**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

**(mark one)**

 

| ý | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED  MARCH 31, 2004** |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |
| **or** |
|   |
| **o**  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                   |

 

**Commission file No. 0-30066**

 

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| **SANDERS  MORRIS HARRIS GROUP INC.**                           |
|-----------------------------------------------------------------|
| (Exact name of registrant as specified in  its charter)         |
|                                                            |   |   |
| **Texas**                                                       |   | **76-0583569** |
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |   |
| **600 Travis, Suite 3000  Houston, Texas 77002**                |
| (Address of principal executive office)                         |
|                                                            |   |   |
| **(713) 993-4610**                                              |
| (Registrant’s telephone number,  including area code)      |

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filing requirements forthe past 90 days.  YES  ý     NO  o

 

Indicate by check mark whether registrant is an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act). YES  ý     NO  o

 

The number ofshares of the registrant’s Common Stock, par value $0.01 per share, outstandingas of May 1, 2004, was 17,554,893.

 

 

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

 

# **INDEX**

# ** **

| **PART I.  CONDENSED CONSOLIDATED FINANCIAL INFORMATION** |                                                                                                                       |
|---------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------|
|                                                                |                                                                                                                       |   |
| Item 1.                                                             | Financial Statements                                                                                                       |   |
|                                                                |                                                                                                                       |   |
|                                                                | Condensed Consolidated Balance Sheet as of  March 31, 2004 (unaudited) and December 31, 2003                     |   |
|                                                                |                                                                                                                       |   |
|                                                                | Condensed Consolidated Statement of Income  for the Three Months Ended March 31, 2004 and 2003 (unaudited)            |   |
|                                                                |                                                                                                                       |   |
|                                                                | Condensed Consolidated Statement of  Shareholders’ Equity for the Three Months Ended March 31, 2004  (unaudited) |   |
|                                                                |                                                                                                                       |   |
|                                                                | Condensed Consolidated Statement of Cash  Flows for the Three Months Ended March 31, 2004 and 2003 (unaudited)        |   |
|                                                                |                                                                                                                       |   |
|                                                                | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                          |   |
|                                                                |                                                                                                                       |   |
| Item 2.                                                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                |   |
|                                                                |                                                                                                                       |   |
| Item  3.                                                            | Quantitative  and Qualitative Disclosures About Market Risk                                                                |   |
|                                                                |                                                                                                                       |   |
| Item 4.                                                             | Controls and  Procedures                                                                                                   |   |
|                                                                |                                                                                                                       |   |
| **PART II.  OTHER  INFORMATION**                          |                                                                                                                       |
|                                                                |                                                                                                                       |   |
| Item 1.                                                             | Legal Proceedings                                                                                                          |   |
|                                                                |                                                                                                                       |   |
| Item 6.                                                             | Exhibits and  Reports on Form 8-K                                                                                          |   |

 

1

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**PARTI.  FINANCIAL INFORMATION**

 

**Item1.  *FinancialStatements***

 

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEET**

(in thousands, except share and per shareamounts)

 
|                                                                                                                 |   | **March 31,  2004** |    | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                 |   | **(unaudited)**          |    |                        |   |
| **ASSETS**                                                                                                           |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                            |   | $                        | 25,048  |                        | $      | 32,590 |   |
| Receivables, net of allowance of $445 and  $400, respectively                                                        |   |                     |    |                        |   |
| Broker-dealers                                                                                                       |   | 798                      |    | 522                         |   |
| Customers                                                                                                            |   | 2,828                    |    | 3,758                       |   |
| Related parties                                                                                                      |   | 6,967                    |    | 6,100                       |   |
| Other                                                                                                                |   | 785                      |    | 822                         |   |
| Deposits with clearing brokers                                                                                       |   | 1,054                    |    | 1,054                       |   |
| Securities owned                                                                                                     |   | 39,328                   |    | 32,322                      |   |
| Securities available for sale                                                                                        |   | 2,904                    |    | 3,156                       |   |
| Furniture and equipment, net                                                                                         |   | 5,254                    |    | 4,227                       |   |
| Deferred tax asset                                                                                                   |   | 47                       |    | —                      |   |
| Other assets                                                                                                         |   | 3,454                    |    | 3,004                       |   |
| Goodwill                                                                                                             |   | 50,247                   |    | 49,447                      |   |
| Total assets                                                                                                         |   | $                        | 138,714 |                        | $      | 137,002 |   |
|                                                                                                                 |   |                     |    |                        |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                        |   |                     |    |                        |   |
|                                                                                                                 |   |                     |    |                        |   |
| Liabilities:                                                                                                         |   |                     |    |                        |   |
| Accounts payable and accrued liabilities                                                                             |   | $                        | 17,130  |                        | $      | 20,060 |   |
| Deferred tax liability                                                                                               |   | —                   |    | 647                         |   |
| Securities sold, not yet purchased                                                                                   |   | 759                      |    | 255                         |   |
| Other liabilities                                                                                                    |   | 122                      |    | 144                         |   |
| Total liabilities                                                                                                    |   | 18,011                   |    | 21,106                      |   |
|                                                                                                                 |   |                     |    |                        |   |
| Commitments and contingencies                                                                                        |   |                     |    |                        |   |
|                                                                                                                 |   |                     |    |                        |   |
| Minority interests                                                                                                   |   | 1,440                    |    | 1,043                       |   |
|                                                                                                                 |   |                     |    |                        |   |
| 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; 18,179,295 and 17,991,653 shares issued, respectively |   | 182                      |    | 180                         |   |
| Additional paid-in capital                                                                                           |   | 116,042                  |    | 113,781                     |   |
| Receivables for shares issued                                                                                        |   | (1,725                   | )       | (1,117                      | )      |
| Retained earnings                                                                                                    |   | 9,285                    |    | 6,015                       |   |
| Accumulated other comprehensive loss                                                                                 |   | (61                      | )       | (70                         | )      |
| Unearned compensation                                                                                                |   | (979                     | )       | (638                        | )      |
| Treasury stock at cost, 739,402 and 724,003  shares, respectively                                                    |   | (3,481                   | )       | (3,298                      | )      |
| Total shareholders’ equity                                                                                      |   | 119,263                  |    | 114,853                     |   |
| Total liabilities and shareholders’ equity                                                                      |   | $                        | 138,714 |                        | $      | 137,002 |   |

