**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**(mark one)**

 

| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY  PERIOD ENDED JUNE 30, 2002** |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------|

** **

**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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**SANDERSMORRIS HARRIS GROUP INC.**

(Exact name ofregistrant 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 3000**                                      |
| **Houston, Texas 77002**                                        |
| (Address of  principal executive office)                        |
|                                                            |   |                                  |
| **(713) 993-4610**                                              |
| (Registrant’s telephone number, including area code)       |

 

 

Indicate by check markwhether the registrant:  (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has been subjectto such filing requirements for the past 90 days.  YES  ý        NO o

 

The number of shares ofthe registrant’s Common Stock, par value $0.01 per share, outstanding as ofAugust 1, 2002, was 16,613,928.

 

 

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

 

# **INDEX**

 
| **PART I.**   **CONDENSED  CONSOLIDATED FINANCIAL INFORMATION** |
|----------------------------------------------------------------------|
|                                                                 |   |   |
| Item  1.                                                             | Financial Statements |
|                                                                 |   |
|                                                                 |   | Condensed  Consolidated Balance Sheet as of June 30, 2002 and December 31, 2001  (unaudited) |
|                                                                 |   |   |
|                                                                 |   | Condensed  Consolidated Statement of Income for the Three and Six Months Ended June 30,  2002 and 2001 (unaudited) |
|                                                                 |   |   |
|                                                                 |   | Condensed  Consolidated Statement of Shareholders’ Equity for the Six Months Ended June  30, 2002 (unaudited) |
|                                                                 |   |   |
|                                                                 |   | Condensed  Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2002  and 2001 (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 |
|                                                                 |   |   |
| **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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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEET**

(in thousands,except share and per share amounts)

(unaudited)

 
|                                                                                                                  |   | **June 30,** |    | **December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|--------------|---------|------------------|--------|
|                                                                                                                  |   | **2002**     |    | **2001**         |   |
| **ASSETS**                                                                                                            |   |         |    |             |   |
| Cash  and cash equivalents                                                                                            |   | $            | 30,297  |             | $      | 30,410 |   |
| Receivables,  net of allowance of $285                                                                                |   |         |    |             |   |
| Broker-dealers                                                                                                        |   | 779          |    | 540              |   |
| Customers                                                                                                             |   | 3,456        |    | 1,918            |   |
| Related  parties                                                                                                      |   | 5,315        |    | 6,688            |   |
| Other                                                                                                                 |   | 679          |    | 631              |   |
| Deposits  with clearing brokers                                                                                       |   | 250          |    | 250              |   |
| Securities  owned                                                                                                     |   | 12,897       |    | 12,153           |   |
| Securities  available for sale                                                                                        |   | 3,476        |    | 1,691            |   |
| Intangible  assets, net of accumulated amortization of $4,268                                                         |   | 47,673       |    | 47,601           |   |
| Furniture  and equipment, net                                                                                         |   | 3,088        |    | 1,924            |   |
| Deferred  income taxes, net                                                                                           |   | 705          |    | 828              |   |
| Other  assets                                                                                                         |   | 1,091        |    | 675              |   |
| Total  assets                                                                                                         |   | $            | 109,706 |             | $      | 105,309 |   |
|                                                                                                                  |   |         |    |             |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                        |   |         |    |             |   |
|                                                                                                                  |   |         |    |             |   |
| Liabilities:                                                                                                          |   |         |    |             |   |
| Accounts  payable and accrued liabilities                                                                             |   | $            | 10,008  |             | $      | 8,538 |   |
| Payable  to clearing broker-dealers                                                                                   |   | 50           |    | 63               |   |
| Securities  sold, not yet purchased                                                                                   |   | 95           |    | 122              |   |
| Other  liabilities                                                                                                    |   | 219          |    | 252              |   |
| Total  liabilities                                                                                                    |   | 10,372       |    | 8,975            |   |
|                                                                                                                  |   |         |    |             |   |
| Commitments  and contingencies                                                                                        |   |         |    |             |   |
|                                                                                                                  |   |         |    |             |   |
| Minority  interests                                                                                                   |   | 124          |    | 51               |   |
|                                                                                                                  |   |         |    |             |   |
| 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;  17,341,226 and 17,009,402 shares issued, respectively |   | 173          |    | 170              |   |
| Additional  paid-in capital                                                                                           |   | 110,168      |    | 109,159          |   |
| Receivables  for shares issued                                                                                        |   | (778         | )       | (541             | )      |
| Accumulated  deficit                                                                                                  |   | (5,696       | )       | (8,766           | )      |
| Accumulated  other comprehensive loss                                                                                 |   | (131         | )       | (57              | )      |
| Unearned  compensation                                                                                                |   | (1,522       | )       | (1,097           | )      |
| Treasury  stock at cost, 676,030 and 597,038 shares, respectively                                                     |   | (3,004       | )       | (2,585           | )      |
| Total  shareholders’ equity                                                                                      |   | 99,210       |    | 96,283           |   |
| Total  liabilities and shareholders’ equity                                                                      |   | $            | 109,706 |             | $      | 105,309 |   |

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

 

2

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF INCOME**

(in thousands,except share and per share amounts)

(unaudited)

 
|                                                                                                  |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                                  |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
| Revenues:                                                                                             |   |                             |   |                           |   |   |   |   |   |
| Commissions                                                                                           |   | $                                | 11,372 |                           | $      | 6,003 |   | $ | 21,032 |   | $ | 12,614 |   |
| Principal  transactions                                                                               |   | 612                              |   | 2,927                          |   | 5,395 |   | 4,922 |   |
| Investment  banking                                                                                   |   | 4,087                            |   | 2,907                          |   | 7,763 |   | 6,932 |   |
| Fiduciary,  custodial and advisory fees                                                               |   | 1,927                            |   | 1,586                          |   | 3,640 |   | 3,236 |   |
| Interest  and dividends                                                                               |   | 461                              |   | 498                            |   | 887 |   | 1,209 |   |
| Other  income                                                                                         |   | 750                              |   | 394                            |   | 1,315 |   | 755 |   |
| Total  revenues                                                                                       |   | 19,209                           |   | 14,315                         |   | 40,032 |   | 29,668 |   |
|                                                                                                  |   |                             |   |                           |   |   |   |   |   |
| Expenses:                                                                                             |   |                             |   |                           |   |   |   |   |   |
| Employee  compensation and benefits                                                                   |   | 12,463                           |   | 8,406                          |   | 25,885 |   | 17,224 |   |
| Floor  brokerage, exchange and clearance fees                                                         |   | 1,064                            |   | 849                            |   | 1,987 |   | 1,720 |   |
| Communications  and data processing                                                                   |   | 900                              |   | 982                            |   | 1,905 |   | 1,850 |   |
| Occupancy                                                                                             |   | 1,152                            |   | 932                            |   | 2,198 |   | 1,803 |   |
| Amortization  of intangible assets                                                                    |   | —                           |   | 549                            |   | — |   | 1,051 |   |
| Other  general and administrative                                                                     |   | 2,046                            |   | 1,565                          |   | 3,949 |   | 2,941 |   |
| Total  expenses                                                                                       |   | 17,625                           |   | 13,283                         |   | 35,924 |   | 26,589 |   |
|                                                                                                  |   |                             |   |                           |   |   |   |   |   |
| Income  before equity in income (loss) of limited  partnerships, income taxes and minority  interests |   | 1,584                            |   | 1,032                          |   | 4,108 |   | 3,079 |   |
| Equity  in income (loss) of limited partnerships                                                      |   | 193                              |   | 11                             |   | 817 |   | (165 | ) |
|                                                                                                  |   | 1,777                            |   | 1,043                          |   | 4,925 |   | 2,914 |   |
| Provision  for income taxes                                                                           |   | (670                             | )      | (605                           | )      | (1,832 | ) | (1,615 | ) |
| Minority  interests in net (income) loss of  consolidated companies                                   |   | (7                               | )      | 41                             |   | (23 | ) | 82 |   |
|                                                                                                  |   |                             |   |                           |   |   |   |   |   |
| Net  income                                                                                           |   | $                                | 1,100  |                           | $      | 479 |   | $ | 3,070 |   | $ | 1,381 |   |
| Earnings  per share:                                                                                  |   |                             |   |                           |   |   |   |   |   |
| Basic                                                                                                 |   | $                                | 0.07   |                           | $      | 0.03 |   | $ | 0.19 |   | $ | 0.09 |   |
| Diluted                                                                                               |   | $                                | 0.07   |                           | $      | 0.03 |   | $ | 0.18 |   | $ | 0.09 |   |
|                                                                                                  |   |                             |   |                           |   |   |   |   |   |
| Weighted  average common shares outstanding:                                                          |   |                             |   |                           |   |   |   |   |   |
| Basic                                                                                                 |   | 16,613,928                       |   | 15,886,740                     |   | 16,541,655 |   | 15,564,598 |   |
| Diluted                                                                                               |   | 16,886,188                       |   | 16,104,537                     |   | 16,748,502 |   | 15,745,908 |   |

