere $24,000 for the six months ended June 30, 2002 and $36,000 for the sixmonths ended June 30, 2003.  Grossrealized losses on securities available for sale were  $3,000 for the six months ended June 30, 2002 and $27,000 for thesix months ended June 30, 2003.

 

### **5.**              INCOME TAXES

 

The differences between the effective tax ratereflected in the income tax provision from operations and the statutory federalrate were as follows:

 
|                                   |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |       |
|----------------------------------------|--------|----------------------------------|--------|--------------------------------|------------|
|                                   |   | **2003**                         |   | **2002**                       |       | **2003** |   | **2002** |   |
|                                   |   | **(in thousands********)**       |   | **(in thousands****)**         | ** ** |
|                                   |   |                             |   |                           |       |   |   |   |   |
| Tax computed  using the statutory rate |   | $                                | 1,958  |                           | $          | 602 |   | $ | 2,645 |   | $ | 1,667 |   |
| State income  taxes and other          |   | 407                              |   | 68                             |       | 549 |   | 165 |   |
| Total                                  |   | $                                | 2,365  |                           | $          | 670 |   | $ | 3,194 |   | $ | 1,832 |   |

### ** **

### **6.**              COMMITMENTS AND CONTINGENCIES

 

There were no firm underwriting commitments open atJune 30, 2003.

 

The Company and its subsidiaries have obligationsunder operating leases that expire by 2012 with initial noncancelable terms inexcess of one year.

 

The Company is a party to various legal proceedingsthat are of an ordinary or routine nature incidental to its operations.  The Company believes it has adequatelyreserved for such litigation matters and that they will not have a materialadverse effect on the Company’s consolidated financial position, results ofoperations, or cash flows.

 

The Company has uncommitted financing arrangementswith clearing brokers who finance customer accounts, certain broker-dealerbalances and firm trading positions. Although these customer accounts and broker-dealer balances are notreflected on the consolidated balance sheet for financial accounting andreporting purposes, the Company has generally agreed to indemnify theseclearing brokers for losses they may sustain in connection with the accounts,and therefore, retains risk on these accounts. The Company is required to maintain certain cash or securities ondeposit with its clearing brokers.

 

9

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### **7.**              EARNINGS PER COMMONSHARE

 

Basic and diluted earnings per-share computations forthe periods indicated were as follows:

 
|                                                                                          |   | **Three Months Ended June 30,**                                |       |
|-----------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------|------------|
|                                                                                          |   | **2003**                                                       |       | **2002** |   |
|                                                                                          |   | **(in thousands, except share and per share amounts********)** | ** ** |
| Computation of  basic and diluted income per common share for the three months ended June 30: |   |                                                           |       |   |   |
| Net income                                                                                    |   | $                                                              | 3,395      |   | $ | 1,100 |   |
| Weighted average  number of common shares outstanding                                         |   | 17,115,147                                                     |       | 16,613,928 |   |
| Common shares  issuable under stock option plan                                               |   | 1,079,830                                                      |       | 1,389,473 |   |
| Less shares  assumed repurchased with proceeds                                                |   | (553,720                                                       | )          | (1,117,213 | ) |
| Weighted average  common shares outstanding                                                   |   | 17,641,257                                                     |       | 16,886,188 |   |
| Basic income per  common share                                                                |   | $                                                              | 0.20       |   | $ | 0.07 |   |
| Diluted income  per common share                                                              |   | $                                                              | 0.19       |   | $ | 0.07 |   |