 

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

 

2

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTOF INCOME**

(in thousands, except share and per share amounts)

(unaudited)

 
|                                                                                         |   | **Three  Months Ended  March 31,** |   |
|----------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                         |   | **2004**                                |   | **2003** |   |
| Revenues:                                                                                    |   |                                    |   |   |   |
| Commissions                                                                                  |   | $                                       | 13,910 |   | $ | 12,312 |   |
| Principal transactions                                                                       |   | 1,454                                   |   | 2,010 |   |
| Investment banking                                                                           |   | 9,536                                   |   | 3,404 |   |
| Fiduciary, custodial and advisory fees                                                       |   | 3,520                                   |   | 1,755 |   |
| Interest and dividends                                                                       |   | 865                                     |   | 525 |   |
| Other income                                                                                 |   | 522                                     |   | 926 |   |
| Total revenues                                                                               |   | 29,807                                  |   | 20,932 |   |
| Expenses:                                                                                    |   |                                    |   |   |   |
| Employee compensation and benefits                                                           |   | 17,857                                  |   | 13,715 |   |
| Floor brokerage, exchange and clearance  fees                                                |   | 1,215                                   |   | 1,430 |   |
| Communications and data processing                                                           |   | 1,537                                   |   | 1,329 |   |
| Occupancy                                                                                    |   | 1,708                                   |   | 1,247 |   |
| Other general and administrative                                                             |   | 2,445                                   |   | 2,061 |   |
| Total expenses                                                                               |   | 24,762                                  |   | 19,782 |   |
| Income before equity in income of limited  partnerships, income taxes and minority interests |   | 5,045                                   |   | 1,150 |   |
| Equity in income of limited partnerships                                                     |   | 805                                     |   | 868 |   |
|                                                                                         |   | 5,850                                   |   | 2,018 |   |
| Provision for income taxes                                                                   |   | (2,128                                  | )      | (830 | ) |
| Minority interests in net (income) loss of  consolidated companies                           |   | (452                                    | )      | 1 |   |
|                                                                                         |   |                                    |   |   |   |
| Net income                                                                                   |   | $                                       | 3,270  |   | $ | 1,189 |   |
|                                                                                         |   |                                    |   |   |   |
| Earnings per share:                                                                          |   |                                    |   |   |   |
| Basic                                                                                        |   | $                                       | 0.19   |   | $ | 0.07 |   |
| Diluted                                                                                      |   | $                                       | 0.18   |   | $ | 0.07 |   |
|                                                                                         |   |                                    |   |   |   |
| Weighted average common shares outstanding:                                                  |   |                                    |   |   |   |
| Basic                                                                                        |   | 17,394,045                              |   | 16,845,379 |   |
| Diluted                                                                                      |   | 17,987,680                              |   | 17,394,518 |   |

 

The accompanying notes are an integral partof the condensed consolidated financial statements.

 

3

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

**CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’EQUITY**

**For the three months endedMarch 31, 2004**

(in thousands, except shares)

(unaudited)

 
|                                                                    |   | **Amounts** |        |       |   | **Shares** |           |
|-------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|------------|----------------|
|                                                                    |   |        |        |       |   |       |           |
| **Common stock**                                                        |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | 180         |       |   |       | 17,991,653     |   |
| Stock issued pursuant to employee benefit  plan                         |   | 2           |        |       |   | 187,642    |           |
| Balance, end of period                                                  |   | 182         |        |       |   | 18,179,295 |           |
| **Additional paid-in  capital**                                         |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | 113,781     |       |   |       |           |   |
| Stock issued pursuant to employee benefit  plan                         |   | 2,261       |        |       |   |       |           |
| Dividends                                                               |   | —      |        |       |   |       |           |
| Balance, end of period                                                  |   | 116,042     |        |       |   |       |           |
| **Receivables for  shares issued**                                      |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | (1,117      | )          |   |       |           |   |
| Issuance of restricted stock                                            |   | (908        | )           |       |   |       |           |
| Amortization of notes receivable                                        |   | 300         |        |       |   |       |           |
| Balance, end of period                                                  |   | (1,725      | )           |       |   |       |           |
| **Retained earnings**                                                   |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | 6,015       |       |   |       |           |   |
| Net income                                                              |   | 3,270       |        | 3,270      |   |       |           |
| Balance, end of period                                                  |   | 9,285       |        | 3,270      |   |       |           |
| **Accumulated other  comprehensive loss**                               |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | (70         | )          |   |       |           |   |
| Net change in unrealized depreciation on  securities available for sale |   | 14          |        | 14         |   |       |           |
| Income tax benefit on change                                            |   | (5          | )           | (5         | )      |       |           |
| Balance, end of period                                                  |   | (61         | )           | 9          |   |       |           |
| **Comprehensive  income**                                               |   |        |        | 3,279      |   |       |           |
| **Unearned  compensation**                                              |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | (638        | )          |   |       |           |   |
| Net issuance of restricted stock                                        |   | (527        | )           |       |   |       |           |
| Amortization of unearned compensation                                   |   | 186         |        |       |   |       |           |
| Balance, end of period                                                  |   | (979        | )           |       |   |       |           |
| **Treasury stock**                                                      |   |        |        |       |   |       |           |
| Balance, beginning of period                                            |   | $           | (3,298      | )          |   |       | (724,003       | ) |
| Acquisition of treasury stock                                           |   | (183        | )           |       |   | (15,399    | )              |
| Balance, end of period                                                  |   | (3,481      | )           |       |   | (739,402   | )              |
| **Total shareholders’  equity and common shares outstanding**      |   | **$**       | **119,263** | ** ** |   |       | **17,439,893** | ** ** |

 

4

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

**CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS**

**For thethree months ended March 31, 2004 and 2003**

(in thousands)