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

 

3

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF SHAREHOLDERS' EQUITY**

**Forthe six months ended June 30, 2002**

(in thousands,except shares)

(unaudited)

 
|                                                                    |   | **Amounts** |       |       |   | **Shares** |           |
|-------------------------------------------------------------------------|--------|-------------|------------|------------|--------|------------|----------------|
|                                                                    |   |        |       |       |   |       |           |
| **Common stock**                                                        |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | 170        |       |   |       | 17,009,402     |   |
| Stock  issued pursuant to employee benefit plan                         |   | 3           |       |       |   | 331,824    |           |
| Balance,  end of period                                                 |   | 173         |       |       |   | 17,341,226 |           |
| **Additional paid-in capital**                                          |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | 109,159    |       |   |       |           |   |
| Stock  issued pursuant to employee benefit plan                         |   | 1,843       |       |       |   |       |           |
| Dividends                                                               |   | (834        | )          |       |   |       |           |
| Balance,  end of period                                                 |   | 110,168     |       |       |   |       |           |
| **Receivables for shares issued**                                       |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | (541       | )          |   |       |           |   |
| Collection  of receivable                                               |   | 48          |       |       |   |       |           |
| Issuance  of restricted stock                                           |   | (518        | )          |       |   |       |           |
| Amortization  of notes receivable                                       |   | 233         |       |       |   |       |           |
| Balance,  end of period                                                 |   | (778        | )          |       |   |       |           |
| **Accumulated deficit**                                                 |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | (8,766     | )          |   |       |           |   |
| Net  income                                                             |   | 3,070       |       | 3,070      |   |       |           |
| Balance,  end of period                                                 |   | (5,696      | )          | 3,070      |   |       |           |
| **Accumulated other comprehensive loss**                                |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | (57        | )          |   |       |           |   |
| Net  change in unrealized appreciation on securities available for sale |   | (112        | )          | (112       | )      |       |           |
| Income  tax provision on change                                         |   | 38          |       | 38         |   |       |           |
| Balance,  end of period                                                 |   | (131        | )          | (74        | )      |       |           |
| **Comprehensive income**                                                |   |        |       | 2,996      |   |       |           |
| **Unearned compensation**                                               |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | (1,097     | )          |   |       |           |   |
| Net  issuance of restricted stock                                       |   | (714        | )          |       |   |       |           |
| Amortization  of unearned compensation                                  |   | 289         |       |       |   |       |           |
| Balance,  end of period                                                 |   | (1,522      | )          |       |   |       |           |
| **Treasury stock**                                                      |   |        |       |       |   |       |           |
| Balance,  beginning of year                                             |   | $           | (2,585     | )          |   |       | (597,038       | ) |
| Acquisition  of treasury stock                                          |   | (582        | )          |       |   | (116,268   | )              |
| Issuance  of treasury stock                                             |   | 163         |       |       |   | 37,276     |           |
| Balance,  end of period                                                 |   | (3,004      | )          |       |   | (676,030   | )              |
| **Total shareholders’ equity and common shares outstanding**       |   | **$**       | **99,210** | ** ** |   | ** ** | **16,665,196** | ** ** |

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

4

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF CASH FLOWS**

**Forthe six months ended June 30, 2002 and 2001**

(in thousands)

(unaudited)

 
|                                                                                          |   | **2002** |   | **2001** |   |
|-----------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                        |   |     |   |     |   |
| Net  income                                                                                   |   | $        | 3,070  |     | $      | 1,381 |   |
| Adjustments  to reconcile net income to net cash  provided by (used in) operating activities: |   |     |   |     |   |
| Realized  (gain) loss on securities available for sale                                        |   | (21      | )      | 126      |   |
| Depreciation                                                                                  |   | 399      |   | 420      |   |
| Amortization  of intangible assets                                                            |   | —   |   | 1,051    |   |
| Provision  for bad debts                                                                      |   | 180      |   | 116      |   |
| Compensation  expense related to amortization of  notes receivable and unearned compensation  |   | 522      |   | 25       |   |
| Deferred  income taxes                                                                        |   | 161      |   | —   |   |
| Minority  interests in net income (loss) of consolidated  companies                           |   | 23       |   | (82      | )      |
| Changes  in operating assets and liabilities:                                                 |   |     |   |     |   |
| Increase  in receivables                                                                      |   | (632     | )      | (6,777   | )      |
| Increase  in securities owned                                                                 |   | (744     | )      | (706     | )      |
| (Increase)  decrease in other assets                                                          |   | (417     | )      | 48       |   |
| Decrease  in securities sold, not yet purchased                                               |   | (27      | )      | (473     | )      |
| Decrease  in other liabilities                                                                |   | (33      | )      | (1,783   | )      |
| Decrease  in payable to clearing broker-dealers                                               |   | (13      | )      | (3       | )      |
| Increase  in accounts payable and accrued liabilities                                         |   | 984      |   | 310      |   |
| Net  cash provided by (used in) operating activities                                          |   | 3,452    |   | (6,347   | )      |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                        |   |     |   |     |   |
| Capital  expenditures                                                                         |   | (1,563   | )      | (458     | )      |
| Acquisitions,  net of cash acquired of $30                                                    |   | —   |   | (20      | )      |
| Purchase  of securities available for sale                                                    |   | (2,307   | )      | (481     | )      |
| Proceeds  from sales and maturities of securities available  for sale                         |   | 431      |   | 1,792    |   |
| Net  cash provided by (used in) investing activities                                          |   | (3,439   | )      | 833      |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                        |   |     |   |     |   |
| Purchase  of treasury stock                                                                   |   | (582     | )      | (884     | )      |
| Collection  of receivable for shares issued                                                   |   | 48       |   | 40       |   |
| Proceeds  from shares issued                                                                  |   | 777      |   | 525      |   |
| Investment  by minority interest                                                              |   | 50       |   | —   |   |
| Dividends  paid                                                                               |   | (419     | )      | —   |   |
| Net  cash used in financing activities                                                        |   | (126     | )      | (319     | )      |
| Net  decrease in cash and cash equivalents                                                    |   | (113     | )      | (5,833   | )      |
| CASH  AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                             |   | 30,410   |   | 25,059   |   |
|                                                                                          |   |     |   |     |   |
| CASH  AND CASH EQUIVALENTS AT END OF PERIOD                                                   |   | $        | 30,297 |     | $      | 19,226 |   |
| Noncash  investing and financing activities:                                                  |   |     |   |     |   |
| Common  stock issued for acquisitions                                                         |   | —   |   | 4,208    |   |
| Cash  (paid) refunded for income taxes                                                        |   | $        | (1,665 | )        | $      | 228 |   |

