SECURITIES AND EXCHANGECOMMISSION

**Washington,D.C. 20549**

----

**FORM 10-Q**

 

**(mark one)**

**ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDEDSEPTEMBER 30, 2001**

**or**

**o  TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**Commission file No. 0-30066**

 

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**SANDERS MORRIS HARRIS GROUP INC.**

(Exactname of registrant as specified in its charter)

 

| **Texas**                                                        |   | **76-0583569**                         |
|------------------------------------------------------------------|--------|----------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) |   | (I.R.S.  Employer  Identification No.) |
|                                                             |   |                                   |
| **600 Travis, Suite 2900  Houston, Texas 77002**                 |
| (Address  of principal executive office)                         |
|                                                             |   |                                   |
| **(713) 993-4610**                                               |
| (Registrant’s  telephone number, including area code)       |

 

Indicate by checkmark whether the registrant:  (1) hasfiled all 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 beensubject to such filing requirements for the past 90 days.       YES  ý NO   o

 

The number ofshares of the registrant’s Common Stock, par value $0.01 per share, outstandingas of November 5, 2001, was 16,097,754.

 

** **

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

 

# **INDEX**

                                                                                                                                                                                                
| **PART I.**  | **CONDENSED CONSOLIDATED  FINANCIAL INFORMATION** |
|--------------|---------------------------------------------------|
|         |                                              |   |
|         | Item 1.                                           | Financial Statements |
|         |                                              |   |
|         |                                              | Condensed Consolidated  Balance Sheet as of September 30, 2001 and December 31, 2000 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Operations for the Three and Nine Months Ended  September 30, 2001 and 2000 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Shareholders' Equity for the Nine Months Ended  September 30, 2001 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Cash Flows for the Nine Months Ended September 30,  2001 and 2000 (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 Risks |
|         |                                              |   |
| **PART II.** | **OTHER INFORMATION**                             |
|         |                                              |   |
|         | Item 1.                                           | Legal Proceedings |
|         |                                              |   |
|         | Item 6.                                           | Exhibits and  Reports on Form 8-K |

 

**PARTI.  FINANCIAL INFORMATION**

**Item1.  *FinancialStatements***

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

**CONDENSED CONSOLIDATED BALANCE SHEET**

(inthousands, except share and per share amounts)

(unaudited)
|                                                                                                                 |   | **September 30,** |    | **December 31,** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------|------------------|--------|
|                                                                                                                 |   | **2001**          |    | **2000**         |   |
| **ASSETS**                                                                                                           |   |              |    |             |   |
| Cash and cash equivalents                                                                                            |   | $                 | 28,232  |             | $      | 25,059 |   |
| Receivables, net of allowance of $100 and $615, respectively                                                         |   |              |    |             |   |
| Broker-dealers                                                                                                       |   | 1,192             |    | 1,643            |   |
| Customers                                                                                                            |   | 1,768             |    | 2,601            |   |
| Related parties                                                                                                      |   | 5,480             |    | 5,017            |   |
| Other                                                                                                                |   | 335               |    | 397              |   |
| Deposits with clearing brokers                                                                                       |   | 250               |    | 250              |   |
| Securities owned                                                                                                     |   | 9,382             |    | 9,675            |   |
| Securities available for sale                                                                                        |   | 2,332             |    | 4,143            |   |
| Intangible assets, net of accumulated amortization of $3,710 and  $2,096, respectively                               |   | 47,894            |    | 45,103           |   |
| Furniture and equipment                                                                                              |   | 2,068             |    | 2,359            |   |
| Other assets                                                                                                         |   | 2,707             |    | 2,967            |   |
| Total assets                                                                                                         |   | $                 | 101,640 |             | $      | 99,214 |   |
|                                                                                                                 |   |              |    |             |   |
| **LIABILITIES  AND SHAREHOLDERS' EQUITY**                                                                            |   |              |    |             |   |
|                                                                                                                 |   |              |    |             |   |
| Liabilities:                                                                                                         |   |              |    |             |   |
| Accounts payable and accrued liabilities                                                                             |   | $                 | 6,666   |             | $      | 6,800 |   |
| Payable to clearing broker-dealers                                                                                   |   | 17                |    | 35               |   |
| Securities sold, not yet purchased                                                                                   |   | 136               |    | 591              |   |
| Net liabilities of discontinued operations                                                                           |   | 53                |    | 1,676            |   |
| Total liabilities                                                                                                    |   | 6,872             |    | 9,102            |   |
|                                                                                                                 |   |              |    |             |   |
| Commitments and contingencies                                                                                        |   |              |    |             |   |
|                                                                                                                 |   |              |    |             |   |
| Minority interests                                                                                                   |   | 42                |    | 186              |   |
|                                                                                                                 |   |              |    |             |   |
| 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;  16,504,805 and 16,100,512 shares issued, respectively |   | 165               |    | 161              |   |
| Additional paid-in capital                                                                                           |   | 106,947           |    | 103,670          |   |
| Receivables for shares issued                                                                                        |   | (724              | )       | (558             | )      |
| Accumulated deficit                                                                                                  |   | (9,336            | )       | (9,711           | )      |
| Accumulated other comprehensive loss                                                                                 |   | (121              | )       | (452             | )      |
| Unearned compensation                                                                                                |   | (442              | )       | -                |   |
| Treasury stock at cost, 416,608 and 802,124 shares, respectively                                                     |   | (1,763            | )       | (3,184           | )      |
| Total shareholders' equity                                                                                           |   | 94,726            |    | 89,926           |   |
| Total liabilities and shareholders' equity                                                                           |   | $                 | 101,640 |             | $      | 99,214 |   |

 

Theaccompanying notes are an integral part of the condensed financial statements.

 

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS**

(inthousands, except share and per share amounts)

(unaudited)

 
|                                                                                                                                  |   | **Three Months Ended** |    | **Nine Months Ended** |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|---------|-----------------------|--------|
|                                                                                                                                  |   | **September 30,**      |    | **September 30,**     |   |
|                                                                                                                                  |   | **2001**               |    | **2000**              |   | **2001** |   | **2000** |   |
| Revenues:                                                                                                                             |   |                   |    |                  |   |   |   |   |   |
| Commissions                                                                                                                           |   | $                      | 5,278   |                  | $      | 5,591 |   | $ | 17,893 |   | $ | 12,321 |   |
| Principal transactions                                                                                                                |   | 1,175                  |    | 1,239                 |   | 6,096 |   | 3,465 |   |
| Investment banking                                                                                                                    |   | 2,521                  |    | 3,973                 |   | 9,453 |   | 10,690 |   |
| Fiduciary, custodial and advisory fees                                                                                                |   | 1,561                  |    | 1,591                 |   | 4,798 |   | 4,281 |   |
| Interest and dividends                                                                                                                |   | 774                    |    | 615                   |   | 1,982 |   | 1,657 |   |
| Other income                                                                                                                          |   | 392                    |    | 283                   |   | 1,147 |   | 663 |   |
| Total revenues                                                                                                                        |   | 11,701                 |    | 13,292                |   | 41,369 |   | 33,077 |   |
|                                                                                                                                  |   |                   |    |                  |   |   |   |   |   |
| Expenses:                                                                                                                             |   |                   |    |                  |   |   |   |   |   |
| Employee compensation and benefits                                                                                                    |   | 9,002                  |    | 7,408                 |   | 26,226 |   | 17,547 |   |
| Floor brokerage, exchange and clearance fees                                                                                          |   | 724                    |    | 714                   |   | 2,444 |   | 1,858 |   |
| Communications and data processing                                                                                                    |   | 976                    |    | 802                   |   | 2,826 |   | 1,893 |   |
| Occupancy                                                                                                                             |   | 1,109                  |    | 783                   |   | 2,913 |   | 1,895 |   |
| Amortization of intangible assets                                                                                                     |   | 562                    |    | 457                   |   | 1,614 |   | 1,116 |   |
| Other general and administrative                                                                                                      |   | 1,833                  |    | 1,452                 |   | 4,773 |   | 3,514 |   |
| Total expenses                                                                                                                        |   | 14,206                 |    | 11,616                |   | 40,796 |   | 27,823 |   |
|                                                                                                                                  |   |                   |    |                  |   |   |   |   |   |
| Income (loss) from continuing operations before equity in income  (loss) of limited partnerships,income taxes  and minority interests |   | (2,505                 | )       | 1,676                 |   | 573 |   | 5,254 |        |
| Equity in income (loss) of limited partnerships                                                                                       |   | 1,106                  |    | (412                  | )      | 941 |   | (941 | ) |
|                                                                                                                                  |   | (1,399                 | )  | 1,264                 |   | 1,514 |   | 4,313 |   |
| Benefit (provision) for income taxes                                                                                                  |   | 278                    |    | (681                  | )      | (1,336 | ) | (2,210 | ) |
| Minority interests in net loss of consolidated companies                                                                              |   | 115                    |    | 51                    |   | 197 |   | 205 |   |
| Income (loss) from continuing operations                                                                                              |   | (1,006                 | )       | 634                   |   | 375 |   | 2,308 |   |
| Loss from discontinued operations, net of tax                                                                                         |   | -                      |    | -                     |   | - |   | (10,573 | )  |
| Net income (loss)                                                                                                                     |   | $                      | (1,006  | )                     | $      | 634 |   | $ | 375 |   | $ | (8,265 | ) |
|                                                                                                                                  |   |                   |    |                  |   |   |   |   |   |
| Earnings (loss) per share:                                                                                                            |   |                   |    |                  |   |   |   |   |   |
| Basic:                                                                                                                                |   |                   |    |                  |   |   |   |   |   |
| From continuing operations                                                                                                            |   | $                      | (0.06   | )                     | $      | 0.04 |   | $ | 0.02 |   | $ | 0.17 |   |
| From discontinued operations                                                                                                          |   | -                      |    | -                     |   | - |   | (0.78 | ) |
| Basic earnings (loss) per share                                                                                                       |   | $                      | (0.06   | )                     | $      | 0.04 |   | $ | 0.02 |   | $ | (0.61 | ) |
| Diluted:                                                                                                                              |   |                   |    |                  |   |   |   |   |   |
| From continuing operations                                                                                                            |   | $                      | (0.06   | )                     | $      | 0.04 |   | $ | 0.02 |   | $ | 0.17 |   |
| From discontinued operations                                                                                                          |   | -                      |    | -                     |   | - |   | (0.78 | ) |
| Diluted earnings (loss) per share                                                                                                     |   | $                      | (0.06   | )                     | $      | 0.04 |   | $ | 0.02 |   | $ | (0.61 | ) |
|                                                                                                                                  |   |                   |    |                  |   |   |   |   |   |
| Weighted average common shares outstanding:                                                                                           |   |                   |    |                  |   |   |   |   |   |
| Basic                                                                                                                                 |   | 16,042,002             |    | 14,595,367            |   | 15,725,481 |   | 13,505,849 |   |
| Diluted                                                                                                                               |   | 16,042,002             |    | 14,659,097            |   | 15,855,625 |   | 13,505,849 |   |