(unaudited)

 
|                                                                                        |   | **2004** |   | **2003** |   |
|---------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                       |   |     |   |     |   |
| Net income                                                                                  |   | $        | 3,270  |     | $      | 1,189 |   |
| Adjustments to reconcile net income to net  cash used in operating activities:              |   |     |   |     |   |
| Realized gain on securities available for  sale                                             |   | (11      | )      | —   |   |
| Depreciation                                                                                |   | 475      |   | 273      |   |
| Provision for bad debts                                                                     |   | 46       |   | —   |   |
| Compensation expense related to  amortization of notes receivable and unearned compensation |   | 486      |   | 416      |   |
| Deferred income taxes                                                                       |   | (699     | )      | 258      |   |
| Minority interests in income (loss) of  consolidated companies                              |   | 452      |   | (1       | )      |
| Changes in operating assets and  liabilities:                                               |   |     |   |     |   |
| Increase in receivables                                                                     |   | (223     | )      | (1,543   | )      |
| Increase in deposits with clearing brokers                                                  |   | —   |   | (502     | )      |
| Increase in securities owned                                                                |   | (7,806   | )      | (372     | )      |
| Increase in other assets                                                                    |   | (455     | )      | (139     | )      |
| Increase (decrease) in securities sold, not  yet purchased                                  |   | 504      |   | (33      | )      |
| Decrease in other liabilities                                                               |   | (22      | )      | (10      | )      |
| Decrease in accounts payable and accrued  liabilities                                       |   | (2,429   | )      | (4,327   | )      |
| Net cash used in operating activities                                                       |   | (6,412   | )      | (4,791   | )      |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                       |   |     |   |     |   |
| Capital expenditures                                                                        |   | (1,495   | )      | (240     | )      |
| Cash of business consolidated                                                               |   | 49       |   | —   |   |
| Purchase of securities available for sale                                                   |   | (41      | )      | (33      | )      |
| Proceeds from sales and maturities of  securities available for sale                        |   | 318      |   | 250      |   |
| Net cash used in investing activities                                                       |   | (1,169   | )      | (23      | )      |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                       |   |     |   |     |   |
| Purchase of treasury stock                                                                  |   | (183     | )      | (119     | )      |
| Proceeds from shares issued                                                                 |   | 828      |   | 1,008    |   |
| Distributions to minority interests                                                         |   | (88      | )      | (219     | )      |
| Payments of cash dividends                                                                  |   | (518     | )      | (424     | )      |
| Net cash provided by financing activities                                                   |   | 39       |   | 246      |   |
| Net decrease in cash and cash equivalents                                                   |   | (7,542   | )      | (4,568   | )      |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD                                           |   | 32,590   |   | 34,890   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                  |   | $        | 25,048 |     | $      | 30,322 |   |
| Noncash investing and financing activities:                                                 |   |     |   |     |   |
| Cash (refund) paid for income taxes                                                         |   | $        | (15    | )        | $      | 139 |   |
| Consolidation:                                                                              |   |     |   |     |   |
| Fixed assets                                                                                |   | 6        |   | —   |   |
| Other assets                                                                                |   | (5       | )      | —   |   |
| Securities owned                                                                            |   | (800     | )      | —   |   |
| Goodwill                                                                                    |   | 800      |   | —   |   |
| Accounts payable and accrued liabilities                                                    |   | (18      | )      | —   |   |
| Minority interests                                                                          |   | (32      | )      | —   |   |

 

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

 

5

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### ** **

**Sanders Morris Harris Group Inc. andSubsidiaries**

**Notesto Condensed Consolidated Financial Statements**

**(unaudited)**

 

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

 

###### *Nature of Operations*

###### * *

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

 

The Company merged with and acquired its operating subsidiaries in 1999through 2003.  The acquisitions wereaccounted for using the purchase method.

 

###### *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 ourconsolidated financial position at March 31, 2004, our results ofoperations for the three months ended March 31, 2004 and 2003, and ourcash flows for the three months ended March 31, 2004 and 2003.  All adjustments are of a normal recurringnature. Interim results are not necessarily indicative of results for a fullyear.

 

These financial statements and notes should be read in conjunction withthe Company’s annual report on Form 10-K for the year ended December 31,2003.

 

###### *Effects of Recently Issued Accounting Standards*

###### * *

InDecember 2003, the FASB issued FASB Interpretation No. 46R (revisedDecember 2003), *Consolidation ofVariable Interest Entities,*which addresses how a businessenterprise should evaluate whether it has a controlling financial interest inan entity through means other than voting rights and accordingly shouldconsolidate the entity.  FIN 46Rreplaces FASB Interpretation No. 46, *Consolidationof Variable Interest Entities,*which was issued inJanuary 2003.  The Company wasrequired to apply FIN 46R to variable interests in VIEs in its consolidatedfinancial statements for the quarter ended March 31, 2004.  For any VIEs that must be consolidated underFIN 46R that were created before January 1, 2004, the assets, liabilitiesand noncontrolling interests of the VIE initially would be measured at theircarrying amounts with any difference between the net amount added to thebalance sheet and any previously recognized interest being recognized as thecumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value atthe date FIN 46R first applies may be used to measure the assets, liabilitiesand noncontrolling interest of the VIE. The Company has identified one entity that requires consolidation underthis Interpretation.  Consolidation ofthis entity increased the Company’s assets and liabilities by approximately$31,000 and had an insignificant effect on the other basic consolidatedfinancial statements.

 

In May 2003,the FASB issued SFAS No. 150, *Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity. *SFAS No. 150requires certain financial instruments that have characteristics of bothliabilities and equity to be classified as a liability on the consolidatedstatement of financial condition.  SFASNo. 150 is effective for financial instruments entered into of modified afterMay 31, 2003, and otherwise is effective at the beginning of the first fiscalperiod beginning after December 15, 2003. The Company does not have any financial instruments affected by theadoption of SFAS No. 150.

 

6

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*Stock-Based Compensation*

 

SFAS No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure,*was issued in December 2002.  SFAS No. 148 amends SFAS No. 123, *Accounting for Stock-Based Compensation,*toprovide alternative methods for transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  In addition, SFAS No 148 amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  The Company has adopted thedisclosure provisions included in SFAS No. 148 in the notes to the consolidatedfinancial statements contained herein.