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

 

5

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**SandersMorris Harris Group Inc. and Subsidiaries**

**Notesto Condensed Consolidated Financial Statements**

**(unaudited)**

 

**1.****          BASIS OFPRESENTATION**

 

*Natureof Operations*

* *

Through itsoperating subsidiaries Pinnacle Management & Trust Co. (“PMT”), SandersMorris Harris Inc. (“SMH”), SMH Capital Advisors (“SMCA”), and KissingerFinancial Services, Inc. (“Kissinger”), the Company provides a broad range offinancial services, including institutional, prime and retail brokerage,investment banking, merchant banking, trust related services, investmentmanagement and financial planning. The Company serves a diverse group ofinstitutional, corporate and individual clients.

 

The Company mergedwith and acquired its operating subsidiaries in 2001, 2000 and 1999.  The acquisitions were accounted for usingthe purchase method.

 

###### *Consolidation*

 

The unauditedcondensed consolidated financial statements of the Company include the accountsof its wholly owned subsidiaries. All material intercompany transactions andbalances have been eliminated in consolidation.

 

In management’sopinion, the unaudited condensed consolidated financial statements include alladjustments necessary for a fair presentation of our financial position at June30, 2002, our results of operations for the three  and six months ended June 30, 2002 and 2001, and our cash flowsfor the six months ended June 30, 2002 and 2001.  All adjustments are ofa normal recurring nature. Interim results are not necessarily indicative ofresults for a full year.

 

These financialstatements and notes should be read in conjunction with the Company’s annualreport on Form 10-K for the year ended December 31, 2001.

 

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

 

SFAS No. 141 entitled “*Business Combinations”* was issued in June 2001 and becameeffective July 1, 2001.  SFAS No. 141requires that all business combinations be accounted for using the purchasemethod of accounting, which requires that acquisitions be recorded at fairvalue as of the date of acquisition. SFAS No. 142 entitled *“Goodwill andOther**Intangible Assets”*was also issued in June 2001, in concert with SFAS No. 141.  SFAS No. 142 became effective for us onJanuary 1, 2002.  As a result, theCompany ceased all goodwill amortization and did not recognize $1.1 million ofgoodwill amortization expense that would have been recognized in the first sixmonths of 2002 under the previous accounting standards.

 

6

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The following table presents the impact of SFAS No.142 on net income and net income per share had the standard been in effect forthe first six months of 2001 (in thousands, except per share amounts):

 

|                                     |   | **Three Months Ended** |   | **Six Months Ended** |   |
|------------------------------------------|--------|------------------------|--------|----------------------|--------|
|                                     |   | **June 30,  2002**     |   | **June 30,  2001**   |   | **June 30,  2002** |   | **June 30,  2001** |   |
| Reported  net income                     |   | $                      | 1,100  |                 | $      | 479 |   | $ | 3,070 |   | $ | 1,381 |   |
| Adjustment:                              |   |                   |   |                 |   |   |   |   |   |
| Amortization  of goodwill                |   | —                 |   | 549                  |   | — |   | 1,051 |   |
| Adjusted  net income                     |   | $                      | 1,100  |                 | $      | 1,028 |   | $ | 3,070 |   | $ | 2,432 |   |
|                                     |   |                   |   |                 |   |   |   |   |   |
| Reported  net income per share - basic   |   | $                      | 0.07   |                 | $      | 0.03 |   | $ | 0.19 |   | $ | 0.09 |   |
| Adjusted  net income per share - basic   |   | $                      | 0.07   |                 | $      | 0.06 |   | $ | 0.19 |   | $ | 0.16 |   |
|                                     |   |                   |   |                 |   |   |   |   |   |
| Reported  net income per share - diluted |   | $                      | 0.07   |                 | $      | 0.03 |   | $ | 0.18 |   | $ | 0.09 |   |
| Adjusted  net income per share - diluted |   | $                      | 0.07   |                 | $      | 0.06 |   | $ | 0.18 |   | $ | 0.15 |   |

 

In accordance with SFAS No. 142, the Company completedtransitional impairment tests during the second quarter of fiscal 2002.  The tests consisted of two steps.  First, total goodwill of $47.6 million as ofDecember 31, 2001 was allocated to the various reporting units in order todetermine the carrying values of the different units.  Next, the fair values of the reporting units were assessed.  Goodwill totaling $38.7 million, $5.7million, and $3.2 million was allocated to the Company’s SMH, PMT and Kissingersubsidiaries, respectively.  The Companyused several methods to value the reporting units, including discounted cashflows, comparisons with valuations of public companies in the same industry,and industry guidelines for the valuation of private companies in a similarbusiness.  The Company determined thatthe fair values of the three reporting units exceeded their carrying values;therefore goodwill does not appear to be impaired as of December 31, 2001.  SFAS No. 142 requires SMHG to performgoodwill impairment tests on at least an annual basis.  There can be no assurance that futuregoodwill impairment tests will not result in a charge to earnings.

 

As of the date ofadoption, the Company had unamortized goodwill in the amount of $47.6million.  Amortization expense relatedto goodwill was $2.2 million for the year ended December 31, 2001, $549,000 forthe three months ended June 30, 2001 and $1.1 million for the six months endedJune 30, 2001.

 

*Reclassifications*

 

Certain reclassificationshave been made to the 2001 condensed consolidated financial statements toconform them with the 2002 presentation.  The reclassifications had no effect on accumulated deficit, results ofoperations or cash flows as previously reported.

 

**2.****          ACQUISITIONS**

 

On April 5, 2001, theCompany acquired Kissinger, a Baltimore, Maryland based financial planningfirm.  The former owner of Kissinger receiveda total of 600,000 of the Company’s common shares.  The acquisition was accounted for as a purchase and, accordingly,the financial information of Kissinger has been included in the Company’sconsolidated financial statements from April 5, 2001.  The purchase price of approximately $3.4 million exceeded thefair value of identifiable net assets acquired by approximately $3.3 million,which has been recorded as goodwill and subject to SFAS No. 142, is no longerbeing amortized.

 

7

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The following summarizedunaudited financial information presents the six months ended June 30, 2001 asif the above transaction occurred on January 1, 2001 compared to the actualresults for the six months ended June 30, 2002:

 
|                        |   | **Six Months Ended  June 30,**                |   |
|-----------------------------|--------|-----------------------------------------------|--------|
|                        |   | **Actual  2002**                              |   | **Proforma  2001** |   |
|                        |   | **(in thousands, except  per share amounts)** |   |
|                        |   |                                          |   |   |   |
| Revenues                    |   | $                                             | 40,032 |   | $ | 30,173 |   |
| Net  income                 |   | 3,070                                         |   | 1,294 |   |
|                        |   |                                          |   |   |   |
| Basic  earnings per share   |   | $                                             | 0.19   |   | $ | 0.08 |   |
| Diluted  earnings per share |   | $                                             | 0.18   |   | $ | 0.08 |   |

 

These unaudited pro formaamounts are derived from the historical financial information of the acquiredbusiness and reflect adjustments for amortization of intangible assets for 2001and for income taxes.  The unaudited proforma financial information does not necessarily represent results that wouldhave occurred if the acquisition had taken place on the basis assumed above,nor are they indicative of the results of future combined operations.