 

Theaccompanying notes are an integral part of the condensed financial statements.

 

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY**

**For the nine months ended September 30, 2001**

(inthousands)

(unaudited)

** **
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 | **Accumulated** |                 |               |                 |       |                 |       |                 |      |                 |
|------------------------------------------------------------------------------------------------------|--------|------------------|----------------------|-------------|----------------------|----------------|----------------------|-----------------|----------------------|-------------------|----------------------|-----------------|----------------------|--------------------|----------------------|------------|----------------------|------------|----------------------|-----------|----------------------|
|                                                                                                 |   |             |                 |        |                 | **Additional** |                 | **Receivables** |                 |              |                 | **Other**       |                 |               |                 |       |                 |       |                 |      |                 |
|                                                                                                 |   | **Common Stock** |                 | **Paid-In** |                 | **for Shares** |                 | **Accumulated** |                 | **Comprehensive** |                 | **Unearned**    |                 | **Treasury Stock** |                 |       |                 |
|                                                                                                 |   | **Shares**       |                 | **Amount**  |                 | **Capital**    |                 | **Issued**      |                 | **Deficit**       |                 | **Loss**        |                 | **Compensation**   |                 | **Shares** |                 | **Amount** |                 | **Total** |                 |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Balance, December 31, 2000                                                                           |   | 16,101           |                 | $           | 161                  |           | $                    | 103,670         |                 | $                 | (558                 | )               | $                    | (9,711             | )                    | $          | (452                 | )          | $                    | -         |                 | (802 | ) | $ | (3,184 | ) | $ | 89,926 |   |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Issuance of stock for  acquisitions                                                             |   | 150              |            | 2           |            | 1,790          |            | -               |            | -                 |            | -               |            | -                  |            | 600        |            | 2,416      |            | 4,208     |            |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Acquisition of treasury stock                                                                        |   | -                |                 | -           |                 | -              |                 | -               |                 | -                 |                 | -               |                 | -                  |                 | (216       | )                    | (1,000     | )                    | (1,000    | )                    |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Exercise of stock options                                                                            |   | -                |                 | -           |                 | -              |                 | -               |                 | -                 |                 | -               |                 | -                  |                 | 1          |                 | 5          |                 | 5         |                 |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Issuance of restricted stock                                                                         |   | 254              |                 | 2           |                 | 1,487          |                 | (235            | )                    | -                 |                 | -               |                 | (503               | )                    | -          |                 | -          |                 | 751       |                 |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Amortization of unearned compensation                                                                |   | -                |                 | -           |                 | -              |                 | 29              |                 | -                 |                 | -               |                 | 61                 |                 | -          |                 | -          |                 | 90        |                 |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Payment against receivables for shares issued                                                        |   | -                |                 | -           |                 | -              |                 | 40              |                 | -                 |                 | -               |                 | -                  |                 | -          |                 | -          |                 | 40        |                 |
|                                                                                                 |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Comprehensive income:                                                                                |   |             |                 |        |                 |           |                 |            |                 |              |                 |            |                 |               |                 |       |                 |       |                 |      |                 |
| Net income                                                                                           |   | -                |                 | -           |                 | -              |                 | -               |                 | 375               |                 | -               |                 | -                  |                 | -          |                 | -          |                 | 375       |                 |
| Net change in unrealized depreciationof securities available for  sale,net of deferred taxes of $171 |   | -                |       | -           |       | -              |       | -               |       | -                 |       | 331             |       | -                  |       | -          |       | -          |       | 331       |       |
| Total comprehensive income                                                                           |   | -                |                 | -           |                 | -              |                 | -               |                 | -                 |                 | -               |                 | -                  |                 | -          |                 | -          |                 | 706       |                 |
| Balance, September 30, 2001                                                                          |   | 16,505           |                 | $           | 165                  |           | $                    | 106,947         |                 | $                 | (724                 | )               | $                    | (9,336             | )                    | $          | (121                 | )          | $                    | (442      | )                    | (417 | ) | $ | (1,763 | ) | $ | 94,726 |   |
|                                                                                                      |        |                  |                      |             |                      |                |                      |                 |                      |                   |                      |                 |                      |                    |                      |            |                      |            |                      |           |                      |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of the condensed financial statements.

 

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

**CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS**

**For the nine months ended September 30, 2001 and 2000**

(inthousands)

(unaudited)