 
|                                                                                        |   | **Six Months Ended June 30,**                                  |       |
|---------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------|------------|
|                                                                                        |   | **2003**                                                       |       | **2002** |   |
|                                                                                        |   | **(in thousands, except share and per share amounts********)** | ** ** |
| Computation of  basic and diluted income per common share for the six months ended June 30: |   |                                                           |       |   |   |
| Net income                                                                                  |   | $                                                              | 4,584      |   | $ | 3,070 |   |
| Weighted average  number of common shares outstanding                                       |   | 16,981,008                                                     |       | 16,541,655 |   |
| Common shares  issuable under stock option plan                                             |   | 1,079,831                                                      |       | 1,254,473 |   |
| Less shares  assumed repurchased with proceeds                                              |   | (534,831                                                       | )          | (1,047,626 | ) |
| Weighted average  common shares outstanding                                                 |   | 17,526,008                                                     |       | 16,748,502 |   |
| Basic income per  common share                                                              |   | $                                                              | 0.27       |   | $ | 0.19 |   |
| Diluted income  per common share                                                            |   | $                                                              | 0.26       |   | $ | 0.18 |   |

 

Outstanding stock options (50,000 for the three monthsended June 30, 2003; 50,000 for the six months ended June 30, 2003; 50,000 forthe three months ended June 30, 2002; and 185,000 for the six months ended June30, 2002) have not been included in diluted earnings per common share becausetheir inclusion would have been antidilutive for the periods presented.

 

10

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### **8.**              BUSINESS SEGMENTINFORMATION

 

The Company’s businesses operate in two reportablebusiness segments.  The Company’sinvestment banking and brokerage segment includes the operations of SMH.  SMH is an investment banking and brokeragefirm whose activities primarily include securities underwriting,  other investment banking services, privateplacements, and institutional, prime and retail brokerage.  The Company’s investment management segmentincludes the operations of Salient/PMT and SMCA.   Salient/PMT is a state chartered trust company which providesinvestment advisory, investment management, and a variety of trust services toindividuals, trusts and institutions. SMCA provides financial planning services to individuals and assetmanagement services to investors with an emphasis on fixed incomesecurities.  The following summarizescertain financial information of each reportable segment for the three, and sixmonths ended June 30, 2003 and 2002, respectively.  

 
| (in  thousands)                                                                                      |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |    |
|------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|---------|
| **Three  Months Ended June 30, 2003**                                                                |   |                                   |   |                       |   |                     |   |                    |    |
| Revenues                                                                                             |   | $                                      | 25,410 |                       | $      | 2,062                    |   | $                       | 147     |   | $ | 27,619 |   |
| Expenses                                                                                             |   | (21,753                                | )      | (1,537                     | )      | (529                     | )      | (23,819                 | )       |
| Income (loss)  before equity in income of limited partnerships, income taxes and minority  interests |   | 3,657                                  |   | 525                        |   | (382                     | )      | 3,800                   |    |
| Equity in income  of limited partnerships                                                            |   | 1,783                                  |   | —                     |   | 202                      |   | 1,985                   |    |
| Income (loss)  before income taxes and minority interests                                            |   | $                                      | 5,440  |                       | $      | 525                      |   | $                       | (180    | ) | $ | 5,785 |   |
|                                                                                                 |   |                                   |   |                       |   |                     |   |                    |    |
| **Three  Months Ended June 30, 2002**                                                                |   |                                   |   |                       |   |                     |   |                    |    |
| Revenues                                                                                             |   | $                                      | 17,620 |                       | $      | 1,585                    |   | $                       | 4       |   | $ | 19,209 |   |
| Expenses                                                                                             |   | (15,797                                | )      | (1,298                     | )      | (530                     | )      | (17,625                 | )       |
| Income (loss)  before equity in income of limited partnerships, income taxes and minority  interests |   | 1,823                                  |   | 287                        |   | (526                     | )      | 1,584                   |    |
| Equity in income  (loss) of limited partnerships                                                     |   | 198                                    |   | —                     |   | (5                       | )      | 193                     |    |
| Income (loss)  before income taxes and minority interests                                            |   | $                                      | 2,021  |                       | $      | 287                      |   | $                       | (531    | ) | $ | 1,777 |   |
|                                                                                                 |   |                                   |   |                       |   |                     |   |                    |    |
| **Six  Months Ended June 30, 2003**                                                                  |   |                                   |   |                       |   |                     |   |                    |    |
| Revenues                                                                                             |   | $                                      | 44,764 |                       | $      | 3,473                    |   | $                       | 313     |   | $ | 48,550 |   |
| Expenses                                                                                             |   | (39,898                                | )      | (2,851                     | )      | (852                     | )      | (43,601                 | )       |
| Income (loss)  before equity in income of limited partnerships, income taxes and minority  interests |   | 4,866                                  |   | 622                        |   | (539                     | )      | 4,949                   |    |
| Equity in income  of limited partnerships                                                            |   | 2,557                                  |   | —                     |   | 296                      |   | 2,853                   |    |
| Income (loss)  before income taxes and minority interests                                            |   | $                                      | 7,423  |                       | $      | 622                      |   | $                       | (243    | ) | $ | 7,802 |   |
|                                                                                                 |   |                                   |   |                       |   |                     |   |                    |    |
| **Six  Months Ended June 30, 2002**                                                                  |   |                                   |   |                       |   |                     |   |                    |    |
| Revenues                                                                                             |   | $                                      | 37,118 |                       | $      | 2,894                    |   | $                       | 20      |   | $ | 40,032 |   |
| Expenses                                                                                             |   | (32,287                                | )      | (2,422                     | )      | (1,215                   | )      | (35,924                 | )       |
| Income (loss)  before equity in income of limited partnerships, income taxes and minority  interests |   | 4,831                                  |   | 472                        |   | (1,195                   | )      | 4,108                   |    |
| Equity in income  of limited partnerships                                                            |   | 745                                    |   | —                     |   | 72                       |   | 817                     |    |
| Income (loss)  before income taxes and minority interests                                            |   | $                                      | 5,576  |                       | $      | 472                      |   | $                       | (1,123) |   | $ | 4,925 |   |