 

During January2002, the former institutional equity professionals of Sutro and Co. (the JudaGroup) joined the Company.  Tom Juda,who headed the Juda Group, was named to lead the institutional equity divisionof SMH.  The Company agreed to reimburseSutro for office and equipment expenses related to the Juda Group.  SMH committed to pay Mr. Juda certain annualminimum levels of compensation for 2002 through 2005, provided Mr. Juda remainsas an employee of SMH.  Additionally,under its Incentive Plan, the Company issued to Mr. Juda an aggregate of357,909 shares of SMHG common stock at a total purchase price that waseffectively at a discount of 33 1/3% to the closing sales price of the stock onthe Nasdaq National Market. Approximately one-third of these shares vest 50% after one year and 25%after the second and third years.  Thediscount totaling $568,000 has been recorded as unearned compensation, and isbeing amortized to expense over the three year vesting period.

 

8

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**3.****             SECURITIES OWNED ANDSECURITIES SOLD, NOT YET PURCHASED**

 

Securities owned andsecurities sold, not yet purchased as of June 30, 2002 were as follows:

 
|                                              |   | **Owned**          |   | **Sold, Not Yet  Purchased** |   |
|---------------------------------------------------|--------|--------------------|--------|------------------------------|--------|
|                                              |   | **(in thousands)** |   |
| Marketable:                                       |   |               |   |                         |   |
| Corporate  stocks (cost $1,675)                   |   | $                  | 1,102  |                         | $      | (95 | ) |
| Corporate  bonds and commercial paper (cost $263) |   | 250                |   | —                       |   |
|                                              |   |               |   |                         |   |
| Not  readily marketable:                          |   |               |   |                         |   |
| Partnerships                                      |   | 7,316              |   | —                       |   |
| Corporate  stocks and warrants (cost $2,731)      |   | 4,229              |   | —                       |   |
|                                              |   | $                  | 12,897 |                         | $      | (95 | ) |

 

Securities notreadily marketable include investment securities (a) for which there is nomarket on a securities exchange or no independent publicly quoted market, (b)that cannot be publicly offered or sold unless registration has been effectedunder the Securities Act of 1933, or (c) that cannot be offered or sold becauseof other arrangements, restrictions, or conditions applicable to the securitiesor to the Company.

 

Securities not readilymarketable consist of investments in limited partnerships, equities, optionsand warrants.  The investments inlimited partnerships are accounted for using the equity method, whichapproximates fair value, and principally consist of Environmental OpportunitiesFund, L.P., Environmental Opportunities Fund II, L.P., EnvironmentalOpportunities Fund II (Institutional), L.P., Corporate Opportunities Fund,L.P., Corporate Opportunities Fund (Institutional), L.P., Sanders OpportunityFund, L.P., Sanders Opportunity Fund (Institutional), L.P., TacticalOpportunities High Yield Fund, L.P., and Life Sciences Opportunity Fund, L.P.

 

**4.****          SECURITIESAVAILABLE FOR SALE**

 

Securities available forsale at June 30, 2002 were as follows:

 
|                                    |   | **Amortized  Cost** |   | **Gross Unrealized** |   | **Estimated  Fair Value** |   |
|-----------------------------------------|--------|---------------------|--------|----------------------|--------|---------------------------|--------|
|                                    |   | **Gains**           |   | **Losses**           |
|                                    |   | **(in thousands)**  |   |
|                                    |   |                |   |                 |   |                      |   |   |   |
| U.S.  Government and agency obligations |   | $                   | 1,310  |                 | $      | 6                         |   | $ | (1 | ) | $ | 1,315 |   |
| Corporate  bonds                        |   | 100                 |   | 2                    |   | —                    |   | 102 |   |
| Marketable  equity securities           |   | 2,268               |   | 48                   |   | (257                      | )      | 2,059 |   |
| Total                                   |   | $                   | 3,678  |                 | $      | 56                        |   | $ | (258 | ) | $ | 3,476 |   |
|                                         |        |                     |        |                      |        |                           |        |  |  |  |  |  |  |  |

 

9

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The contractual maturitiesof debt securities available for sale at June 30, 2002 were as follows:

 
| Due  after 1 year through 5 years   |   | $   | 1,315  |   |
|-------------------------------------|--------|-----|--------|--------|
| Due  after 5 years through 10 years |   | 102 |   |
|                                |   | $   | 1,417  |   |

 

Gross gains onsales of securities available for sale were $24,000 and $130,000 for the sixmonths ended June 30, 2002 and 2001, respectively.  Gross realized losses on securities available for sale were$3,000 and $256,000 for the six months ended June 30, 2002 and 2001,respectively.

 

**5.****          INCOME TAXES**

 

The differencesbetween the effective tax rate reflected in the income tax provision fromoperations and the statutory federal rate were as follows:

 
|                                    |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                    |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
|                                    |   | **(in thousands)**               |   | **(in thousands)**             |   |
|                                    |   |                             |   |                           |   |   |   |   |   |
| Tax  computed using the statutory rate  |   | $                                | 602    |                           | $      | 369 |   | $ | 1,667 |   | $ | 1,019 |   |
| Nondeductible  amortization of goodwill |   | —                           |   | 187                            |   | — |   | 357 |   |
| State  income taxes and other           |   | 68                               |   | 49                             |   | 165 |   | 239 |   |
| Total                                   |   | $                                | 670    |                           | $      | 605 |   | $ | 1,832 |   | $ | 1,615 |   |

 

**6.             COMMITMENTS AND CONTINGENCIES**

 

There were no firmunderwriting commitments open at June 30, 2002.

 

The Company andits subsidiaries have obligations under operating leases that expire by 2012with initial noncancelable terms in excess of one year.

 

The Company is a partyto various legal proceedings that are of an ordinary or routine natureincidental to its operations.  TheCompany believes it has adequately reserved for such litigation matters andthat they will not have a material adverse effect on the Company’s consolidatedfinancial condition, results of operations, or cash flows.

 

The Company hasuncommitted financing arrangements with clearing brokers who finance customeraccounts, certain broker-dealer balances and firm trading positions.  Although these customer accounts andbroker-dealer balances are not reflected on the consolidated balance sheet forfinancial accounting reporting purposes, the Company has generally agreed toindemnify these clearing brokers for losses they may sustain in connection withthe accounts, and therefore, retains risk on these accounts.  The Company is required to maintain certaincash or securities on deposit with its clearing brokers.