 
|                                                                                      |   | **2001** | ** ** | **2000** | ** ** |
|-------------------------------------------------------------------------------------------|--------|----------|------------|----------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |   |     |       |     |       |
| Net income (loss)                                                                         |   | $        | 375        |     | $          | (8,265 | ) |
| Adjustments to reconcile  net income (loss) to net cash provided by operating activities: |   |     |       |     |       |
|                                                                                      |   |     |       |     |       |
| Realized loss (gain) on securities available for sale                                     |   | 1,256    |       | (655     | )          |
| Depreciation                                                                              |   | 883      |       | 493      |       |
| Amortization of intangible assets                                                         |   | 1,614    |       | 1,116    |       |
| Stock compensation                                                                        |   | 841      |       | -        |       |
| Minority interests in net loss of consolidated companies                                  |   | (197     | )          | (205     | )          |
| Changes in operating assets and liabilities:                                              |   |     |       |     |       |
| Decrease in receivables                                                                   |   | 1,161    |       | 156,163  |       |
| Decrease in deposits with clearing brokers                                                |   | -        |       | 5,473    |       |
| Decrease in securities owned                                                              |   | 293      |       | 83,398   |       |
| (Increase) decrease in other assets                                                       |   | (2       | )          | 3,057    |       |
| Decrease in securities sold, not yet purchased                                            |   | (455     | )          | (120,238 | )          |
| Increase (decrease) in assets and liabilities of discontinued  operations                 |   | (1,828   | )          | 8,064    |       |
| Decrease in payable to clearing broker-dealers                                            |   | (18      | )          | (118,045 | )          |
| Decrease in accounts payable and accrued liabilities                                      |   | (521     | )          | (3,873   | )          |
| Net cash provided by operating activitie                                                  |   | 3,402    |       | 6,483    |       |
|                                                                                      |   |     |       |     |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |   | -        |       |     |       |
| Capital expenditures                                                                      |   | (549     | )          | (614     | )          |
| Acquisitions, net of cash acquired of $30 and $13,516, respectively                       |   | (35      | )          | 7,785    |       |
| Proceeds from sale of discontinued operations                                             |   | 205      |       | 3,099    |       |
| Purchase of securities available for sale                                                 |   | (829     | )     | (4,820   | )          |
| Proceeds from sales and maturities of securities available for sale                       |   | 1,886    |       | 5,338    |       |
| Net cash provided by investing activities                                                 |   | 678      |       | 10,788   |       |
|                                                                                      |   |     |       |     |       |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |   |     |       |     |       |
| Purchase of treasury stock                                                                |   | (1,000   | )          | (2,292   | )          |
| Collection of receivables for shares issued                                               |   | 40       |       | 87       |       |
| Investment by minority interest                                                           |   | 86       |       | -        |       |
| Distributions to minority interest                                                        |   | (33      | )          | (33      | )          |
| Net cash used in financing activities                                                     |   | (907     | )          | (2,238   | )          |
| Net increase in cash and cash equivalents                                                 |   | 3,173    |       | 15,033   |       |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                          |   | 25,059   |       | 10,495   |       |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                |   | $        | 28,232     |     | $          | 25,528 |   |
|                                                                                      |   |     |       |     |       |
| Noncash investing and financing activities:                                               |   |     |       |     |       |
| Common stock issued for acquisitions                                                      |   | $        | 4,208      |     | $          | 40,027 |   |
| Cash paid for income taxes                                                                |   | $        | 657        |     | $          | - |   |
| Shares issued in exchange for notes                                                       |   | $        | -          |     | $          | (650 | ) |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**Notes to Condensed Consolidated Financial Statements**

**(unaudited)**

 

### **1.     BASIS OFPRESENTATION**

 

###### *Nature of Operations*

 

Through its operating subsidiaries Pinnacle Management & Trust Co.(“PMT”), Sanders Morris Harris Inc. (“SMH”), SMH Capital Advisors, andKissinger Financial Services, Inc. (“Kissinger”), the Company provides a broadrange of financial services, including institutional and retail brokerage,investment banking, merchant banking, trust related services, investmentmanagement and financial planning.  TheCompany serves a diverse group of institutional, corporate and individualclients.

 

The Company merged with and acquired its operating subsidiaries in2001, 2000 and 1999.  The acquisitionswere accounted for using the purchase method, and as a result current periodresults are not comparable to the prior period.

 

OnMay 22, 2001, the Company’s shareholders voted to change the Company’s namefrom Pinnacle Global Group, Inc. to Sanders Morris Harris Group Inc., topresent a more cohesive group identity to our clients and the investment communityas a whole.

###### * *

###### *Consolidation*

 

The unaudited condensed consolidated financial statements of theCompany include the accounts of its wholly owned subsidiaries. All materialintercompany transactions and balances have been eliminated in consolidation.

 

In management's opinion, the unaudited condensed consolidated financialstatements include all adjustments necessary for a fair presentation of ourfinancial position at September 30, 2001, our results of operations for thethree and nine months ended September 30, 2001 and 2000, and our cash flows forthe nine months ended September 30, 2001 and 2000.  All the adjustments are of a normal recurring nature. Interimresults are not necessarily indicative of results for a full year.

 

These financial statements and notes should be read in conjunction withthe Company’s annual report on Form 10-K for the year ended December 31, 2000.

 

###### *Recently Issued Accounting Standards*

###### * *

SFAS No. 141entitled “*Business Combinations*”was issued in June 2001 and became effective July 1, 2001.  SFAS No. 141 requires that all businesscombinations be accounted for using the purchase method of accounting, whichrequires that acquisitions be recorded at fair value as of the date ofacquisition.  The pooling-of-interestsmethod of accounting allowed under prior standards, which reflected businesscombinations using historical financial information, is now prohibited.  SFAS No. 142 entitled "*Goodwill and Other Intangible Assets*"was also issued in June 2001, in concert with SFAS No. 141.  SFAS No. 142 becomes effective for us onJanuary 1, 2002.  On that date, goodwillwill no longer be amortized, but will be tested for impairment using a fairvalue approach.  Currently existinggoodwill ($47.9 million at September 30, 2001) will continue to be amortizedthrough December 31, 2001.  We will notamortize any goodwill resulting from an acquisition made during the remainderof 2001.  SFAS No. 142 requires goodwillto be tested for impairment at a level referred to as a “reporting unit,”generally one level lower than our reportable segments.  SFAS No. 142 requires us to perform thefirst goodwill impairment test on all reporting units within six months ofadoption.  The first step is to comparethe fair value with the book value of a reporting unit.  If the fair value of a reporting unit isless than its book value, the second step will be to calculate the impairmentloss, if any.  We will recognize anyimpairment loss from the initial adoption of SFAS No. 142 as a change inaccounting principle.  After the initialadoption, goodwill of a reporting unit will be tested for impairment on anannual basis and between annual tests if an event occurs or circumstanceschange that would more likely than not reduce the fair value of a reportingunit below its carrying amount.

 

Asof the date of adoption, the Company expects to have unamortized goodwill inthe amount of $47.3 million, which will be subject to the transition provisionsof Statements 141 and 142.  Amortizationexpense related to goodwill was $1.6 million for both the year ended December31, 2000 and the nine months ended September 30, 2001.  Because of the extensive effort needed tocomply with adopting Statements 141 and 142, it is not practicable to reasonablyestimate the impact of adopting these Statements on the Company’s financialstatements at the date of this report, including whether any transitionalimpairment losses will be required to be recognized as the cumulative effect ofa change in accounting principle.

 

*Reclassifications*

 

Certainreclassifications have been made to the 2000 condensed consolidated financialstatements to conform them with the 2001 presentation.   The reclassifications had no effect onretained earnings, results of operations or cash flows as previously reported.

 

### **2.     ACQUISITIONS**

 

On January 29,1999, the Company acquired Harris Webb & Garrison, Inc. (“HWG”), PMT, andSpires Financial, L.P. (“Spires”). The former owners of HWG, PMT, and Spiresreceived 3,562,500 shares of the Company's common stock, which represented49.98% of the outstanding common stock. The acquisitions were accounted for aspurchases and, accordingly, the financial information of HWG, PMT, and Spiresis included in the Company's consolidated financial statements from the date ofacquisition.  The purchase price ofapproximately $31 million exceeded the fair value of identifiable net assetsacquired by approximately $22 million, which has been recorded as goodwill andsubject to SFAS No. 142, which will be implemented in January 2002, is being amortizedon a straight-line basis over 25 years. During the second quarter of 2000, the Company charged off approximately$8.3 million of goodwill related to the discontinuance of operations of Spires.

 

On January 31,2000, HWG merged with Sanders Morris Mundy Inc. (“SMM”). SMM survived themerger, became a wholly owned subsidiary of the Company and was renamedSMH.  The former owners of SMM received7,125,220 shares of the Company's common stock in the merger, which representedapproximately 50% of the Company's outstanding common stock. The merger wasaccounted for as a purchase and, accordingly, the financial information of SMMhas been included in the Company's consolidated financial statements fromFebruary 1, 2000.  The purchase price ofapproximately $37 million exceeded the fair value of identifiable net assetsacquired by approximately $23 million, which has been recorded as goodwill andsubject to SFAS No. 142, which will be implemented in January 2002, is beingamortized on a straight-line basis over 25 years.

 

On June 30, 2000,SMH acquired Blackford Securities Corporation (“Blackford”).  The former owners of Blackford received1,000,000 shares of the Company’s common stock and $5.5 million in cash.  The acquisition was accounted for as apurchase and, accordingly, the financial information of Blackford has beenincluded in the Company’s consolidated financial statements from June 30,2000.  The purchase price ofapproximately $9.3 million exceeded the fair value of identifiable net assetsacquired by approximately $7.1 million, which has been recorded as goodwill andsubject to SFAS No. 142, which will be implemented in January 2002, is beingamortized on a straight-line basis over 20 years.