 
| (in  thousands)                       |   | **Investment  Banking and  Brokerage** | ** ** | **Investment********Management** | ** ** | **Corporate  and Other** | ** ** | **Consolidated********Total** | ** ** |
|---------------------------------------|--------|----------------------------------------|------------|----------------------------------|------------|--------------------------|------------|-------------------------------|------------|
| Total assets as  of June 30, 2003     |   | $                                      | 86,200     |                             | $          | 7,243                    |       | $                             | 30,583     |   | $ | 124,026 |   |
| Total assets as  of December 31, 2002 |   | $                                      | 80,614     |                             | $          | 6,701                    |       | $                             | 30,008     |   | $ | 117,323 |   |

 

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### **9.**              EMPLOYEE BENEFITPLANS

 

Under its 1998 Incentive Plan, as amended, the Companyhas reserved 25% of the issued and outstanding Common Stock of the Company, or4,000,000 shares of Common Stock, whichever is greater, for the purpose ofissuing incentive awards under the Incentive Plan.  The Company had 1,560,126 shares of Common Stock available forgrant under the Incentive Plan at June 30, 2003.

 

**Stock Options**

 

The Incentive Plan provides for the issuance toeligible employees of, among other things, incentive and non-qualified stockoptions, that may expire up to 10 years from the date of grant.   The outstanding options vest over varyingperiods and have an exercise price equal to the closing price of the Company’sstock on the date of the grant.

 

**Restricted and Capital Incentive Plan(“CIP”)**

 

Effective January 2, 2001, the Company adopted the CIPunder its Incentive Plan in which eligible employees may purchase shares of theCompany’s restricted common stock at a discount of up to 33 1/3 % of the 20-dayaverage of the closing sales prices for a share of the Company’s common stock,ending on the day prior to the date the shares are issued.  The CIP was amended effective November 1,2001 to include eligible consultants as potential participants under theprogram.

 

All shares issued are valued at the closing price onthe date the shares are issued. Consideration paid through the deferral of salaries, commissions, ordiscretionary bonuses is recorded as compensation expense on the date theshares are issued.  The differencebetween the value of the shares issued and the consideration paid is recordedas unearned compensation and is shown as a separate component of shareholders’equity.  Additionally, shares are issuedunder the Incentive Plan in conjunction with notes receivable, which are alsoshown as a separate component of shareholders’ equity. Unearned compensationand the notes receivable are amortized to compensation expense over thethree-year vesting periods.