### ** **

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**7.             EARNINGS PER COMMON SHARE**

 

Basic and dilutedearnings per–share computations for the periods indicated were asfollows:

 

 
|                                                                                             |   | **Three Months Ended June 30,**                        |   |
|--------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                                                                             |   | **2002**                                               |   | **2001** |   |
|                                                                                             |   | **(in thousands, except share and per share amounts)** |   |
| Computation  of basic and diluted earnings per common share for the three months ended  June 30: |   |                                                   |   |   |   |
| Net  income                                                                                      |   | $                                                      | 1,100  |   | $ | 479 |   |
| Weighted  average number of common shares outstanding                                            |   | 16,613,928                                             |   | 15,886,740 |   |
| Common  shares issuable under stock option plan                                                  |   | 1,389,473                                              |   | 1,114,943 |   |
| Less  shares assumed repurchased with proceeds                                                   |   | (1,117,213                                             | )      | (897,146 | ) |
| Weighted  average common shares outstanding                                                      |   | 16,886,188                                             |   | 16,104,537 |   |
| Basic  earnings per common share                                                                 |   | $                                                      | 0.07   |   | $ | 0.03 |   |
| Diluted  earnings per common share                                                               |   | $                                                      | 0.07   |   | $ | 0.03 |   |

 

 
|                                                                                           |   | **Six Months Ended June 30,**                          |       |
|------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|------------|
|                                                                                           |   | **2002**                                               |       | **2001** | ** ** |
|                                                                                           |   | **(in thousands, except share and per share amounts)** | ** ** |
| Computation  of basic and diluted earnings per common share for the six months ended June  30: |   |                                                   |       |   |   |
| Net  income                                                                                    |   | $                                                      | 3,070      |   | $ | 1,381 |   |
| Weighted  average number of common shares outstanding                                          |   | 16,541,655                                             |       | 15,564,598 |   |
| Common  shares issuable under stock option plan                                                |   | 1,254,473                                              |       | 1,114,943 |   |
| Less  shares assumed repurchased with proceeds                                                 |   | (1,047,626                                             | )          | (933,633 | ) |
| Weighted  average common shares outstanding                                                    |   | 16,748,502                                             |       | 15,745,908 |   |
| Basic  earnings per common share                                                               |   | $                                                      | 0.19       |   | $ | 0.09 |   |
| Diluted  earnings per common share                                                             |   | $                                                      | 0.18       |   | $ | 0.09 |   |

 

Stock optionsoutstanding of 185,000 and 50,000 at June 30, 2002 and 2001, respectively, havenot been included in diluted earnings per common share for the six months endedJune 30, 2002 and 2001 because their inclusion would have been antidilutive forthe periods presented.  Stock optionsoutstanding of 50,000 have not been included in diluted earnings per share forthe three months ended June 30, 2002 and 2001 because their inclusion wouldhave been antidilutive for the periods presented.

 

**8.             BUSINESS SEGMENT INFORMATION**

 

The Company’sbusinesses operate in two reportable business segments.  The Company’s investment banking andbrokerage segment includes the operations of SMH.  SMH is an investment banking and brokerage firm whose activitiesprimarily include securities underwriting, private placements, andinstitutional and retail brokerage services. The Company’s investment management segment includes the operations ofPMT, SMH Capital Advisors and Kissinger.  PMT is a state chartered trust company providing a variety of trustservices, including investment management, estate settlement and retirementplanning.  SMH Capital Advisors providesinvestment management services to investors who include fixed income securitiesas a major part of their

 

11

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investmentportfolios.  Kissinger providesfinancial planning services to individuals. The following summarizes certain financial information of eachreportable segment for the three and six months ended June 30, 2002 and 2001,respectively.

 

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| **(in thousands)**                                                                                          |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |   |
|-------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|--------|
| **Three Months Ended June 30, 2002**                                                                        |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                                    |   | $                                      | 17,620 |                       | $      | 1,585                    |   | $                       | 4      |   | $ | 19,209 |   |
| Amortization  of intangible assets                                                                          |   | —                                 |   | —                     |   | —                   |   | —                  |   |
| Other  expenses                                                                                             |   | (15,797                                | )      | (1,298                     | )      | (530                     | )      | (17,625                 | )      |
| Income  (loss) before equity in income (loss) 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 |   |
| **Three Months Ended June 30, 2001**                                                                        |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                                    |   | $                                      | 13,148 |                       | $      | 1,107                    |   | $                       | 60     |   | $ | 14,315 |   |
| Amortization  of intangible assets                                                                          |   | (341                                   | )      | —                     |   | (208                     | )      | (549                    | )      |
| Other  expenses                                                                                             |   | (11,180                                | )      | (1,024                     | )      | (530                     | )      | (12,734                 | )      |
| Income  (loss) before equity in income of limited partnerships, income taxes and  minority interests        |   | 1,627                                  |   | 83                         |   | (678                     | )      | 1,032                   |   |
| Equity  in income of limited partnerships                                                                   |   | 11                                     |   | —                     |   | —                   |   | 11                      |   |
| Income  (loss) before income taxes and minority interests                                                   |   | $                                      | 1,638  |                       | $      | 83                       |   | $                       | (678   | ) | $ | 1,043 |   |

 
| **(in thousands)**                                                                                   |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |   |
|------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|--------|
| **Six Months Ended June 30, 2002**                                                                   |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                             |   | $                                      | 37,118 |                       | $      | 2,894                    |   | $                       | 20     |   | $ | 40,032 |   |
| Amortization  of intangible assets                                                                   |   | —                                 |   | —                     |   | —                   |   | —                  |   |
| Other  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 |   |
| **Six Months Ended June 30, 2001**                                                                   |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                             |   | $                                      | 27,625 |                       | $      | 1,839                    |   | $                       | 204    |   | $ | 29,668 |   |
| Amortization  of intangible assets                                                                   |   | (681                                   | )      | —                     |   | (370                     | )      | (1,051                  | )      |
| Other  expenses                                                                                      |   | (22,797                                | )      | (1,718                     | )      | (1,023                   | )      | (25,538                 | )      |
| Income  (loss) before equity in loss of limited partnerships, income taxes and  minority interests   |   | 4,147                                  |   | 121                        |   | (1,189                   | )      | 3,079                   |   |
| Equity  in loss of limited partnerships                                                              |   | (165                                   | )      | —                     |   | —                   |   | (165                    | )      |
| Income  (loss) before income taxes and minority interests                                            |   | $                                      | 3,982  |                       | $      | 121                      |   | $                       | (1,189 | ) | $ | 2,914 |   |

 
| **(in thousands)**                    |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |   |
|---------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|--------|
| Total  assets as of June 30, 2002     |   | $                                      | 72,248 |                       | $      | 6,007                    |   | $                       | 31,451 |   | $ | 109,706 |   |
| Total  assets as of December 31, 2001 |   | $                                      | 67,408 |                       | $      | 5,997                    |   | $                       | 31,904 |   | $ | 105,309 |   |

 

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**9.             EMPLOYEE BENEFIT PLANS**

 

Under its 1998 IncentivePlan as amended, the Company has reserved 25% of the issued and outstandingCommon Stock of the Company, or 4,000,000 shares of  Common Stock, whichever is greater, for the purpose of issuingincentive awards under the Incentive Plan. The Company had 1,644,861 shares of Common Stock available for grantunder the Incentive Plan at June 30, 2002.

 

**StockOptions**

 

The Incentive Planprovides for the issuance to eligible employees of, among other things,incentive and non-qualified stock options, that may expire up to 10 years fromthe date of grant.   The outstandingoptions vest over varying periods and have an exercise price equal to theclosing price of the Company’s stock on the date of the grant.

 

**Restrictedand Capital Incentive Plan (“CIP”)**

 

Effective January 2,2001, the Company adopted the CIP under its Incentive Plan in which eligibleemployees may purchase shares of the Company’s restricted common stock at aprice equal to 66.6% of the 20-day average of the closing sales prices for ashare of the Company’s common stock, ending on the day prior to the date theshares are issued.  The CIP was amendedeffective November 1, 2001 to include eligible consultants as potentialparticipants under the program.