 

The Companyapplies the intrinsic value-based method of accounting prescribed by AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*and related interpretations includingFASB Interpretation No. 44, *Accounting forCertain Transactions involving Stock Compensation an Interpretation of APBOpinion No. 25,*issued in March 2000, to account for its fixedplan stock options.  Under this method,compensation expense is recorded on the date of grant only if the currentmarket price of the underlying stock exceeded the exercise price.

 

The followingtable illustrates the effect on net income as if the Company had applied thefair value recognition provisions of SFAS No. 123 as amended by SFAS No. 148:

 
|                                                                                                                                          |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                                                                          |   | **2004**                                |   | **2003** |   |
| Net income as reported                                                                                                                        |   | $                                       | 3,270  |   | $ | 1,189 |   |
| Deduct: Total stock based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (61                                     | )      | (124 | ) |
| Pro forma net income                                                                                                                          |   | $                                       | 3,209  |   | $ | 1,065 |   |
|                                                                                                                                          |   |                                    |   |   |   |
| Earnings per share                                                                                                                            |   |                                    |   |   |   |
| Basic-as reported                                                                                                                             |   | $                                       | 0.19   |   | $ | 0.07 |   |
| Basic-pro forma                                                                                                                               |   | $                                       | 0.18   |   | $ | 0.06 |   |
|                                                                                                                                          |   |                                    |   |   |   |
| Diluted-as reported                                                                                                                           |   | $                                       | 0.18   |   | $ | 0.07 |   |
| Diluted-pro forma                                                                                                                             |   | $                                       | 0.18   |   | $ | 0.06 |   |

 

*Reclassifications*

 

Certain reclassificationshave been made to the 2003 condensed consolidated financial statements toconform them with the 2004 presentation.  The reclassifications had no effect on retained earnings, results ofoperations or cash flows as previously reported.

 

7

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### **2.**              ACQUISTIONS

### ** **

On May 2, 2003, the Company acquired a 50% ownershipinterest in the Salient companies. Additionally, the Company acquired a 23.15% profits interest in theadvisor to The Endowment Fund, a related entity.  The former owners of Salient and The Endowment Fund received cashpayments totaling $1.75 million and may later receive an additional $250,000cash payment and up to 1,200,000 common shares.   The Salient companies and Pinnacle Management & TrustCompany (“PMT”) were contributed to Salient Capital Management, which entity’sClass A limited partner units are jointly owned by the Company and the formerowners of Salient.  Additionally, theCompany received Class B limited partner units of Salient/PMT, which in theevent of a liquidation or sale of Salient/PMT entitle the Company to firstreceive proceeds equal to the net asset value of PMT as of May 2, 2003,(approximately $4.4 million) with the remaining proceeds to be divided equallyamong the owners of the Class A units. The Salient companies provide investment advisory services toindividuals and institutions.  TheEndowment Fund is a diversified fund of funds using hedge fund managers thatspecialize in a variety of investment approaches.  The acquisitions were accounted for as a purchase, andaccordingly, the financial information of the Salient companies and the advisorto The Endowment Fund has been included in the Company’s consolidated financialstatements from May 2, 2003.  Thepurchase price of approximately $1.8 million exceeded the fair market value ofidentifiable net assets by approximately $1.7 million, which has been recordedas goodwill.  The Company uses theconsolidation method to account for its investment in Salient/PMT.

 

On December 2, 2003, the Company acquired theTulsa, Oklahoma branch office of U.S. Bankcorp Piper Jaffray Inc.  The Tulsa office provides retail brokerageservices to its clients.  The formerowner of the Tulsa office received $377,000 in cash.  The acquisition was accounted for as a purchase and, accordingly,the financial information of the Tulsa office has been included in theCompany’s consolidated financial statements from December 2, 2003.  The purchase price of approximately $377,000exceeded the fair value of identifiable net assets acquired by approximately$17,000, which has been recorded as goodwill.

 

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

### ** **

Securities owned and securities sold, not yet purchased as ofMarch 31, 2004 were as follows:

 
|                                 |   | **Owned**           |   | **Sold, Not  Yet  Purchased** |   |
|--------------------------------------|--------|---------------------|--------|-------------------------------|--------|
|                                 |   | **(in  thousands)** |   |
| Marketable:                          |   |                |   |                          |   |
| U.S. Government and agency           |   | $                   | 6,958  |                          | $      | — |   |
| Corporate stocks                     |   | 565                 |   | 759                           |   |
| Corporate bonds and commercial paper |   | 5,339               |   | —                        |   |
|                                 |   | 12,862              |   | 759                           |   |
| Not readily marketable:              |   |                |   |                          |   |
| Partnerships                         |   | 20,079              |   | —                        |   |
| Corporate stocks and warrants        |   | 6,387               |   | —                        |   |
|                                 |   | $                   | 39,328 |                          | $      | 759 |   |

 

Securities not readily marketable include investmentsecurities (a) for which there is no market on a securities exchange or noindependent publicly quoted market, (b) that cannot be publicly offered or soldunless registration has been effected under the Securities Act of 1933, or (c)that cannot be offered or sold because of other arrangements, restrictions, orconditions applicable to the securities or to the Company.  Not readily marketable securities consist ofinvestments in limited partnerships, equities, options and warrants.  The

 

8

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investments in limited partnerships are accounted for using the equitymethod, which approximates fair value, and principally consist of EnvironmentalOpportunities Fund, L.P., Environmental Opportunities Fund II, L.P.,Environmental Opportunities Fund II (Institutional), L.P., CorporateOpportunities Fund, 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., and Life Sciences OpportunityFund, L.P., Life Sciences Opportunity Fund (Institutional), L.P., Life SciencesOpportunity Fund II, L.P., Life Sciences Opportunity Fund (Institutional) II,L.P. and 2003 Houston Energy Partners, L.P.