 

On October 2, 2000 theCompany acquired the Cummer/Moyers companies (“C/M”).  The former owners of C/M received a total of 850,000 of theCompany’s common shares during October 2000 and an additional 150,000 commonshares in May 2001 for exceeding specified performance levels. The acquisitionwas accounted for as a purchase and, accordingly, the financial information ofC/M has been included in the Company’s consolidated financial statements fromOctober 2, 2000.  The purchase price ofapproximately $5.9 million exceeded the fair value of identifiable net assetsacquired by approximately $5.9 million, which has been recorded as goodwill andsubject to SFAS No. 142, which will be implemented in January 2002, is beingamortized on a straight-line basis over 20 years.  In conjunction with the acquisition, Cummer/Moyers Securities,Inc. (“CMS”), the broker-dealer division of C/M, was merged into SMH, andCummer/Moyers Capital Advisors (“CMCA”), the asset manager division of C/M wassubsequently renamed SMH Capital Advisors and became a direct subsidiary of theCompany.

 

On April 5, 2001, theCompany acquired Kissinger, a Baltimore, Maryland based financial planningfirm.  The former owner of Kissingerreceived a total of 600,000 of the Company’s common shares.  The acquisition was accounted for as apurchase and, accordingly the financial information of Kissinger has beenincluded in the Company’s consolidated financial statements from April 5,2001.  The purchase price ofapproximately $3.4 million exceeded the fair value of identifiable net assetsacquired by approximately $3.5 million, which has been recorded as goodwill andsubject to SFAS No. 142, which will be implemented in January 2002, is beingamortized on a straight-line basis over 20 years.

 

The following summarizedunaudited pro forma financial information assumes the SMM merger and theBlackford, C/M and Kissinger acquisitions occurred on January 1, 2000 andfurther assumes the discontinuance of the operations of Spires on January 1,2000:

 
|                                                                    |   | **Three Months Ended**    |         | **Nine Months Ended**     |       |
|-------------------------------------------------------------------------|--------|---------------------------|--------------|---------------------------|------------|
|                                                                    |   | ** September 30,**   |         | **September 30,**         |       |
|                                                                    |   | **2001**                  | ** **   | **2000**                  | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                                    |   | **(in thousands, except** |         | **(in thousands, except** |       |
|                                                                    |   | **per share amounts** )   |         | **per share amounts)**    |       |
| Revenues                                                                |   | $                         |  11,701 |                      | $          |  14,473 |   | $ |  41,874 |   | $ |  46,631 |   |
| Income (loss) from continuing operations                                |   | (1,006                    | )            | 695                       |       | 226 |   | 3,876 |   |
| Basic and diluted earnings  (loss) per share from continuing operations |   | $                         |  (0.06  | )                         | $          | 0.04 |     | $ | 0.01 |   | $ |  0.23 |     |
|                                                                         |        |                           |              |                           |            |  |  |  |  |  |  |  |  |  |

 

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

 

### **3.     SECURITIESOWNED AND SECURITIES SOLD, NOT YET PURCHASED**

 

Securities owned andsecurities sold, not yet purchased as of September 30, 2001 were as follows:

 

|                          |   |               |       | **Sold, Not Yet** |   |
|-------------------------------|--------|--------------------|------------|-------------------|--------|
|                          |   | **Owned**          |       | **Purchased**     |   |
|                          |   | **(in thousands)** | ** ** |
| Marketable:                   |   |               |       |              |   |
| Corporate stocks              |   | $                  | 2,405      |              | $      | (136 | ) |
|                          |   |               |       |              |   |
| Not readily marketable:       |   |               |       |              |   |
| Partnerships                  |   | 3,954              |       | -                 |   |
| Corporate stocks and warrants |   | 3,023              |       | -                 |   |
|                          |   | $                  | 9,382      |              | $      | (136 | ) |

 

Securities not readilymarketable include investment securities (a) for which there is no market on asecurities exchange or no independent publicly quoted market, (b) that cannotbe publicly offered or sold unless registration has been effected under theSecurities Act of 1933, as amended, or (c) that cannot be offered or soldbecause of other arrangements, restrictions, or conditions applicable to thesecurities or 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, and consist ofEnvironmental Opportunities Fund, L.P., Environmental Opportunities Fund II,L.P., Environmental Opportunities Fund II (Institutional), L.P., Corporate OpportunitiesFund, L.P., Corporate Opportunities Fund (Institutional), L.P., SandersOpportunity Fund, L.P., Sanders Opportunity Fund (Institutional), L.P.,Tactical Opportunities High Yield Fund, L.P., Life Sciences Opportunity Fund,L.P., and PTC-Houston Management, L.P.

 

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

 

Securitiesavailable for sale at September 30, 2001 were as follows:

** **
|                                   |   | **Amortized** |   | **Gross Unrealized** |   | **Estimated** |   |
|----------------------------------------|--------|---------------|--------|----------------------|--------|---------------|--------|
|                                   |   | **Cost**      |   | **Gains**            |   | **Losses**    |   | **Fair Value** |   |
|                                   |   |          |   | **(in thousands)**   |   |          |   |
| U.S. Government and agency obligations |   | $             | 51     |                 | $      | 1             |   | - |   | $ | 52 |   |
| Corporate bonds                        |   | 100           |   | 1                    |   | -             |   | 101 |   |
| Marketable equity securities           |   | 2,364         |   | 21                   |   | (206          | )      | 2,179 |   |
| Total                                  |   | $             | 2,515  |                 | $      | 23            |   | $ | (206 | ) | $ | 2,332 |   |
|                                        |        |               |        |                      |        |               |        |  |  |  |  |  |  |  |

 

The contractual maturities of debt securitiesavailable for sale at September 30, 2001 were as follows:

 

| Due after 1 year through 5 years   |   | $   | 52     |   |
|------------------------------------|--------|-----|--------|--------|
| Due after 5 years through 10 years |   | 101 |   |
|                               |   | $   | 153    |   |

 

Grossgains on sales of securities available for sale were $130,000 and $884,000 forthe nine months ended September 30, 2001 and 2000, respectively.  Gross realized losses, including unrealizedimpairment losses, on securities available for sale were $1,386,000 and$229,000 for the nine months ended September 30, 2001 and 2000, respectively.

 

Managementevaluates securities available for sale to determine if a decline in value isother than temporary.  Such evaluationconsiders the length of time and the extent to which market value has been lessthan cost, the financial condition and near-term prospects of the issuer, andthe intent and ability of the Company to retain its investment in the issuerfor a period of time sufficient to allow for any anticipated recovery in marketvalue.  In the three months endedSeptember 30, 2001, the Company recognized in earnings unrealized losses of$969,000 on securities whose declines in value were deemed other thantemporary.  Management believes theremaining unrealized losses are temporary at September 30, 2001.  However, a write-down accounted for as arealized loss may be necessary in the future.

 

### **5.     INCOMETAXES**

 

The differences between the effective tax ratereflected in the income tax provision (benefit) for continuing operations andthe statutory federal rate were as follows:

 
|                                   |   | **Three Months Ended** |       | **Nine Months Ended** |       |
|----------------------------------------|--------|------------------------|------------|-----------------------|------------|
|                                   |   | **September 30,**      |       | **September 30,**     |       |
|                                   |   | **2001**               | ** ** | **2000**              | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                   |   | **(in thousands****)** | ** ** | **(in thousands)**    | ** ** |
| Tax computed using the statutory rate  |   | $                      | (476       | )                     | $          | 430 |   | $ | 515 |   | $ | 1,467 |   |
| Nondeductible amortization of goodwill |   | 191                    |       | 155                   |       | 549 |   | 379 |   |
| State income taxes and other           |   | 7                      |       | 96                    |       | 272 |   | 364 |   |
| Total                                  |   | $                      | (278       | )                     | $          | 681 |   | $ | 1,336 |   | $ | 2,210 |   |

 

TheCompany's effective tax rate was 88% and 51% for the nine months endedSeptember 30, 2001 and 2000, respectively. The Company's effective tax rate was 20% and 54% for the three monthsended September 30, 2001 and 2000, respectively.

 

### **6.     DISCONTINUEDOPERATIONS**

###### * *

*EnergyRecovery Resources, Inc.*

 

The Board of Directors adopted a plan to discontinue the operations ofEnergy Recovery Resources, Inc. (“ERRI”) effective December 31, 1998.  The assets and liabilities of ERRI were soldon July 13, 2000.  The purchaserretained approximately $566,000 of the sale proceeds to pay for potentialpost-closing balance sheet adjustments related to minimum working capital, netasset value thresholds established in the sale agreement, and certainenvironmental claims.  In January 2001,the threshold shortage was determined to be $361,000, which amount was appliedagainst the retained balance.  Thepurchaser remitted the remaining balance of $205,000 to the Company in July2001.