 

All shares issued arevalued at the closing price on the date the shares are issued.  Consideration paid through the deferral ofsalaries, commissions, or discretionary bonuses is recorded as compensationexpense on the date the shares are issued. The difference between the value of the shares issued and theconsideration paid is recorded as unearned compensation and is shown as aseparate component of shareholders’ equity. Additionally, shares are issued under the CIP in conjunction with notesreceivable, which are also shown as a separate component of shareholders’equity. Unearned compensation and the notes receivable are amortized tocompensation expense over the three-year vesting periods.  The value of shares issued under the CIPaggregated $1.8 million and $917,000, respectively, during the six months endedJune 30, 2002 and 2001.  Additions tounearned compensation aggregated $714,000 and $395,000, respectively, duringthe six months ended June 30, 2002 and 2001. Additions to notes receivable aggregated $518,000 during the six monthsended June 30, 2002.  Amortization ofunearned compensation and notes receivable during the six months ended June 30,2002 was $289,000 and $233,000, respectively. Amortization of unearned compensation was $25,000 during the six monthsended June 30, 2001.

 

**10.          RELATED PARTIES**

 

The Company had receivablesfrom related parties totaling $5.3 million at June 30, 2002, primarilyconsisting of $1.8 million of unpaid management fees earned on the Company’sinvestments in limited partnerships and $2.9 million of notes receivable fromemployees.

 

14

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**Item 2.  *Management’s Discussion andAnalysis of Financial Condition and Results of Operations***

 

The followingdiscussion should be read in conjunction with the Condensed ConsolidatedFinancial Statements and their related notes.

 

**General**

 

We providediversified financial services through our subsidiaries, includinginstitutional and retail brokerage, investment banking, merchant banking, trustrelated services, investment management and financial planning. All of theseactivities are highly competitive and are sensitive to many factors outside ourcontrol, including those factors listed under “Factors AffectingForward-Looking Statements.”

 

We closely monitorour operating environment to enable us to respond promptly to market cycles. Inaddition, we seek to lessen earnings volatility by controlling expenses,increasing fee-based business and developing new revenue sources. Nonetheless,operating results for any specific period should not be consideredrepresentative of future performance.

 

On April 5, 2001,we acquired Kissinger Financial Services, Inc. (“Kissinger”).  The former owner of Kissinger received atotal of 600,000 of our common shares. Kissinger, based in Baltimore, Maryland, provides financial planning servicesto individuals.  The acquisition wasaccounted for under the purchase method, and thus, the financial informationfor Kissinger has been included in our consolidated financial statements fromApril 5, 2001.

 

On January 2,2002, the former institutional equity professionals of Sutro & Co. (the“Juda Group”) joined Sanders Morris Harris. The 23 professionals that make up the Juda Group complemented SandersMorris Harris’ existing institutional division by increasing our customer baseand by adding equity research coverage in areas that we did not previouslyserve.  As an inducement for theprincipal of the Juda Group to join Sanders Morris Harris, we issued anaggregate of 357,909 shares of SMHG common stock to the principal under our1998 Incentive Plan at a total purchase price that represented effectively a 331/3% discount to the then closing sales price of our common stock on the NasdaqNational Market.  Approximatelyone-third of these shares, or 107,223 shares, vest over a three year period,with 50% of these shares vesting after one year and 25% of these shares vestingafter the second and third years.

 

**Componentsof Revenues and Expenses**

 

*Revenues*.              Our revenues are comprisedprimarily of (1) commission revenue from retail and institutional brokeragetransactions, fees from asset-based advisory services, and principal and agenttransactions, (2) investment banking revenue from corporate finance fees,mergers and acquisitions fees and merchant banking fees and (3) fees from assetmanagement, financial planning and fiduciary services.  We also earn interest on the cash held anddividends received from the equity securities held by us for our corporatecapital accounts and have gains (or losses) 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.  Other sources of revenue include revenueearned from gains on the sale of securities held in our corporate accounts, andfrom realized and unrealized gains (or losses) on securities in our possession.

 

*Expenses.*              Our expenses consist of (1)employee compensation and benefits, (2) brokerage and clearing costs, (3)interest expense and (4) other expenses. Compensation and benefits is our largest expense item and includeswages, salaries and benefits. During the first six months of 2002, compensationand benefits represented 72% of total expenses, and 65% of total revenues.  Compensation and benefits have both avariable component based on revenue production and a fixed component.  The variable component includesinstitutional and retail sales commissions, bonuses, overrides, and tradingdesk incentives.  Retail andinstitutional commissions are based on a competitive commission schedule.  The investment banking group and theresearch group receive a salary and discretionary bonus as compensation.  The fixed component 

 

15

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includes administrativeand executive salaries, payroll taxes, employee benefits and temporary employeecosts.

 

Brokerage andclearance expenses include clearing and settlement costs associated with theretail and institutional brokerage business at SMH.  SMH clears its transactions primarily through the PershingDivision of Donaldson, Lufkin and Jenrette Securities Corporation, a CreditSuisse First Boston Company, and other clearing brokers.

 

Other expensesinclude (1) occupancy and equipment expenses, such as rent and utility chargesfor facilities, and (2) communications and data processing expenses, such asthird-party systems, data, and software program providers.

 

Amortizationexpense in 2001 reflects the amortization of the goodwill recorded throughmergers and acquisitions.

 

**Results of Operations**

 

*Three Months Ended June 30, 2002 Compared to Three MonthsEnded June 30, 2001*

 

In January 2002, 23 former institutional equity professionals of the JudaGroup joined Sanders Morris Harris complementing our existing institutionaldivision by increasing our customer base and by adding equity research coveragein areas that we did not previously serve. Accordingly, the addition of the Juda Group is reflected in ouroperating results for the three months ended June 30, 2002, but not for thecomparable second quarter in 2001.

 

Totalrevenues rose to $19.2 million in 2002 from $14.3 million in 2001 primarily dueto an increase in commission revenue resulting from the addition of the formerinstitutional equity professionals of the Juda Group.  Total expenses for the period increased to $17.6 million from$13.3 million in the previous year primarily due to compensation expensesrelated to the increase in revenues, and to the increase in other expensesassociated with the addition of the Juda Group.  Equity in income of limited partnerships increased from $11,000during the second quarter of 2001 to $193,000 during the second quarter of2002, primarily due to increases in the values of certain securities held inthe investment portfolios of the limited partnerships managed by theCompany.  Net income for the threemonths ended June 30, 2002 increased to $1.1 million from $479,000 in2001.  Approximately $549,000 of theincrease in net income is attributable to a goodwill charge incurred in 2001without a corresponding charge during 2002. Basic and diluted earnings per share was $0.07 for the three monthsended June 30, 2002 compared to $0.03 for the same period in 2001.

 

Commissionsrevenue increased to $11.4 million in 2002 from $6.0 million in 2001, primarilyas a result of the addition of the Juda Group. Principal transactions revenue totaled $612,000 in 2002 versus $2.9million in 2001, mainly due to a decline in fixed income brokerage revenuesfrom $2.6 million in 2001 to $385,000 during 2002.  This drop in revenues from fixed income brokerage is directlyrelated to the relatively stable interest rate environment during the secondquarter of 2002, compared to the declining interest rate scenario during theprior year period.  Investment bankingrevenue increased to $4.1 million in 2002 from $2.9 million in 2001,principally due to an increase in fees earned from the Company’s participationin various syndicates that underwrite and distribute securities.  Revenues from fiduciary, custodial andadvisory fees increased to $1.9 million in 2002 from $1.6 million in 2001,reflecting an increase in fees earned from asset-based advisory services.  Interest and dividend income declined to$461,000 in 2002 from $498,000 in the same period last year reflecting a declinein interest rates from 2001 to 2002. Other income increased from $394,000 during 2001 to $750,000 during2002, due to an increase in interest earned on the Company’s cash balances andcustomer credit balances at the Company’s clearing brokers.