 

The Company has issued a letter of credit in theamount of $1.5 million to the owner of one of the offices that we lease tosecure payment of our lease obligation for that facility.  The letter of credit is secured bysecurities owned in the amount of $1.5 million.

 

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

### ** **

Securitiesavailable for sale at March 31, 2004 were as follows:

 
|                                   |   | **Amortized  Cost** |   | **Gross  Unrealized** |   | **Estimated  Fair Value** |   |
|----------------------------------------|--------|---------------------|--------|-----------------------|--------|---------------------------|--------|
| **Gains**                              |   | **Losses**          |
|                                   |   | **(in  thousands)** |   |
|                                   |   |                |   |                  |   |                      |   |   |   |
| U.S. Government and agency obligations |   | $                   | 1,045  |                  | $      | 18                        |   | $ | — |   | $ | 1,063 |   |
| Marketable equity securities           |   | 1,956               |   | 100                   |   | (215                      | )      | 1,841 |   |
| Total                                  |   | $                   | 3,001  |                  | $      | 118                       |   | $ | (215 | ) | $ | 2,904 |   |

 

The contractual maturities ofdebt securities available for sale at March 31, 2004, were as follows:

 
| Due before 5 years                  |   | $ | 759 |   |
|-------------------------------------|--------|---|-----|--------|
| Due after 25 years through 30 years |   | $ | 304 |   |

 

Gross realized gains on sales of securities available for sale were$11,000 for the three months ended March 31, 2004.  No realized losses on securities availablefor sale were recorded for the three months ended March 31, 2004.  No realized gains or losses on sales ofsecurities available for sale were recorded during the three months endedMarch 31, 2003.

 

The Company has pledged securities valued at $250,000 to the bankcommissioner of the state of Oklahoma to secure its performance of fiduciaryduties for trust activities in that state.

 

9

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### **5.**              INCOME TAXES

### ** **

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

 
|                                  |   | **Three  Months Ended  March 31,** |   |
|---------------------------------------|--------|-----------------------------------------|--------|
|                                  |   | **2004**                                |   | **2003** |   |
|                                  |   | **(in  thousands)**                     |   |
|                                  |   |                                    |   |   |   |
| Tax computed using the statutory rate |   | $                                       | 1,835  |   | $ | 686 |   |
| State income taxes and other          |   | 293                                     |   | 144 |   |
| Total                                 |   | $                                       | 2,128  |   | $ | 830 |   |

 

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

### ** **

There were no firm underwriting commitments open at March 31,2004.

 

The Company and its subsidiaries have obligations under operatingleases that expire by 2014 with initial noncancelable terms in excess of oneyear.

 

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 position, 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 and reporting purposes, theCompany has generally agreed to indemnify these clearing brokers for lossesthey may sustain in connection with the accounts, and therefore, retains riskon these accounts.  The Company is requiredto maintain certain cash or securities on deposit with its clearing brokers.

 

The Company has issued a letter of credit in the amount of $1.5 millionto the owner of one of the offices that we lease to secure payment of our leaseobligation for that facility.  Theletter of credit is secured by securities owned in the amount of $1.5 million.

 

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### **7.**              EARNINGS PER COMMON SHARE

### ** **

Basic and diluted earnings per-share computations for the periodsindicated were as follows:

 
|                                                                                     |   | **Three  Months Ended March 31,**                  |        |
|------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|-------------|
|                                                                                     |   | **2004**                                                |        | **2003** |   |
|                                                                                     |   | **(in  thousands, except share and per share amounts)** |        |
| Computation of basic income per common share for  the three months ended  March 31: |   |                                                    |        |   |   |
| Net income                                                                               |   | $                                                       |  3,270 |   | $ |  1,189 |   |
| Weighted average number of common shares  outstanding                                    |   | 17,394,045                                              |        | 16,845,379 |   |
| Basic income per common share                                                            |   | $                                                       | 0.19        |   | $ | 0.07 |   |

 
|                                                                                       |   | **Three  Months Ended March 31,**                  |   |
|--------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                                                                       |   | **2004**                                                |   | **2003** |   |
|                                                                                       |   | **(in  thousands, except share and per share amounts)** |   |
| Computation of diluted income per common share for  the three months ended  March 31: |   |                                                    |   |   |   |
| Net income                                                                                 |   | $                                                       | 3,270  |   | $ | 1,189 |   |
| Weighted average number of common shares  outstanding                                      |   | 17,394,045                                              |   | 16,845,379 |   |
| Common shares issuable under stock option plan                                             |   | 1,033,627                                               |   | 1,309,511 |   |
| Less shares assumed repurchased with proceeds                                              |   | (439,992                                                | )      | (760,372 | ) |
| Weighted average common shares outstanding                                                 |   | 17,987,680                                              |   | 17,394,518 |   |
| Diluted income per common share                                                            |   | $                                                       | 0.18   |   | $ | 0.07 |   |

 

Outstanding stock options exercisable for 50,000 common shares for thethree months ended March 31, 2003 have not been included in dilutedearnings per common share because their inclusion would have been antidilutive.

 

11

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### **8.**              BUSINESS SEGMENT INFORMATION

### ** **

The Company’s businesses operate in two reportable business segments.  The Company’s investment banking andbrokerage segment includes the operations of SMH.  SMH is an investment banking and brokerage firm whose activitiesprimarily include securities underwriting, other investment banking services, private placements, andinstitutional, prime and retail brokerage. The Company’s asset management segment includes the operations ofSalient/PMT and SMH Capital Advisors.  PMT is a state chartered trust company providing a variety of trustservices, including investment management, estate settlement and retirementplanning.  SMH Capital Advisors providesfinancial planning services to individuals and asset management services toinvestors with an emphasis on fixed income securities.  The following summarizes certain financialinformation of each reportable segment for the three months endedMarch 31, 2004 and 2003, respectively.