 

###### *Engineered Systems, Inc.*

 

Engineered Systems, Inc.'s("ESI") operations were discontinued as of December 31, 1995. Theassets of ESI were disposed of on December 23, 1997.  The purchaser agreed to complete customer contracts in process atthe time of the sale. However, the Company remained liable for costs incurredby the purchaser in excess of amounts recoverable from customers. A finalpayment of approximately $250,000 was made during April 2001 to reimburse thepurchaser for completion costs.

 

###### *Spires Financial, L.P.*

 

Spires’ operations werediscontinued in June 2000 due to departures of certain key employees andchanges in the mortgage-backed securities market resulting in part frominterest rate increases.  Spiresincurred net losses of $10.8 million for the year ended December 31, 2000,including goodwill impairment of $8.3 million and $2.5 million, net of tax, foroperating losses, abandoned leases, and other expenses.  The Company retained cash, receivables frombroker-dealers, deposits with clearing brokers, and securities owned, but theother assets and liabilities of Spires totaling $463,000, including proprietarysoftware, databases, and property, were held for sale at December 31, 2000 andwere sold to a company associated with a former officer and director of theCompany in January 2001.  No additionalgain or loss was recorded on the sale.

 

### **7.     COMMITMENTSAND CONTINGENCIES**

 

There were no firm underwriting commitments open at September 30, 2001.

 

The Company and its subsidiaries have obligations under operatingleases that expire by 2007 with initial noncancelable terms in excess of oneyear.  During the first nine months of2001, the Company entered into agreements to sublease two of its office locationsto independent parties.

 

TheCompany has contingent liabilities and potential loss exposures related todiscontinued operations.  The Companymay also be exposed to certain liabilities and claims associated with thediscontinued liquid waste business.  Inconnection with the sale of ERRI, the Company remains contingently liable forcertain environmental claims with a maximum exposure of $2.2 million untilJanuary 2002.  A portion of thesepotential environmental claims is covered by insurance with a maximumdeductible of $50,000 per occurrence. However, at September 30, 2001, the Company is not aware of theexistence of any such environmental claims. The Company believes such potential claims will not have a materialadverse effect on the Company’s consolidated financial condition, results ofoperations, or cash flows.

 

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

 

The Company has uncommitted financing arrangements with clearingbrokers who finance customer accounts, certain broker-dealer balances and firmtrading positions.  Although thesecustomer accounts and broker-dealer balances are not reflected on theconsolidated balance sheet for financial accounting reporting purposes, theCompany has generally agreed to indemnify these clearing brokers for lossesthey may sustain in connection with the accounts and therefore, retains risk onthese accounts.  The Company is requiredto maintain certain cash or securities on deposit with its clearing brokers.

 

**8.     EARNINGS PER COMMON SHARE**

 

Basic and diluted earnings (loss) per-share computations for theperiods indicated were as follows:

 
|                                                                                                        |   | **Three Months Ended September 30,**                   |       |
|-------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|------------|
|                                                                                                        |   | **2001**                                               |       | **2000** | ** ** |
|                                                                                                        |   | **(in thousands, except per share amounts)**** ** | ** ** |
| Computation of basic and diluted earnings (loss) per common share for  the three months ended September 30: |   |                                                   |       |   |   |
| Net income (loss) applicable to common stock                                                                |   | $                                                      | (1,006     | ) | $ | 634 |   |
| Weighted average number of common shares outstanding                                                   |   | 16,042                                                 |       | 14,595 |   |
| Common shares issuable under stock option plan                                                              |   | -                                                      |       | 798 |   |
| Less shares assumed repurchased with proceeds                                                               |   | -                                                      |       | (734 | ) |
| Weighted average common shares outstanding                                                                  |   | 16,042                                                 |       | 14,659 |   |
| Basic earnings (loss) per common share                                                                      |   | $                                                      | (0.06      | ) | $ | 0.04 |   |
| Diluted earnings (loss) per common share                                                                    |   | $                                                      | (0.06      | ) | $ | 0.04 |   |

 
|                                                                                                       |   | **Nine Months Ended September 30,**                    | ** ** |
|------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|------------|
|                                                                                                       |   | **2001**                                               |       | **2000** | ** ** |
|                                                                                                       |   | **(in thousands, except per share amounts)**** ** | ** ** |
| Computation of basic and diluted earnings (loss) per common share for  the nine months ended September 30: |   |                                                   |       |   |   |
| Net income (loss) applicable to common stock                                                               |   | $                                                      | 375        |   | $ | (8,265 | ) |
| Weighted average number of common   shares outstanding                                                |   | 15,725                                                 |       | 13,506 |   |
| Common shares issuable under stock option plan                                                             |   | 1,099                                                  |       | - |   |
| Less shares assumed repurchased with proceeds                                                              |   | (968                                                   | )          | - |   |
| Weighted average common shares outstanding                                                                 |   | 15,856                                                 |       | 13,506 |   |
| Basic earnings (loss) per common share                                                                     |   | $                                                      | 0.02       |   | $ | (0.61 | ) |
| Diluted earnings (loss) per common share                                                                   |   | $                                                      | 0.02       |   | $ | (0.61 | ) |

 

Stock options outstanding of 50,000 and 202,649 at September 30, 2001and 2000, respectively, have not been included in diluted earnings (loss) percommon share because their inclusion would have been antidilutive for theperiods presented.

 

### **9.     BUSINESSSEGMENT INFORMATION**

 

The Company's continuingbusinesses operate in two reportable business segments.  The Company’s investment banking andbrokerage segment includes the operations of SMH and its predecessor, HWG.  SMH is an investment banking and brokerageservices firm whose activities primarily include securities underwriting andretail brokerage services.  TheCompany’s investment management segment includes the operations of PMT, SMHCapital Advisors and Kissinger.   PMT isa state chartered trust company providing a variety of trust services includinginvestment management, estate settlement, and retirement planning.  SMH Capital Advisors provides investmentmanagement services to investors who include fixed income securities as a majorpart of their investment portfolios. Kissinger provides financial planning services to individuals.  The Spires segment was discontinued during thesecond quarter of 2000.  The followingsummarizes certain financial information of each reportable segment for thethree and nine months ended September 30, 2001 and 2000, respectively.  During the three and nine months endedSeptember 30, 2001, the investment management segment revenues include netrealized losses, including unrealized impairment losses, on securitiesavailable for sale of $1,130,000 and $1,256,000, respectively, compared to netrealized gains of $219,000 and $655,000, respectively, in the comparable prioryear periods.

 
|                                                                                                      |   | **As of or for the Three Months Ended September 30, 2001** |       | **As of or for the Three Months Ended September 30, 2000** | ** ** |
|-----------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
|                                                                                                      |   | **Investment Banking and Brokerage**                       |       | **Investment Management**                                  |       | **Investment Banking and Brokerage** |   | **Investment Management** | ** ** |
|                                                                                                      |   | **(in thousands)**                                         | ** ** | **(in thousands****)**                                     | ** ** |
| Revenues                                                                                                  |   | $                                                          | 11,482     |                                                       | $          | 114 |   | $ | 12,208 |   | $ | 906 |   |
| Income (loss) before  equity in income (loss) of limited partnerships, incometaxes and minority interests |   | (535                                                       | )          | (921                                                       | )          | 2,168 |   | 310 |   |
| Equity in income (loss) of limited partnerships                                                           |   | 1,106                                                      |       | -                                                          |       | (412 | ) | - |   |
| Total assets                                                                                              |   | 65,486                                                     |       | 5,053                                                      |       | 31,804 |   | 5,906 |   |
|                                                                                                           |        |                                                            |            |                                                            |            |  |  |  |  |  |  |  |  |

 
|                                                                                                            |   | **As of or for the Nine Months Ended September 30, 2001** |   | **As of or for the Nine Months Ended September 30, 2000** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|--------|-----------------------------------------------------------|--------|
|                                                                                                            |   | **Investment Banking and Brokerage**                      |   | **Investment Management**                                 |   | **Investment Banking and Brokerage** |   | **Investment Management** | ** ** |
|                                                                                                            |   | **(in thousands****)**                                    |   | **(in thousands)**                                        |   |
| Revenues                                                                                                        |   | $                                                         | 39,108 |                                                      | $      | 1,953 |   | $ | 29,454 |   | $ | 2,591 |   |
| Income (loss) before  equity in income (loss) of limited partnerships, income taxes and minority interests |   | 4,293                                                     |   | (800                                                      | )      | 5,837 |   | 995 |   |
| Equity in income (loss) of limited partnerships                                                                 |   | 941                                                       |   | -                                                         |   | (941 | ) | - |   |
| Total assets                                                                                                    |   | 65,486                                                    |   | 5,053                                                     |   | 31,804 |   | 5,906 |   |
|                                                                                                                 |        |                                                           |        |                                                           |        |  |  |  |  |  |  |  |  |