 

The following summarizes certain information relatedto the CIP for the three and six months ended June 30, 2003 and 2002.

 
|                                   |   | **Three Months Ended  June 30,**  |   | **Six Months Ended  June 30,**    |   |
|----------------------------------------|--------|-----------------------------------|--------|-----------------------------------|--------|
|                                   |   | **2003**                          |   | **2002**                          |   | **2003** |   | **2002** |   |
|                                   |   | **(in thousands, except shares)** |   | **(in thousands, except shares)** |   |
|                                   |   |                              |   |                              |   |   |   |   |   |
| Number of shares  issued               |   | 24,125                            |   | 102,799                           |   | 92,778 |   | 331,824 |   |
| Value of shares  issued                |   | $                                 | 236    |                              | $      | 640 |   | $ | 785 |   | $ | 1,829 |   |
| Additions to unearned  compensation    |   | 22                                |   | 107                               |   | 57 |   | 714 |   |
| Additions to  notes receivable         |   | 213                               |   | 284                               |   | 729 |   | 518 |   |
| Amortization of  unearned compensation |   | 275                               |   | 180                               |   | 481 |   | 289 |   |
| Amortization of notes receivables      |   | 175                               |   | 136                               |   | 384 |   | 233 |   |
|                                        |        |                                   |        |                                   |        |  |  |  |  |  |  |  |  |

 

### **10.**       RELATED PARTIES

 

The Company had receivables from related partiestotaling $5.8 million at June 30, 2003, consisting primarily of $1.6 million ofunpaid management fees earned on the Company’s investments in limitedpartnerships and $3.4 million of notes receivable from employees andconsultants.

 

12

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**Item 2.**  **  *Management’sDiscussion and Analysis of Financial Condition and Results of Operations***

 

The following discussion should be read in conjunctionwith the Condensed Consolidated Financial Statements and their related notes.

 

**General**

 

We provide diversified financial services through oursubsidiaries, including institutional, prime and retail brokerage, investmentbanking, merchant banking, financial advisory, trust related services,investment management and financial planning. All of these activities arehighly competitive and are sensitive to many factors outside our control,including those factors listed under “Factors Affecting Forward-LookingStatements.”

 

We closely monitor our operating environment to enableus to respond promptly to market cycles. In addition, we seek to lessenearnings volatility by controlling expenses, increasing fee-based business anddeveloping new revenue sources. Nonetheless, operating results for any specificperiod should not be considered representative of future performance.

 

**Components of Revenues and Expenses**

 

*Revenues*.      Ourrevenues are comprised primarily of (1) commission revenue from retail, primeand institutional brokerage transactions, (2) fees from asset-based advisoryservices, (3) principal and agent transactions, (4) investment banking revenuefrom corporate finance fees, public and private offerings, mergers andacquisitions, merchant banking and (5) fees from asset management, financialplanning and fiduciary services.  Wealso earn interest on the cash held and dividends received from the equitysecurities held by us for our corporate capital accounts and have realized andunrealized gains (or losses) on securities in our inventory account.  Interest income results from interest earnedon our inventories of fixed income securities prior to sale, and from interestand dividends earned on investments in our capital accounts.

 

*Expenses.*      Ourexpenses consist of (1) employee compensation and benefits, (2) brokerage andclearing costs, and (3) other expenses. Compensation and benefits have both a variable component based onrevenue production and a fixed component. The variable component includes institutional and retail salescommissions, bonuses, overrides, and trading desk incentives.  Retail and institutional commissions arebased on a competitive commission schedule. The investment banking group and the research group receive a salary anddiscretionary bonus as compensation. The fixed component includes administrative and executive salaries,payroll taxes, employee benefits and temporary employee costs.  Compensation and benefits is our largestexpense item and includes wages, salaries and benefits. During the secondquarter of 2003, compensation and benefits represented 70% of total expenses,and 61% of total revenues compared to 71% of total expenses, and 65% of totalrevenues during the comparable period in 2002.   During the first six months of 2003, compensation and benefitsrepresented 70% of total expenses, and 63% of total revenues compared to 72% oftotal expenses, and 65% of total revenues during the comparable period in 2002.