 
| **(in thousands)**                                                                                  |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |   |
|-----------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|--------|
| **Three Months Ended  March 31, 2004**                                                         |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                            |   | $                                      | 27,335 |                       | $      | 2,593                    |   | $                       | (121   | ) | $ | 29,807 |   |
| Expenses                                                                                            |   | (22,164                                | )      | (2,139                     | )      | (459                     | )      | (24,762                 | )      |
| Income (loss) before equity in income of  limited partnerships, income taxes and minority interests |   | 5,171                                  |   | 454                        |   | (580                     | )      | 5,045                   |   |
| Equity in income of limited partnerships                                                            |   | 732                                    |   | —                     |   | 73                       |   | 805                     |   |
| Income (loss) before income taxes and  minority interests                                           |   | $                                      | 5,903  |                       | $      | 454                      |   | $                       | (507   | ) | $ | 5,850 |   |
|                                                                                                |   |                                   |   |                       |   |                     |   |                    |   |
| **Three Months Ended  March 31, 2003**                                                         |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                            |   | $                                      | 19,355 |                       | $      | 1,411                    |   | $                       | 166    |   | $ | 20,932 |   |
| Expenses                                                                                            |   | (18,145                                | )      | (1,314                     | )      | (323                     | )      | (19,782                 | )      |
| Income (loss) before equity in income of  limited partnerships, income taxes and minority interests |   | 1,210                                  |   | 97                         |   | (157                     | )      | 1,150                   |   |
| Equity in income of limited partnerships                                                            |   | 774                                    |   | —                     |   | 94                       |   | 868                     |   |
| Income (loss) before income taxes and  minority interests                                           |   | $                                      | 1,984  |                       | $      | 97                       |   | $                       | (63    | ) | $ | 2,018 |   |

 
| **(in thousands)**                        |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |   |
|-------------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|--------|
| Total assets as of March 31, 2004    |   | $                                      | 92,704 |                       | $      | 9,022                    |   | $                       | 36,988 |   | $ | 138,714 |   |
| Total assets as of December 31, 2003 |   | $                                      | 96,805 |                       | $      | 8,600                    |   | $                       | 31,597 |   | $ | 137,002 |   |

 

### **9.**              EMPLOYEE BENEFIT PLANS

### ** **

Under its 1998 Incentive Plan, as amended, the Company has reserved 25%of the issued and outstanding Common Stock of the Company, or 4,000,000 sharesof Common Stock, whichever is greater, for the purpose of issuing incentiveawards under the Incentive Plan.  TheCompany had 1,465,108 shares of Common Stock available for grant under theIncentive Plan at March 31, 2004.

 

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**Stock Options**

 

The Incentive Plan provides for the issuance to eligible employees of,among other things, incentive and non-qualified stock options, that may expireup to 10 years from the date of grant.  The outstanding options vest over varying periods and have an exerciseprice equal to the closing price of the Company’s stock on the date of thegrant.

 

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

 

Effective January 2, 2001, the Company adopted the CIP under itsIncentive Plan in which eligible employees may purchase shares of the Company’srestricted common stock at a discount of up to 33 1/3 % of the 20-day averageof the closing sales prices for a share of the Company’s common stock, endingon the day prior to the date the shares are issued.  The CIP was amended effective November 1, 2001 to includeeligible consultants as potential participants under the program.

 

All shares issued are valued at the closing price on the date theshares are issued.  Consideration paidthrough the deferral of salaries, commissions, or discretionary bonuses isrecorded as compensation expense on the date the shares are issued.  The difference between the value of theshares issued and the consideration paid is recorded as unearned compensationand is shown as a separate component of shareholders’ equity.  Additionally, shares are issued under theIncentive Plan in conjunction with notes receivable, which are also shown as aseparate component of shareholders’ equity. Unearned compensation and the notesreceivable are amortized to compensation expense over the three-year vestingperiods.

 

The following summarizes certain information related to the CIP for thethree months ended March 31, 2004 and 2003.

 
|                                  |   | **Three  Months Ended  March 31,** |   |
|---------------------------------------|--------|-----------------------------------------|--------|
|                                  |   | **2004**                                |   | **2003** |   |
|                                  |   | **(in  thousands, except shares)**      |   |
|                                  |   |                                    |   |   |   |
| Number of shares issued               |   | 118,137                                 |   | 68,653 |   |
| Value of shares issued                |   | $                                       | 1,435  |   | $ | 549 |   |
| Additions to unearned compensation    |   | 527                                     |   | 34 |   |
| Additions to notes receivable         |   | 908                                     |   | 515 |   |
| Amortization of unearned compensation |   | 186                                     |   | 207 |   |
| Amortization of notes receivable      |   | 300                                     |   | 209 |   |
|                                       |        |                                         |        |  |  |  |  |

 

### **10.**       RELATED PARTIES

### ** **

The Company had receivables from related parties totaling $7.0 millionat March 31, 2004, primarily consisting of $2.5 million of unpaidmanagement fees earned on the Company’s investments in limited partnerships and$4.2 million of notes receivable from employees and consultants.

 

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### **11.**       SUBSQUENT EVENT

### ** **

On April 1, 2004, the Company acquired a 69% interest in CharlotteCapital.  Employees of Charlotte Capitalretain ownership of 31% of the firm. Charlotte Capital, based in Charlotte, North Carolina, manages approximately$400 million in assets for institutional investors in small cap value and midcap value styles.  SMHG paid $3.4million in cash at closing, and is obligated to pay an additional amount in 18months.  The base amount of the finalpayment is $2.3 million; however, such amount may be adjusted up or down basedon changes in the firm’s revenues and assets under management.  Employees of Charlotte Capital can earn upto an additional 9% ownership interest by achieving specified revenue run ratesduring the 18-month period following closing.

 

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**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**

 

We provide diversified financial services through our subsidiaries,including institutional, prime and retail brokerage, investment banking,merchant banking, financial advisory, trust related services, investmentmanagement and financial planning. All of these activities are highlycompetitive and are sensitive to many factors outside our control, includingthose factors listed under “Factors Affecting Forward-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.