 

The following table reconciles the reportable segments to theconsolidated income (loss) from continuing operations before equity in income(loss) of limited partnerships, income taxes and minority interests reported inthe condensed statement of operations for the three and nine months endedSeptember 30, 2001 and 2000, respectively:

 
|                                                                                                                                  |   | **Three Months Ended   September 30,** |       | **Nine Months Ended   September 30,** |       |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                                                                                                                  |   | **2001**                               | ** ** | **2000**                              | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                                                                                                  |   | **(in thousands)**                     | ** ** | **(in thousands****)**                | ** ** |
| Income (loss) before equity in income (loss) of limitedpartnerships,  income taxes and minority interests:                            |   |                                   |       |                                  |       |   |   |   |   |
| Investment Banking and Brokerage                                                                                                      |   | $                                      | (535       | )                                     | $          | 2,168 |   | $ | 4,293 |   | $ | 5,837 |   |
| Investment Management                                                                                                                 |   | (921                                   | )          | 310                                   |       | (800 | ) | 995 |   |
|                                                                                                                                  |   | (1,456)                                |       | 2,478                                 |       | 3,493 |   | 6,832 |   |
|                                                                                                                                  |   |                                   |       |                                  |       |   |   |   |   |
| Amortization of intangible assets                                                                                                     |   | (562                                   | )          | (457                                  | )          | (1,614 | ) | (1,116 | ) |
| Corporate revenues and expenses, net                                                                                                  |   | (487                                   | )          | (345                                  | )          | (1,306 | ) | (462 | ) |
| Income (loss) from continuing operations before equity in income  (loss) of limited partnerships, income taxes and minority interests |   | $                                      | (2,505     | )                                     | $          | 1,676 |   | $ | 573 |   | $ | 5,254 |   |

 

### **10.  INCENTIVE PLAN**

 

Effective January 1, 2001,the Company adopted a deferred compensation program under the Company’s 1998Incentive Plan in which eligible employees may receive shares of the Company’srestricted common stock at a price equal to 66.6% of the 20-day average of theclosing sales prices for a share of the Company’s common stock, as reported onthe National Association of Securities Dealers Automated Quotation System(“NASDAQ”), ending on the day prior to the date the shares are issued.  The shares issued are valued at the closingsales price on the date the shares are issued. The difference between the value of the shares issued and thecompensation expense recorded is classified as unearned compensation and isshown as a separate component of shareholders’ equity.  The deferred compensation program wasamended effective November 1, 2001 to include eligible consultants as potentialparticipants under the program.

 

**11.  COMPREHENSIVE INCOME  (LOSS)**

 

Comprehensive income (loss) consists of the following:

 
|                                                                                 |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|--------------------------------------------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                                                                 |   | **2001**                              | ** ** | **2000**                             | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                                                 |   | **(in thousands****)**                | ** ** | **(in thousands)**                   | ** ** |
| Net income (loss)                                                                    |   | $                                     | (1,006     | )                                    | $          | 634 |   | $ | 375 |   | $ | (8,265 | ) |
| Other comprehensive income (loss), net of tax:                                       |   |                                  |       |                                 |       |   |   |   |   |
| Unrealized appreciation (depreciation) on securities available for  sale             |   | 1,096                                 |       | (371                                 | )          | 1,110 |   | (590 | ) |
| Reclassification adjustment for realized gains (loss) included in net  income (loss) |   | (700                                  | )          | 136                                  |       | (779 | ) | 406 |   |
| Net change in unrealized depreciation on securities available for  sale, net of tax  |   | 396                                   |       | (235                                 | )          | 331 |   | (184 | ) |
| Total comprehensive income (loss)                                                    |   | $                                     | (610       | )                                    | $          | 399 |   | $ | 706 |   | $ | (8,449 | ) |

 

**12.  RELATEDPARTIES**

 

The Company had receivablesfrom related parties totaling $5,686,000 at September 30, 2001, primarilyconsisting of $2,024,000 of unpaid management fees earned on the Company’sinvestments in limited partnerships and $3,323,000 of notes receivable fromemployees.

 

The Company consolidatedcertain notes receivable and advanced an additional $1.3 million to the limitedpartnerships during the nine months ended September 30, 2001, resulting in anew note in the original principal amount of $2,847,000.  This note was repaid in full during thethird quarter of 2001.

 

During the first quarter of2001, the Company amended the notes receivable from shareholders (for sharesissued) to allow the shareholders to commence payment in January 2002 andcontinuing thereafter for seven years.

 

**Item 2.**    ***Management’s Discussion and Analysis of Financial Conditionand Results of Operations***

 

The following discussion should be read in conjunction with theCondensed Consolidated Financial Statements and their related notes.

 

**General**

 

Weprovide diversified 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 monitor our operating environment to enable us to respondpromptly to market cycles. In addition, we seek to lessen earnings volatilityby controlling expenses, increasing fee-based business and developing newrevenue sources. Nonetheless, operating results for any specific period shouldnot be considered representative of future performance.

 

Certain assets and liabilities of Spires Financial, L.P. (“Spires”)totaling $463,000, including proprietary software, databases, and property,were held for sale at December 31, 2000 and were sold to a company associatedwith a former officer and director of the Company in January 2001.  No additional gain or loss was recorded onthe sale.

 

On October 2, 2000, we acquired the Cummer/Moyers companies (“C/M”).The former owners of Cummer/Moyers received a total of 850,000 of our commonshares during October 2000 and earned an additional 150,000 common shares inMay 2001 for exceeding specified performance levels.  The acquisition was accounted for under the purchase method, andthus, the financial information of C/M has been included in our consolidatedfinancial statements from October 2, 2000.

 

On April 5, 2001, we acquired Kissinger Financial Services, Inc.(“Kissinger”).  The former owner ofKissinger received a total of 600,000 of our common shares.  Kissinger, based in Baltimore, Maryland,provides financial planning services to individuals.  The acquisition was accounted for under the purchase method, andthus, the financial information for Kissinger has been included in ourconsolidated financial statements from April 5, 2001.

 

On May 22, 2001, the Company’s shareholders voted to change theCompany’s name to Sanders Morris Harris Group Inc., to present a more cohesivegroup identity to our clients and the investment community as a whole.

 

**Componentsof Revenues and Expenses**

 

*Revenues*.       Our revenues are comprised primarily of(1) commission revenue from retail and institutional brokerage transactions, feesfrom asset-based advisory services, and principal and agent transactions, (2)investment banking revenue from corporate finance fees, mergers andacquisitions fees and merchant banking fees and (3) fees from asset management,financial planning and fiduciary services. We also earn interest on the cash held and dividends received from theequity securities held by us for our corporate capital accounts and have gains(or losses) in our inventory account. Interest income results from interest earned on our inventories of fixedincome securities prior to sale, and from interest and dividends earned oninvestments in our capital accounts. Other sources of revenue include revenue earned from gains on the saleof securities held in our corporate accounts, and from realized and unrealizedgains (or losses) on securities in our possession.

 

*Expenses.*       Our expenses consist of (1) compensationand benefits, (2) brokerage and clearing costs, (3) interest expense and (4)other expenses.  Compensation andbenefits is our largest expense item and includes wages, salaries, commissionspaid to retail and institutional brokers and investment and merchant bankers,and benefits. During the first nine months of 2001, compensation and benefitsrepresented 64% of total expenses, and 63% of total revenues.  Compensation and benefits have both avariable component based on revenue production and a fixed component.  The variable component includes institutionaland retail sales commissions, bonuses, overrides, and trading desk incentives.  Retail and institutional commissions arebased on a competitive commission schedule. The investment banking group and the research group receive a salary anddiscretionary bonus as compensation. The fixed component includes administrative and executive salaries,payroll taxes, employee benefits, and temporary employee costs.

 

Brokerage and clearance expenses include clearing and settlement costsassociated with the retail and institutional brokerage business at SMH.  SMH clears its transactions primarilythrough the Pershing Division of Donaldson, Lufkin and Jenrette SecuritiesCorporation, a Credit Suisse First Boston Company, and other clearing brokers.