 

Brokerage and clearance expenses include clearing andtrade execution costs associated with the retail, prime and institutionalbrokerage business at SMH.  SMH clearsits transactions primarily through the Pershing Division of Bank of New YorkCo. and other clearing brokers.

 

Other expenses include (1) occupancy and equipmentexpenses, such as rent and utility charges for facilities, and (2)communications and data processing expenses, such as third-party systems,quotes, market data and software program providers.

 

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**Resultsof Operations**

 

*ThreeMonths Ended June 30, 2003 Compared to Three Months Ended June 30, 2002*

 

Total revenues increased 44%to $27.6 million in the second quarter of 2003 from $19.2 million for the samequarter in 2002 mainly due to increases in prime brokerage services, investmentbanking and fixed income trading.  Totalexpenses for the same 2003 period increased to $23.8 million from $17.6 millionin the same quarter of the previous year. Equity in income of limited partnerships increased from $193,000 duringthe second quarter of 2002 to $2.0 million during the second quarter of 2003,due to increases in the values of securities held in the investment portfoliosof the limited partnerships managed by the Company.  Net income for the three month period ended June 30, 2003increased to $3.4 million from $1.1 million in the same period in 2002.  Basic income per share was $0.20 for thethree months ended June 30, 2003 compared to $0.07 for the same period in2002.  Diluted income per share was$0.19 for the three months ended June 30, 2003 compared to $0.07 for the sameperiod in 2002.

 

Commissions revenueincreased to $13.3 million in the second quarter of 2003 from $11.4 million in2002, primarily as a result of increased trading volume related to the growthof both the number and size of prime broker accounts.  Principal transactions revenue totaled $3.9 million for the 2003period versus $612,000 in the second quarter of 2002, principally due toincreases in revenues from prime brokerage services and fixed incometrading.  Investment banking revenue increasedto $6.8 million during the second quarter of 2003 from $4.1 million in the sameperiod of 2002, principally due to an increase in fees earned from privateplacement transactions.  Revenues fromfiduciary, custodial and advisory fees increased to $2.5 million in the secondquarter of 2003 from $1.9 million in same quarter of 2002.  Interest and dividend income increased to$684,000 in 2003 from $461,000 in the same period last year.  Other income decreased from $750,000 during2002 to $351,000 during 2003.

 

During the three monthsended June 30, 2003, employee compensation and benefits, increased to $16.7million from $12.5 million in the same period last year reflecting commissionsand bonuses paid on the revenue increases. Floor brokerage, exchange and clearance fees increased to $1.5 millionin the second quarter of 2003 from $1.1 million in the same quarter of 2002reflecting increased clearing and execution costs resulting from the additionaltrading volume attributable to the growth in revenues from prime brokerageservices.  Communication and dataprocessing costs increased to $1.4 million in 2003 from $900,000 in the sameperiod last year resulting primarily from increased personnel and tradingvolumes related to the prime brokerage division.   Occupancy costs totaled $1.6 million during the second quarterof 2003, compared to $1.2 million in the prior year quarter.  Other general and administrative expensesincreased to $2.6 million during the second quarter of 2003 from $2.0 millionin the second quarter of last year mainly due to the growth in the primebrokerage division.

 

The effective tax rate fromoperations was 41% for the three months ended June 30, 2003 compared to 38% forthe three months ended June 30, 2002.