 

Duringthe three months ended June 30, 2002, employee compensation and benefits,increased to $12.5 million from $8.4 million in the same period last year dueto the increase in revenues and the addition of the Juda Group.  Floor brokerage, exchange and clearance feesincreased to $1.1 million in 2002 from $849,000 in 2001 reflecting increasedclearing and execution costs resulting from the additional trading volume

 

16

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attributableto the Juda Group.  Communication anddata processing costs (including quotes and market data services) declined to$900,000 in 2002 from $982,000 in the same period last year reflecting theresults of the Company’s efforts to improve the efficient use of purchasedmarket data services, as well as the negotiation of lower prices for certainpurchased services.  Occupancy costsincreased to $1.2 million in 2002 from $932,000 in 2001 due to the additionalrent expense for office leases for the Juda Group.  Due to adoption of SFAS No. 142 on January 1, 2002, the Companyno longer amortizes goodwill.  Duringthe second quarter of 2001, goodwill amortization totaled $549,000.  Other general and administrative expensesincreased to $2 million from $1.6 million mainly due to the addition of theJuda Group.

 

The effective tax rate from operations was 37.4% for the three monthsended June 30, 2002 compared to 53.9% for the three months ended June 30,2001.  Our effective tax rate exceedsthe federal statutory income tax rate primarily as a result of nondeductiblegoodwill amortization in 2001 and state income taxes for both 2002 and 2001.

 

###### *Six Months Ended June 30, 2002 Compared to SixMonths Ended June 30, 2001*

 

Kissinger was acquired on April 5, 2001, hence their operating resultsare not included in the Company’s financial statements for the first threemonths of 2001.  The data for the sixmonths ended June 30, 2002 reflects the operating results of Kissinger for theentire period.  The January 2, 2002addition of the Juda Group is reflected in our operating results for the sixmonths ended June 30, 2002, but not for the comparable first half of 2001.

 

Total revenues rose to $40 million in 2002 from $29.7 million in 2001primarily due to an increase in revenues resulting from the addition of theJuda Group and from the acquisition of Kissinger.  Total expenses for the period increased to $35.9 million from$26.6 million in the previous year principally due to compensation expensesrelated to the increase in revenues, and to the increase in other expensesassociated with the addition of the Juda Group and the acquisition ofKissinger.  Equity in income (loss) oflimited partnerships increased from a loss of $165,000 during the first sixmonths of 2001 to income of $817,000 during the first half of 2002, primarilydue to increases in the values of certain securities held in the investmentportfolios of the limited partnerships managed by the Company.  Net income for the six months ended June 30,2002 increased to $3.1 million in 2002 from $1.4 million in 2001.  Approximately $1.1 million of the increasein net income is attributable to goodwill amortization incurred in 2001 withoutany corresponding amortization charge during 2002.  Basic and diluted earnings per share was $0.19 and $0.18,respectively, for the six months ended June 30, 2002 compared to $0.09 for thesame period in 2001.

 

Commissions revenue increased to $21 million in 2002 from $12.6 millionsin 2001, primarily as a result of the addition of the Juda Group. Principaltransactions revenue totaled $5.4 million in 2002 versus $4.9 million in2001.  The increase in principaltransaction revenues represents a rise in revenues of $600,000 derived fromfixed income brokerage, partially offset by a decline of $400,000 in the valueof warrants received from investment banking transactions.  Investment banking revenue increased to $7.8million in 2002 from $6.9 million in 2001, primarily due to an increase in feesearned from the Company’s participation in various syndicates that underwriteand distribute securities. Revenues from fiduciary, custodial and advisory feesincreased from $3.2 million in 2001 to $3.6 million in 2002, mainly due to anincrease in fees earned from asset-based advisory services. Interest anddividend income declined to $887,000 in 2002 from $1.2 million in the sameperiod last year reflecting a decline in interest rates from 2001 to 2002.  Other income increased to $1.3 million in2002 from $755,000 in 2001, due to an increase in interest earned on theCompany’s cash balances and customer credit balances at the Company’s clearingbrokers.

 

During the six months ended June 30, 2002, employee compensation andbenefits increased to $25.9 million from $17.2 million in the same period lastyear due to the increase in revenues resulting from the addition of the JudaGroup and the acquisition of Kissinger. Floor brokerage, exchange and clearance fees increased to $2 million in2002 from $1.7 million in 2001, reflecting increased clearing and executioncosts resulting from the additional trading volume attributable to the JudaGroup.  Communication and dataprocessing costs, (including quotes and market data services) totaled $1.9million for the six months ended June 30, 2002 and 2001.   Occupancy costs increased to $2.2 million in2002 from $1.8 million in 2001

 

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primarilydue to the additional rent expense for office leases for the Juda Group andKissinger.  Due to adoption of SFAS 142on January 1, 2002, the Company no longer amortizes goodwill.   During the first half of 2001, goodwillamortization totaled $1.1 million. Other general and administrative expenses increased to $3.9 million from$2.9 million mainly due to the addition of the Juda Group and the acquisitionof Kissinger.

 

The effective tax rate from operations was 37.9% for the six months endedJune 30, 2002 compared to 55.8% for the six months ended June 30, 2001.  Our effective tax rate exceeds the federalstatutory income tax rate primarily as a result of nondeductible goodwillamortization in 2001 and state income taxes for both 2002 and 2001.

 

**Liquidity and Capital Resources**

 

We intend tosatisfy a large portion of our funding needs with our own capital resources,consisting largely of internally generated earnings and liquid assets wecurrently hold.

 

At June 30, 2002,we had approximately $30.3 million in cash and cash equivalents, which togetherwith receivables from broker-dealers, deposits with clearing brokers,marketable securities owned, and securities available for sale representedabout 33% of our total assets at the end of the second quarter.

 

For the six monthsended June 30, 2002, net cash provided by operations totaled $3.5 millionversus cash used in operations of $6.3 million during the first half of2001.  Accounts receivable increased by$6.8 million during the first half of 2001, primarily due to increases inmanagement fees and notes receivable from the Company’s proprietary funds, andin notes receivable from other related parties.  Other liabilities, consisting of net liabilities of discontinuedoperations, declined by $1.8 million during the six months ended June 30, 2001,principally due to the sale of the remaining assets of Spires and the paymentof final expenses associated with the disposition of Engineered Systems,Inc.  Accounts payable and accruedliabilities increased by $984,000 during the first six months of 2002,primarily due to increases in accrued compensation costs and dividends payable.

 

Capitalexpenditures for the first half of 2002 were $1.6 million, mainly for thepurchase of furniture and computer equipment and software, as well as forleasehold improvements, necessary for our growth.  During the first six months of 2002, we reacquired 116,268 of ourcommon shares at a total cost of approximately $582,000.

 

At June 30, 2002,SMH, our registered broker-dealer subsidiary, was in compliance with the netcapital requirements of the Securities and Exchange Commission’s Uniform NetCapital Rules and had capital in excess of the required minimum.  PMT was in compliance with the TexasDepartment of Banking net capital requirement and had capital in excess of therequired minimum.

 

We are a party tovarious legal proceedings that are of an ordinary or routine nature incidentalto our operations.  We believe we haveadequately reserved for such litigation matters and that they will not have amaterial adverse effect on our consolidated financial condition, results ofoperations, or cash flows.