 

**Components of Revenues and Expenses**

 

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

 

*Expenses.*                   Ourexpenses consist of (1) employee compensation and benefits, (2) brokerage andclearing costs, and (3) other expenses. Compensation and benefits have both a variable component based onrevenue production and a fixed component. The variable component includes institutional and retail sales commissions,bonuses, overrides, and other incentives. Retail and institutional commissions are based on a competitivecommission schedule.  The investmentbanking group and the research group receive a salary and discretionary bonusas compensation.  The fixed componentincludes administrative and executive salaries, payroll taxes, employeebenefits and temporary employee costs. Compensation and benefits is our largest expense item and includeswages, salaries and benefits. During the first three months of 2004,compensation and benefits represented 72% of total expenses, and 60% of totalrevenues compared to 69% of total expenses, and 66% of total revenues duringthe comparable period in 2003.

 

Brokerage and clearance expenses include clearing and trade executioncosts associated with the retail, prime and institutional brokerage business atSMH.  SMH clears its transactionsprimarily through Pershing LLC, a member of BNY Securities Group and asubsidiary of The Bank of New York and other clearing brokers.

 

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

 

# **Overview**

# ** **

Our financial services business is affected by general economicconditions. The improvement in the economy, as well as in the overall stockmarket has had a positive impact on our equity commission revenues,  underwriting fees derived from publicofferings, and advisory fees from private placements. During 2003, the declinein interest rates during the first quarter led to an increase in residentialloan refinancing, which had a

 

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positive impact on that portion of our business that derives its incomefrom mortgage-backed fixed-income securities.

 

Our revenues relating to asset-based advisory services and managedaccounts are typically from fees based on the market value of assets undermanagement. The overall increase in equity prices resulted in growth in thevalues of our customers’ investment portfolios, which in turn led to highermanagement fees for the Company.  Theimproved stock market has caused many of our customers to rebalance theirinvestment portfolios, thereby reducing concentrations in money marketinstruments and increasing exposure to equity and other securities with agreater potential for growth.

 

We have organized 13 private equity funds for the purpose of investingin public and private companies that we believe are either significantlyundervalued relative to their growth potential or have substantial prospectsfor capital growth. We invest in these funds along with our clients and earnmanagement fees based on capital commitments, net assets or capitalcontributions. We also receive incentive compensation of a portion of theprofit if the profit exceeds specified hurdle rates. The improvement in theoverall stock market, as well as in individual investment positions owned bythe private equity funds provided the Company with realized and unrealizedgains from its ownership interests and incentive compensation due to fundperformance.

 

We invest a portion of our excess cash in public equity and debtsecurities that we feel are undervalued. Additionally, we may receive warrantsas a part of our compensation for investment banking services.

 

We have expanded both the range and depth of services offered to ourclients through a combination of acquisitions and internal expansion. Thisgrowth has necessitated that we add personnel, as well as production-related incentive compensation plans.We have also improved and expanded our infrastructure including facilities,technology, and information services, to enable us to better compete with otherfirms that offer services similar to ours.

 

**Results of Operations**

 

*Three Months EndedMarch 31, 2004 Compared to Three Months Ended March 31, 2003*

 

Total revenues were $29.8 million in thefirst quarter of 2004 compared to $20.9 million for the same quarter in 2003.  An increase in investment banking revenuefrom prime brokerage services was partially offset by a decline in fixed incomebrokerage revenues.  Total expenses forthe 2004 period increased to $24.8 million from $19.8 million in the samequarter of the previous year.  Equity inincome of limited partnerships declined from $868,000 during the first quarterof 2003 to $805,000 during the first quarter of 2004.  Net income for the three month period ended March 31, 2004increased to $3.3 million from $1.2 million in the same period in 2003.  Basic income per share was $0.19 for thethree months ended March 31, 2004 compared to $0.07 for the same period in2003.   Diluted income per share was$0.18 for the three months ended March 31, 2004 compared to $0.07 for thesame period in 2003.

 

Commissions revenue increased to $13.9million in the first quarter of 2004 from $12.3 million in 2003, primarily as aresult of increased trading volume in our retail brokerage division.  Principal transactions revenue totaled $1.5million for the 2004 period versus $2.0 million in the first quarter of2003.   Revenues from fixed incomebrokerage declined to $1.1 million during the first quarter of 2004 from $1.6million during the comparable prior year quarter mainly due to reduced tradingvolume attributable to fixed income products. Investment banking revenue increased to $9.5 million during the firstquarter of 2004 from $3.4 million in the same period of 2003, principally dueto an increase in fees earned from private placement transactions.  Revenues from fiduciary, custodial andadvisory fees increased to $3.5 million in the first quarter of 2004 from $1.8million in same quarter of 2003 primarily due to the acquisition of Salient duringthe second quarter of 2003.  Interestand dividend income increased to $865,000 in 2004 from $525,000 in the sameperiod last year.  Interest income hasincreased due to higher margin interest reflecting an increase in marginbalances.  Other income declined from$926,000 during 2003 to $522,000 during 2004, due to a

 

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decline in fees earned on the Company’s cashbalances and customer credit balances at its clearing brokers resulting fromlower deposit balances.

 

During the three months ended March 31,2004, employee compensation and benefits increased to $17.9 million from $13.7million in the same period last year due to the higher revenue during2004.  Floor brokerage, exchange andclearance fees declined to $1.2 million in the first quarter of 2004 from $1.4million in the same quarter of 2003 reflecting lower clearing and executioncosts resulting from the reduced trading volume attributable to prime brokerageservices.  Communication and data processingcosts increased to $1.5 million in 2004 from $1.3 million in the same periodlast year resulting primarily from increased personnel and additionaloffices.  Occupancy costs totaled $1.7million during the first quarter of 2004, compared to $1.2 million in the prioryear quarter due to expansion of our New York City offices, and the additionsof Salient and the Tulsa office of U.S. Bankcorp Piper Jaffray Inc., which wasacquired in December 2003.  Othergeneral and administrative expenses increased to $2.4 million during the firstthree months of 2004 from $2.1 million in the first quarter of last year mainlydue to our growth.

 

The effective tax rate from operations was39% for the three months ended March 31, 2004 compared to 41% for thethree months ended March 31, 2003.