 

*Six MonthsEnded June 30, 2003 Compared to Six Months Ended June 30, 2002*

 

Total revenues increased 21%to $48.6 million in the first half of 2003 from $40.0 million for the sameperiod in 2002, principally due to increases in prime brokerage services andinvestment banking.  Total expenses forthe same 2003 period increased to $43.6 million from $35.9 million in the sameperiod of the previous year.  Equity inincome of limited partnerships increased from $817,000 during the first six monthsof 2002 to $2.9 million during the first six months of 2003, due to increasesin the values of securities held in the investment portfolios of the limitedpartnerships managed by the Company. Net income for the six month period ended June 30, 2003 increased to$4.6 million from $3.1 million in the same period in 2002.  Basic income per share was $0.27 for the sixmonths ended June 30, 2003 compared to $0.19 for the same period in 2002.  Diluted income per share was $0.26 for thesix months ended June 30, 2003, compared to $0.18 for the same period in 2002.

 

14

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Commissions revenueincreased to $25.6 million in the first six months of 2003 from $21.0 millionin 2002, primarily as a result of increased trading volume related to thegrowth of both the number and size of prime broker accounts.  Principal transactions revenue totaled $5.9million for the 2003 period versus $5.4 million in 2002.   Investment banking revenue increased to$10.2 million during the first six months of 2003 from $7.8 million in the sameperiod of 2002, principally due to an increase in fees earned from privateplacement transactions.  Revenues fromfiduciary, custodial and advisory fees increased to $4.3 million in the firsthalf of 2003 from $3.6 million in same period of 2002.  Interest and dividend income increased to$1.2 million in 2003 from $887,000 in the same period last year.

 

During the six months endedJune 30, 2003, employee compensation and benefits, increased to $30.4 millionfrom $25.9 million in the same period last year, reflecting commissions andbonuses paid on increased revenues.   Floor brokerage, exchange and clearance fees increased to $2.9 millionin the first half of 2003 from $2.0 million in the same period of 2002reflecting increased clearing and execution costs resulting from the additionaltrading volume attributable to the growth in revenues from prime brokerageservices.  Communication and dataprocessing costs increased to $2.7 million in 2003 from $1.9 million in thesame period last year resulting primarily from increased personnel and tradingvolumes related to the prime brokerage division.   Occupancy costs totaled $2.9 million during the first half of2003, compared to $2.2 million in the prior year period.  Other general and administrative expensesincreased to $4.7 million during the first half of 2003 from $3.9 million inthe first six months of last year mainly due to the growth in the primebrokerage division.

 

The effective tax rate fromoperations was 41% for the six months ended June 30, 2003 compared to 37% forthe six months ended June 30, 2002.

 

**Liquidityand Capital Resources**

 

We intend to satisfy a large portion of our fundingneeds with our own capital resources, consisting largely of internallygenerated earnings and liquid assets we currently hold.

 

At June 30, 2003, we had approximately $34.4 millionin cash and cash equivalents, which together with receivables frombroker-dealers, deposits with clearing brokers, marketable securities owned,and securities available for sale represented about 33% of our total assets atthe end of the second quarter.

 

For the six months ended June 30, 2003, net cash usedin operations totaled $50,000 versus net cash provided by operations of $3.5million during the first six months of 2002. Accounts receivable increased by $2.0 million during the six monthsended June 30, 2003, principally due to increases in notes receivable fromemployees during the first half of 2003. Securities owned increased by $3.5 million during the first six monthsof 2003 primarily due to increases in the values of the limited partnershipsmanaged by the Company and an increase in the value of warrants held by theCompany that were received as part of investment banking transactions.

 

Capital expenditures for the first six months of 2003were $460,000, mainly for the purchase of furniture and computer equipment andsoftware, as well as for leasehold improvements necessary for our growth.  During the first six months of 2003, we reacquired19,654 of our common shares at a total cost of approximately $168,000.

 

At June 30, 2003, SMH, our registered broker-dealersubsidiary, was in compliance with the net capital requirements of theSecurities and Exchange Commission’s Uniform Net Capital Rules and had capitalin excess of the required minimum.  PMTwas in compliance with the Texas Department of Banking net capital requirementand had capital in excess of the required minimum.

 

We are a party to various legal proceedings that areof an ordinary or routine nature incidental to our operations.  We believe we have adequately reserved forsuch litigation matters and that they will not have a material adverse effecton our consolidated financial position, results of operations, or cash flows.