 

A portion of ourassets is highly liquid and short-term in nature, consisting of cash and assetsreadily convertible into cash. Securities borrowed and securities loaned, along with receivables fromcustomers and payables to customers, fluctuate as a result of the changes inthe level of positions held to facilitate customer transactions and changes inmarket conditions.  Receivables fromothers and payables to others fluctuate primarily due to the change inadjustment to securities owned on a trade date basis.

 

**Factors Affecting Forward-Looking Statements**

 

This quarterly report onForm 10-Q includes “forward–looking statements” within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities and Exchange Act of 1934, as amended (the “Acts”). These forward–lookingstatements may relate to such matters as anticipated financial performance,future revenues or earnings, business prospects, projected ventures, newproducts,

 

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anticipated marketperformance and similar matters. The Private Securities Litigation Reform Actof 1995 provides a safe harbor for forward–looking statements. To complywith the safe harbor, the Company cautions readers that a variety of factorscould cause the Company’s actual results to differ materially from theanticipated results or other expectations expressed in the Company’s forward–lookingstatements. These risks and uncertainties, many of which are beyond theCompany’s control, include, but are not limited to (1) trading volume in thesecurities markets; (2) volatility of the securities markets and interestrates; (3) changes in regulatory requirements, which could affect the demandfor the Company’s services or the cost of doing business; (4) general economicconditions, both domestic and foreign, especially in the regions where theCompany does business; (5) changes in the rate of inflation and related impacton securities markets; (6) competition from existing financial institutions andother new participants in the securities markets; (7) legal developmentsaffecting the litigation experience of the securities industry; (8) successfulimplementation of technology solutions; (9) changes in valuations of theCompany’s trading and warrant portfolios resulting from mark-to-marketadjustments; (10) dependence on key personnel and (11) demand for the Company’sservices. The Company does not undertake to publicly update or revise anyforward–looking statements.

 

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

 

**Market Risks**

 

At June 30, 2002,PMT had equity securities under management with a fair value of $456million.  PMT’s fee income for the sixmonths ended June 30, 2002 would have been reduced by approximately $103,000assuming a hypothetical 10% decrease in the value of its equity securitiesunder management.  PMT’s fee incomecould also be reduced from changes in interest rates to the extent that suchchanges reduce the carrying value of securities under management.  Additionally, PMT’s securities available forsale are recorded at a fair value of approximately $3.5 million at June 30,2002.  These securities are subject toequity price risk.  These securitieshave an original cost of $3.7 million. At June 30, 2002, the unrealized decline in market value totaling$202,000, less tax benefit of $71,000, has been included as a separatecomponent of shareholders’ equity.

 

Managementevaluates the realizability of securities available for sale to determine if adecline in value is other than temporary. Such evaluation considers the length of time and the extent to whichmarket value has been less than cost, the financial condition and near-termprospects of the issuer, and the intent and ability of the Company to retainits investment in the issuer for a period of time sufficient to allow for anyanticipated recovery in market value. Management believes the unrealized losses are temporary at June 30,2002.  However, a write-down accountedfor as a realized loss may be necessary in the future.

 

SMH’s tradingequity securities are marked to market on a daily basis.  At June 30, 2002, SMH’s trading equitysecurities were recorded at a fair value of approximately $1.1 million.  These trading equity securities are subjectto equity price risk.  This risk wouldamount to approximately $110,000 based on a potential loss in fair value from ahypothetical 10% decrease in the market value of such equity securities.  The actual equity price risk related to thetrading equity securities may differ substantially.

 

**PART II.   OTHERINFORMATION**

 

**Item 1.  *LegalProceedings***

 

We are a party tovarious legal proceedings that are of an ordinary or routine nature incidentalto our operations.  Certain of ourlitigation and claims are covered by insurance with a maximum deductible of$50,000.    We believe we haveadequately reserved for such litigation matters and that they will not have amaterial adverse effect on our consolidated financial condition, results ofoperations, or cash flows.

 

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**Item4. ***Submission of Matters to a Vote of Security Holders*

 

On May 30, 2002,the Company held its annual meeting of shareholders to:

 

(1)                                votefor election to the Company’s Board of Directors; and

 

(2)                                approvean amendment to the Company’s 1998 Incentive Plan to increase the number ofshares of our common stock available for incentive awards or incentive stockoptions from the greater of 1,100,000 shares or 15% of the total number ofshares of common stock outstanding to the greater of 4,000,000 shares or 25% ofthe total number of shares of common stock outstanding.  The results of the votes were as follows:

 
|                    |   | **Number of  Shares  Voted For** |   | **Number of  Shares  Voted Against** |   | **Number of  Shares  Withheld** |   | **Number of  Broker  Non-Votes** |   |
|-------------------------|--------|----------------------------------|--------|--------------------------------------|--------|---------------------------------|--------|----------------------------------|--------|
|                    |   |                             |   |                                 |   |                            |   |                             |   |
| Election  of directors: |   |                             |   |                                 |   |                            |   |                             |   |
|                    |   |                             |   |                                 |   |                            |   |                             |   |
| George  L. Ball         |   | 14,311,439                       |   | —                               |   | 472,813                         |   | —                           |   |
| Donald  R. Campbell     |   | 14,347,851                       |   | —                               |   | 436,401                         |   | —                           |   |
| Robert  E. Garrison II  |   | 14,709,652                       |   | —                               |   | 74,600                          |   | —                           |   |
| Titus  H. Harris, Jr.   |   | 14,708,652                       |   | —                               |   | 75,600                          |   | —                           |   |
| Ben  T. Morris          |   | 14,709,652                       |   | —                               |   | 74,600                          |   | —                           |   |
| Nolan  Ryan             |   | 14,329,009                       |   | —                               |   | 455,243                         |   | —                           |   |
| Don  A. Sanders         |   | 14,708,852                       |   | —                               |   | 75,400                          |   | —                           |   |
| John  H. Styles         |   | 14,709,852                       |   | —                               |   | 74,400                          |   | —                           |   |
| W.  Blair Waltrip       |   | 14,441,697                       |   | —                               |   | 342,555                         |   | —                           |   |
| Dan  S. Wilford         |   | 14,709,352                       |   | —                               |   | 74,900                          |   | —                           |   |

 
|                                    |   | **Number of  Shares  Voted For** |   | **Number of  Shares  Voted Against** |   | **Number of  Shares  Abstained** |   | **Number of  Broker  Non-Votes** | ** ** |
|-----------------------------------------|--------|----------------------------------|--------|--------------------------------------|--------|----------------------------------|--------|----------------------------------|------------|
| Approval  to amend  the Incentive Plan: |   | 11,060,481                       |   | 433,005                              |   | 580,363                          |   | —                           |       |

 

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**Item 6**.  ***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).                                                                           |
|                 9.1 |   | Sanders Morris Harris  Group Inc. Capital Incentive Program (as amended and restated effective  November 1, 2001) (filed as Exhibit 10.1 to the Company’s Form 10-Q for the  quarter ended September 30, 2001 (File No. 000-30066) and incorporated herein  by reference). |
|             *99.1                       |   | Certification Pursuant  to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                               |
|             *99.2                       |   | Certification Pursuant  to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                               |

 

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

 

 

(b) Reports onForm 8–K.

 

 

On June 6, 2002,the Company filed a current report on Form 8-K relating to the election of twonew directors, as well as the election of new corporate officers.

 

On June 7, 2002,the Company filed a current report on Form 8-K relating to the declaration byits board of directors of a cash dividend in the amount of $0.025 per share ofcommon stock.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly 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 9, 2002** |                                  |   |
|           |                    |                                       |  |  |  |

 

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