 

On April 1, 2004, the Company acquired a 69% interest in CharlotteCapital.  Employees of Charlotte Capitalretain ownership of 31% of the firm. Charlotte Capital, based in Charlotte, North Carolina, managesapproximately $400 million in assets for institutional investors in small capvalue and mid cap value styles.  SMHGpaid $3.4 million in cash at closing, and is obligated to pay an additionalamount in 18 months.  The base amount ofthe final payment is $2.3 million; however, such amount may be adjusted up ordown based on changes in the firm’s revenues and assets under management.  Employees of Charlotte Capital can earn upto an additional 9% ownership interest by achieving specified revenue run ratesduring the 18-month period following closing

 

**Liquidity and CapitalResources**

 

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 March 31, 2004, we had approximately $25.0 million in cash andcash equivalents, which together with receivables from broker-dealers, depositswith clearing brokers, marketable securities owned, and securities availablefor sale represented about 31% of our total assets at the end of the firstquarter.

 

For the three months ended March 31, 2004, net cash used inoperations totaled $6.4 million versus $4.8 million during the first threemonths of 2003.  Accounts payable andaccrued liabilities declined by $2.4 million during the three months endedMarch 31, 2004, principally due to the payment of accrued compensationduring the first quarter of 2004. Securities owned increased by $7.8 million during the first three monthsof 2004, primarily due to new investments.

 

Capital expenditures for the first quarter of 2004 were $1.5 million,mainly for the purchase of furniture and computer equipment and software, aswell as for leasehold improvements, necessary for our growth.  During the first three months of 2004, wereacquired 15,399 of our common shares at a total cost of approximately$183,000.

 

At March 31, 2004, 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 financialposition, results of operations, or cash flows.

 

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**Factors AffectingForward-Looking Statements**

 

This quarterly report on Form 10-Q includes “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities and Exchange Act of1934, as amended (the “Acts”). These forward-looking statements may relate tosuch matters as anticipated financial performance, future revenues or earnings,business prospects, projected ventures, new products, anticipated marketperformance and similar matters. The Private Securities Litigation Reform Actof 1995 provides a safe harbor for forward-looking statements. To comply withthe safe harbor, the Company cautions readers that a variety of factors couldcause the Company’s actual results to differ materially from the anticipatedresults or other expectations expressed in the Company’s forward-lookingstatements. These risks and uncertainties, many of which are beyond theCompany’s control, include, but are not limited to (1) trading volume in thesecurities markets; (2) volatility of the securities markets and interestrates; (3) changes in regulatory requirements, which could affect the demandfor the Company’s services or the cost of doing business; (4) general economicconditions, both domestic and foreign, especially in the regions where theCompany does business; (5) changes in the rate of inflation and related impacton securities markets; (6) competition from existing financial institutions andother new participants in the securities markets; (7) legal developmentsaffecting the litigation experience of the securities industry; (8) successfulimplementation of technology solutions; (9) changes in valuations of theCompany’s trading and warrant portfolios resulting from mark-to-marketadjustments; (10) dependence on key personnel and (11) demand for the Company’sservices. The Company does not undertake to publicly update or revise anyforward-looking statements.

 

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

 

**Market Risks**

** **

At March 31, 2004, PMT had equity securities under management witha fair value of $594 million.  PMT’ssecurities available for sale are recorded at a fair value of approximately$2.9 million at March 31, 2004. These securities are subject to equity price risk.  These securities have an original cost of$3.0 million.  At March 31, 2004,the unrealized decline in market value totaling $97,000 less tax of $36,000,has been included as a separate component of shareholders’ equity.

 

Management evaluates the realizability of securities available for saleto determine if a decline in value is other than temporary.  Such evaluation considers the length of timeand the extent to which market value has been less than cost, the financialcondition and near-term prospects of the issuer, and the intent and ability ofthe Company to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in market value.  Management believes the unrealized lossesare temporary at March 31, 2004. However, a write-down accounted for as a realized loss may be necessaryin the future.

 

The Company’s trading equity and debt securities aremarked to market on a daily basis.  AtMarch 31, 2004, the Company’s trading equity and debt securities were recordedat a fair value of approximately $12.9 million.  These trading equity and debt securities are subject to equityprice risk.  This risk would amount toapproximately $1.3 million based on a potential loss in fair value from ahypothetical 10% decrease in the market value of such equity and debtsecurities.  The actual equity pricerisk related to the trading equity and debt securities may differsubstantially.

 

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

 

Our management, including our Chief ExecutiveOfficer and Chief Financial Officer, have conducted an evaluation of theeffectiveness of our disclosure controls and procedures (as defined in Rule13a-14(c) promulgated under Exchange Act as of the end of the fiscal periodcovered by this report.  Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures are effective for timelygathering, analyzing and disclosing the information we are required to disclosein our reports filed under the Exchange Act. There have been no significant changes made in our internal controlsover financials reporting or in other factors that could significantly affectour internal controls over financial reporting subsequent to the date of thisevaluation.

 

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**PART II.  OTHER INFORMATION**

 

**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 financial position,results of operations, or cash flows.

 

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| **Item 6**.  ***Exhibits and Reports on Form 8-K*** |
|----------------------------------------------------------|
|                                                     |
| (a) Exhibits                                             |

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

 

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* Filed herewith.

 

 

(b)         Reports on Form 8-K.

 

On February 19, 2004, the Company filed a current report on Form8-K under Item 5 relating to the declaration by its board of directors of acash dividend in the amount of $0.0375 per share of common stock.   On March 11, 2004, the Company filed acurrent report on Form 8-K under Item 12 relating to a press release announcingits earnings for the quarter ended December 31, 2003.

 

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**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/   BEN T. MORRIS |   |
|                        |                                 | **Ben T. Morris** |   |
|                        |                                 | **Chief Executive Officer** |   |
|                        |                                 |   |   |
|                        |                                 |   |   |
|                        | By                                   | /s/  RICK BERRY |   |
|                        |                                 | **Rick Berry** |   |
|                        |                                 | **Chief Financial Officer** |   |
|                        |                                 |   |   |
|                        |                                 |   |   |
| **Date:  May 7, 2004** |                                 |   |   |
|                             |                                      |  |  |  |

 

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