 

Other expenses include (1) occupancy and equipment expenses, such asrent and utility charges for facilities, and (2) communications and dataprocessing expense, such as third-party systems, data, and software programproviders.

 

Amortization expense reflects the amortization of the goodwill recordedthrough mergers and acquisitions.

 

**Results of Operations**

 

###### *Three Months Ended September 30, 2001 Compared toThree Months Ended September 30, 2000*

 

Our financial results for the third quarter of 2000 include the resultsof operations of Sanders Morris Harris Inc. (“SMH”) and Pinnacle Management& Trust (“PMT”) for the entire period. C/M and Kissinger were acquired on October 2, 2000 and April 5, 2001,respectively; hence their operating results are not included in the Company’sfinancial statements for the three months ended September 30, 2000.

 

Total revenues declined to $11.7 million in 2001 from $13.3 million in2000 reflecting the downturn in the economy, as well as in the overall stockmarket (including closure of the markets for four days in the period), whichhad a negative impact on our equity commission revenues and on underwritingfees derived from public and private offerings.  The events of September 11, 2001 and the subsequent disruption tothe capital markets resulted in an additional decline in commission-basedrevenues during the 2001 third quarter and contributed to lower valuations formany of the Company’s investment securities at September 30, 2001.  Total expenses for the period increased to$14.2 million from $11.6 million in the previous year principally fromcompensation and benefits paid to employees who joined the Company followingthe C/M and Kissinger acquisitions and the creation of the fixed incomebrokerage group.  The Company lost $1.0million, or $0.06 per share, from continuing operations during the three monthsended September 30, 2001, compared to income from continuing operations of$634,000, or $0.04 per share, during the prior year period.

 

Commissions revenue declined to $5.3 million in 2001 from $5.6 millionin 2000 primarily due to the industry-wide slowdown in the financialmarkets.  Principal transactions revenuetotaled $1.2 million in both 2001 and 2000. The third quarter of 2001 includes approximately $3.0 million ofprincipal transaction revenues related to fixed income brokerage, a servicethat was started during the third quarter of 2000.  Income from fixed income brokerage was partially offset by losseson the Company’s available for sale investment portfolio of $1.1 million during2001, compared to gains of $219,000 during the prior year period.  The decline in the equity markets alsocaused a $1.3 million loss in the value of certain warrants received by thefirm in conjunction with its investment banking activities.  The decline in overall stock prices and thereduction in interest rates have caused many investors to shift a portion oftheir investment portfolios into fixed income securities.  Investment banking revenue declined to $2.5million in 2001 from $4.0 million in 2000 mainly due to the decline in underwritingfees earned from public and private offerings caused by the overall weakness inthe stock market. Fiduciary, custodial and advisory fees revenue totaled $1.6million for both 2001 and 2000.  Whilethe Company’s number of accounts under management has increased due to theacquisitions of C/M and Kissinger, the value of those accounts has declinedthus reducing average asset management fees per account.  Interest and dividend income increased to$774,000 in 2001 from $615,000 in the same period last year primarily due tointerest earned on a note receivable from the Company’s investment in a limitedpartnership.

 

For the three months ended September 30, 2001, employee compensationand benefits increased to $9.0 million from $7.4 million in the same periodlast year primarily due to commissions paid on fixed income brokerage, as wellas an increase in the total number of employees at the Company resulting fromthe acquisitions of C/M and Kissinger. Communication and data processing costs, including quotes and marketdata services, increased to $976,000 in 2001 from $802,000 in the same periodlast year principally due to the cost of additional communication andinformation services related to the expanded brokerage and investmentoperations brought about by the acquisitions of C/M and Kissinger, and theaddition of the fixed income trading group. Occupancy costs increased to $1.1 million in 2001 from $783,000 in 2000primarily from the addition of five new office leases at SMH, C/M, andKissinger.  Intangible assetamortization increased to $562,000 from $457,000 as a result of additionalgoodwill recorded in the C/M and Kissinger acquisitions.  Other general and administrative expensesincreased to $1.8 million from $1.5 million mainly due to the acquisitions ofC/M and Kissinger.

 

The effective tax rate from continuing operations was 20% (benefit) forthe three months ended September 30, 2001 compared to 54% (expense) for thethree months ended September 30, 2000. Our effective tax rate typically exceedsthe federal statutory income tax rate primarily as a result of nondeductiblegoodwill amortization and state income taxes.

 

###### *Nine Months Ended September 30, 2001 Compared to NineMonths Ended September 30, 2000*

 

Our financial results for the first nine months of 2000 include theresults of operations of HWG and PMT for the entire period, and SMM andBlackford from the date of merger, January 31, 2000 and June 30, 2000,respectively.  C/M and Kissinger wereacquired on October 2, 2000, and April 5, 2001, respectively; hence theiroperating results are not included in the Company’s financial statements forthe first nine months of 2000.  The datafor the nine months ended September 30, 2001 reflects the operating results ofSMH, PMT, Blackford, and C/M, for the entire period, and Kissinger from the dateof acquisition, April 5, 2001.

 

Total revenues rose to $41.4 million in 2001 from $33.1 million in 2000primarily due to an increase in the number of sales and marketing professionalsfollowing the merger with SMM and the acquisitions of C/M, Blackford, andKissinger, as well as the establishment during the third quarter of 2000 of thefixed income brokerage group.  Totalexpenses for the period increased to $40.8 million from $27.8 million in theprevious year principally due to the additional costs associated with theCompany’s expansion of brokerage and investment management services offered toits customers.  Income from continuingoperations for the nine months ended September 30, 2001 totaled $375,000,compared to $2.3 million in the prior year period.  The decrease in income from continuing operations resulted fromdepressed financial market conditions impacting revenue growth coupled withincreased expenses from acquisitions. Basic and diluted income per share from continuing operations was $0.02 forthe nine months ended September 30, 2001, compared to $0.17 in 2000.

 

Commissions revenue increased to $17.9 million in 2001 from $12.3million in 2000 primarily due to an increase in the number of retail andinstitutional brokers resulting from the acquisitions of C/M and Blackford andthe opening of a new SMH office in Dallas, as well as an increase in mutualfund commissions resulting from the acquisition of Kissinger.  Principal transactions revenue totaled $6.1million in 2001 versus $3.5 million in 2000. The first nine months of 2001 include approximately $6.7 million ofprincipal transaction revenues related to fixed income brokerage, a servicethat SMH first offered during the third quarter of 2000.  This income was partially offset by netlosses on the Company’s available for sale securities totaling $1.3 millionduring 2001, compared to net gains of $655,000 during 2000.  The decline in the equity markets alsocaused a $686,000 loss in the value of certain warrants received by the firm inconjunction with its investment banking activities.  Investment banking revenue declined to $9.5 million in 2001 from$10.7 million in 2000 mainly due to a reduction in fees and commissions earnedthrough public security offerings reflecting the overall weakness in the stockmarket.  Fiduciary, custodial andadvisory fees revenue increased to $4.8 million in 2001 compared to $4.3million in 2000 resulting principally from the addition of approximately 2,500fee based accounts obtained through the acquisitions of C/M and Kissinger andfrom fees earned from SMH’s investments in limited partnerships and from feesearned by brokers to manage individual accounts.  Interest and dividend income increased to $2.0 million in 2001 from$1.7 million in the same period last year primarily due to interest earned on anote receivable from the Company’s investment in a limited partnership.

For the nine months ended September 30, 2001, employee compensation andbenefits increased to $26.2 million from $17.5 million in the same period lastyear.  Due to the merger with SMH andthe acquisitions of Blackford, C/M and Kissinger, total employees increasedfrom 108 at January 1, 2000 to 242 at September 30, 2001.  Floor brokerage, exchange and clearance feesincreased to $2.4 million in 2001 from $1.9 million in 2000 mainly due to theexpansion of brokerage operations related to the Blackford, C/M and Kissingeracquisitions, as well as the opening of the Dallas office and the addition ofthe fixed income trading group at SMH. Communication and data processing costs, including quotes and marketdata services, increased to $2.8 million in 2001 from $1.9 million in the sameperiod last year principally due to the inclusion of Blackford, C/M, andKissinger for the 2001 period. Occupancy costs increased to $2.9 million in 2001 from $1.9 million in2000 primarily from the additional rent expense for office leases at SMH,Blackford, C/M, and Kissinger.  AtJanuary 1, 2000, the Company had three office leases compared to twelve atSeptember 30, 2001.  Intangible assetamortization increased to $1.6 million from $1.1 million primarily as a resultof additional goodwill recorded in the Blackford, C/M, and Kissingeracquisitions.  Other general andadministrative expenses increased to $4.8 million from $3.5 million mainly dueto the Blackford, C/M, and Kissinger acquisitions.