 

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**FactorsAffecting Forward-Looking Statements**

 

This quarterly report on Form 10-Q includes“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities andExchange Act of 1934, as amended (the “Acts”). These forward-looking statementsmay relate to such matters as anticipated financial performance, futurerevenues or earnings, business prospects, projected ventures, new products,anticipated market performance and similar matters. The Private SecuritiesLitigation Reform Act of 1995 provides a safe harbor for forward-lookingstatements. To comply with the safe harbor, the Company cautions readers that avariety of factors could cause the Company’s actual results to differmaterially from the anticipated results or other expectations expressed in theCompany’s forward-looking statements. These risks and uncertainties, many ofwhich are beyond the Company’s control, include, but are not limited to (1)trading volume in the securities markets; (2) volatility of the securitiesmarkets and interest rates; (3) changes in regulatory requirements, which couldaffect the demand for the Company’s services or the cost of doing business; (4)general economic conditions, both domestic and foreign, especially in theregions where the Company does business; (5) changes in the rate of inflationand related impact on securities markets; (6) competition from existingfinancial institutions and other new participants in the securities markets;(7) legal developments affecting the litigation experience of the securitiesindustry; (8) successful implementation of technology solutions; (9) changes invaluations of the Company’s trading and warrant portfolios resulting frommark-to-market adjustments; (10) dependence on key personnel and (11) demandfor the Company’s services. The Company does not undertake to publicly updateor revise any forward-looking statements.

 

**Item3*.  Quantitative and Qualitative DisclosuresAbout Market Risk***

 

**Market Risks**

 

At June 30, 2003, PMT had equity securities undermanagement with a fair value of $527 million. PMT’s fee income for the six months ended June 30, 2003 would have beenreduced by approximately $49,000 assuming a hypothetical 10% decrease in the valueof its equity securities under management. PMT’s securities available for sale are recorded at a fair value ofapproximately $2.7 million at June 30, 2003. These securities are subject to equity price risk.  These securities have an original cost of $2.9million.  At June 30, 2003, theunrealized decline in market value totaling $250,000, less tax benefit of$92,000, has been included as a separate component of shareholders’ equity.

 

Management evaluates the realizability of securitiesavailable for sale to determine if a decline in value is other thantemporary.  Such evaluation considersthe length of time and the extent to which market value has been less thancost, the financial condition and near-term prospects of the issuer, and theintent and ability of the Company to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in marketvalue.  Management believes theunrealized losses are temporary at June 30, 2003.  However, a write-down accounted for as a realized loss may benecessary in the future.

 

The Company’s trading equity and debt securities aremarked to market on a daily basis.  AtJune 30, 2003, the Company’s trading equity and debt securities were recordedat a fair value of approximately $2.0 million. These trading equity and debt securities are subject to equity pricerisk.  This risk would amount toapproximately $200,000 based on a potential loss in fair value from ahypothetical 10% decrease in the market value of such equity and debtsecurities.  The actual equity pricerisk related to the trading equity and debt securities may differsubstantially.

 

**Item 4. ***Controls and Procedures*

 

*    *   Our management, including ourChief Executive Officer and Chief Financial Officer, have conducted anevaluation of the effectiveness of our disclosure controls and procedures as ofthe end of the quarter covered by this report. Based upon that evaluation, our Chief Executive Officer and ChiefFinancial Officer have concluded that our disclosure controls and proceduresare effective for timely gathering, analyzing and 

 

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disclosing the information we are required todisclose in our reports filed under the Securities Exchange Act of 1934, asamended.  There have been no changes inour internal control over financial reporting that occurred during the quartercovered by this report that materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**PART II****.   OTHER INFORMATION**

 

**Item 1.  *Legal Proceedings***

 

We are a party to various legal proceedings that areof an ordinary or routine nature incidental to our operations.  Certain of our litigation and claims arecovered by insurance with a maximum deductible of $50,000.    We believe we have adequately reserved forsuch litigation matters and that they will not have a material adverse effecton our consolidated financial position, results of operations, or cash flows.