 

The effective tax rate from continuing operations was 88% for the ninemonths ended September 30, 2001 compared to 51% for the nine months endedSeptember 30, 2000. Our effective tax rate exceeds the federal statutory incometax rate primarily as a result of nondeductible goodwill amortization and stateincome taxes.

 

Losses from discontinued operations, net of tax, were $10.6 million inthe first nine months of 2000.  The lossfrom discontinued operations consists of $600,000 related to the July 2000 saleof Energy Recovery Resources, Inc. (“ERRI”), $100,000 associated withadditional costs incurred to complete customer contracts related to the 1997sale of Engineered Systems, Inc. (“ESI”), and $9.9 million related to Spireswhich included an $8.3 million charge for impairment of goodwill and $1.6million, net of tax, for operating losses, abandoned leases, and otherexpenses.

 

**Liquidity and Capital Resources**

 

We intend to satisfy a large portion of our funding needs with our owncapital resources, consisting largely of internally generated earnings andliquid assets we currently hold.

 

At September 30, 2001, we had approximately $28.2 million in cash andcash equivalents, which together with receivables from broker-dealers, depositswith clearing brokers, securities owned, and securities available for salerepresented about 41% of our total assets at quarter-end.

 

For the nine months ended September 30, 2001, net cash provided byoperations totaled $3.4 million versus $6.5 million during 2000.  Current year cash provided by operations wasthe result of decreases in working capital and other adjustments totaling $3.0million combined with net income of $375,000.

 

Capital expenditures for the first three quarters of 2001 were$549,000, mainly for the purchase of furniture and computer equipment andsoftware, as well as for leasehold improvements, necessary for our growth.  During the first three quarters of 2001, wereacquired 215,592 of our common shares at a total cost of approximately$1,000,000.

 

At September 30, 2001, SMH, our registered broker-dealer subsidiary,was in compliance with the net capital requirements of the Securities andExchange Commission's Uniform Net Capital Rules and had capital in excess ofthe required minimum.  PMT was incompliance with the Texas Department of Banking net capital requirement and hadcapital in excess of the required minimum.

 

We are a party to various legal proceedings that are of an ordinary orroutine nature incidental to our operations. We believe we have adequately reserved for such litigation matters andthat they will not have a material adverse effect on our consolidated financialcondition, results of operations, or cash flows.

 

We may be exposed to certain liabilities and claims associated with ourdiscontinued liquid waste business.  Inconnection with the sale of ERRI, we remain contingently liable for potentialenvironmental claims with a maximum exposure of $2.2 million until January2002.  At September 30, 2001, we are notaware of the existence of any such environmental claims.  A portion of such potential claims iscovered by insurance with a maximum deductible of $50,000 per occurrence.  We believe such potential claims will nothave a material adverse effect on our consolidated financial condition, resultsof operations, or cash flows.

 

Aportion of our assets is highly liquid and short-term in nature, consisting ofcash and assets readily 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 from othersand payables to others fluctuate primarily due to the change in adjustment tosecurities 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"). Theseforward-looking statements may relate to such matters as anticipated financialperformance, future revenues or earnings, business prospects, projectedventures, new products, anticipated market performance and similar matters. ThePrivate Securities Litigation Reform Act of 1995 provides a safe harbor forforward-looking statements. To comply with the safe harbor, the Companycautions readers that a variety of factors could cause the Company's actualresults to differ materially from the anticipated results or other expectationsexpressed in the Company's forward-looking statements. These risks and uncertainties,many of which are beyond the Company's control, include, but are not limited to(1) trading volume in the securities markets; (2) volatility of the securitiesmarkets and interest rates; (3) changes in regulatory requirements which couldaffect the demand for the Company's services or the cost of doing business; (4)general economic conditions, both domestic and foreign, especially in theregions where the Company does business; (5) changes in the rate of inflationand related impact on securities markets; (6) competition from existingfinancial institutions and other new participants in the securities markets;(7) legal developments affecting the litigation experience of the securitiesindustry; (8) successful implementation of technology solutions; and (9) demandfor the Company's services. The Company does not undertake to publicly updateor revise any forward-looking statements.

 

**Item 3*. Quantitative and Qualitative Disclosures About Market Risks***

 

**MarketRisks**

 

AtSeptember 30, 2001, PMT had equity securities under management with a fairvalue of $443 million.  PMT's fee incomefor the period ended September 30, 2001 would have been reduced byapproximately $72,000 assuming a hypothetical 10% decrease in the value of itsequity securities under management. PMT's fee income could also be reduced from changes in interest rates tothe extent that such changes reduce the carrying value of securities undermanagement.  Additionally, PMT’ssecurities available for sale are recorded at a fair value of approximately$2.3 million at September 30, 2001. These securities are subject to equity price risk.  These securities have an original cost of$2.5 million.  At September 30, 2001,the unrealized decline in market value totaling $183,000, less tax of $62,000,has been included as a separate component 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 remaining unrealized losses are temporary atSeptember 30, 2001.  However, awrite-down accounted for as a realized loss may be necessary in the future.

 

SMH's trading equity securities are marked to market on a dailybasis.  At September 30, 2001, SMH'strading equity securities were recorded at a fair value of approximately $2.4million.  These trading equitysecurities are subject to equity price risk. This risk would amount to approximately $240,000 based on a potentialloss in fair value from a hypothetical 10% decrease in the market value of suchequity securities.  The actual equityprice risk related to the trading equity securities may differ substantially.

 

**PART II.  OTHERINFORMATION**

 

**Item 1.  *LegalProceedings***

 

We are a party to various legal proceedings that are of an ordinary orroutine nature incidental to our operations. Certain of our litigation and claims are covered by insurance with amaximum deductible of $50,000.    Webelieve we have adequately reserved for such litigation matters and that theywill not have a material adverse effect on our consolidated financialcondition, results of operations, or cash flows.

 

We may be exposed to certain liabilities and claims associated with ourdiscontinued liquid waste business.   Inconnection with the sale of ERRI, we remain contingently liable for certainenvironmental claims with a maximum exposure of $2.2 million until January2002.  At September 30, 2001, we are notaware of any such environmental claims. A portion of such potential claims is covered by insurance with amaximum deductible of $50,000 per occurrence. We believe such potential claims will not have a material adverse effecton our consolidated financial condition, results of operations, or cash flows.

 

**Item 6**.  ***Exhibits andReports on Form 8-K***

 
| **Exhibit**
**Number**
  |  
**Description**
  |
|-------------------------------|-------------------------------|
| 3.1                           |                          | Articles of Incorporation of the Company (Filed as  Appendix F to the Proxy Statement/Prospectus of the Company dated December  31, 1998 (Reg. No. 333-65417) and incorporated herein by reference). |
| 3.2                           |                          | Articles  of Amendment of the Articles of Incorporation of the Company dated  June 8, 2000 (Filed as Exhibit 3.2 to the Company’s Form 10-Q for  the quarter ended June 30, 2001 (File No. 000-30066) and incorporated by  reference). |
| 3.3                           |                          | Articles  of Amendment of the Articles of Incorporation of the Company dated  May 22, 2001 (Filed as Exhibit 3.3 to the Company’s Form 10-Q for  the quarter ended June 30, 2001 (File No. 000-30066) and incorporated by  reference). |
| 3.4                           |                          | Amended  and Restated Bylaws of the Company (Filed as an exhibit to the Company's Form  10-K for the year ending December 31, 1998 (File No. 333-65417) and  incorporated herein by reference). |
| 10.1                          |                          | Sanders Morris  Harris Group Inc. Capital Incentive Program (as amended and restated

effective November 1,  2001). |

 

             (b) Reports on Form 8-K.

 

There were no reports on Form 8-Kfiled during the three-month period ended September 30, 2001.

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                              | **SANDERS  MORRIS HARRIS GROUP INC.** |
|-----------------------------------|---------------------------------------|
|                              |                                  |   |
|                              | By                                    | /s/  ROBERT E. GARRISON II |
|                              |                                  | **Robert E.  Garrison II** |
|                              |                                  | **President  & Chief Executive Officer** |
|                              |                                  |   |
|                              |                                  |   |
|                              | By                                    | /s/  RICK BERRY |
|                              |                                  | **Rick  Berry** |
|                              |                                  | **Chief  Financial Officer** |
| **Date:  November 8,  2001** |                                  |   |