 

**Item4. ***Submission of Matters to aVote of Security Holders*

 

On June 19, 2003, the Company held its annual meeting of shareholdersto vote for election to the Company’s Board of Directors.  Each nominee was elected and the results of thevotes were as follows:

 
|                   |   | **Number of  Shares  Voted For** |   | **Number of  Shares  Voted Against** |   | **Number of  Shares  Withheld** |   | **Number of  Broker  Non-Votes** |   |
|------------------------|--------|----------------------------------|--------|--------------------------------------|--------|---------------------------------|--------|----------------------------------|--------|
|                   |   |                             |   |                                 |   |                            |   |                             |   |
| George L. Ball         |   | 15,543,856                       |   | —                               |   | 145,376                         |   | —                           |   |
| Donald R.  Campbell    |   | 14,673,423                       |   | —                               |   | 1,015,810                       |   | —                           |   |
| Robert E.  Garrison II |   | 15,543,856                       |   | —                               |   | 145,376                         |   | —                           |   |
| Titus H. Harris,  Jr.  |   | 15,543,856                       |   | —                               |   | 145,376                         |   | —                           |   |
| Ben T. Morris          |   | 15,543,856                       |   | —                               |   | 145,376                         |   | —                           |   |
| Nolan Ryan             |   | 15,543,856                       |   | —                               |   | 145,376                         |   | —                           |   |
| Don A. Sanders         |   | 15,543,856                       |   | —                               |   | 145,376                         |   | —                           |   |
| John H. Styles         |   | 15,619,300                       |   | —                               |   | 69,922                          |   | —                           |   |
| W. Blair Waltrip       |   | 15,609,198                       |   | —                               |   | 80,035                          |   | —                           |   |
| Dan S. Wilford         |   | 15,038,510                       |   | —                               |   | 650,722                         |   | —                           |   |

 

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**Item6**.  ***Exhibits and Reports on Form 8-K***

 

(a) Exhibits

 
| **Exhibit   Number** |   | **Description**                                                                                                                                                                                                     |
|----------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |   | Articles of Incorporation of the Company, as amended  (filed as Exhibit 3.1 to the Company’s  Form 10-K for the year ended December 31, 2001 (File No. 000-30066) and  incorporated herein by reference). |
| 3.2                  |   | Amended and Restated Bylaws of the Company (filed as Exhibit 3.2 to the  Company’s Form 10-K for the year ending December 31, 1998 (File No.  000-30066) and incorporated herein by reference).                |
| *31.1                |   | Certification of  Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the  Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.              |
| *31.2                |   | Certification of  Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the  Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.              |
| *32.1                |   | Certification of  the Chief Executive Officer Pursuant to 18 U.S.C. 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                    |
| *32.2                |   | Certification of  the Chief Financial Officer Pursuant to 18 U.S.C. 1350, as Adopted Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                    |

 
|        |
|--------|
|   |   | * Filed  herewith. |

 
| (b)    |   | Reports on Form 8-K.                                                                                                                                                                                                                                                                |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                |
|   |   | On May 14, 2003, the Company filed a current report  on Form 8-K relating to (i) the declaration by its board of directors of a  cash dividend in the amount of $0.03 per share of common stock, and (ii) the  Company’s earnings report for the quarter ended March 31, 2003. |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 

 
|      |                 | **SANDERS MORRIS HARRIS GROUP INC.** |
|-----------|----------------------|--------------------------------------|
|      |                 |                                 |   |
|      |                 | By                                   | /s/  BEN T.  MORRIS |
|      |                 |                                 | **Ben T.  Morris** |   |
|      |                 |                                 | **Chief Executive Officer** |   |
|      |                 |                                 |   |
|      |                 |                                 |   |
|      |                 | By                                   | /s/  RICK  BERRY |
|      |                 |                                 | **Rick Berry** |   |
|      |                 |                                 | **Chief Financial Officer** |   |
|      |
| **Date:** | **August  12, 2003** |
|           |                      |                                      |  |  |  |

 

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