**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**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  SEPTEMBER 30, 2002** |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                            |
| or         |
|       |   |                                                                                                                                            |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**                                                   |

 

**Commissionfile No. 0-30066**

 

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**SANDERS MORRIS HARRIS GROUP INC.**

(Exact name of registrantas 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 principalexecutive office)

 

**(713) 993-4610**

(Registrant’stelephone number, including area code)

 

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.       YESý    NO  o

 

The number ofshares of the registrant’s Common Stock, par value $0.01 per share, outstandingas of November 1, 2002, was 16,721,424.

 

 

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**SANDERS MORRIS HARRIS GROUP INC. ANDSUBSIDIARIES**

 

# **INDEX**

 

 
| **PART I.**  | **CONDENSED CONSOLIDATED  FINANCIAL INFORMATION** |
|--------------|---------------------------------------------------|
|         |                                              |   |
| Item 1.      |                                              | Financial Statements |
|         |                                              |   |
|         |                                              | Condensed Consolidated Balance Sheet as  of September 30, 2002 and

December 31,  2001 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed Consolidated Statement of  Income for the Three and Nine Months

Ended September 30, 2002 and 2001 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed Consolidated Statement  of Shareholders’ Equity for the Nine

Months Ended September 30, 2002 (unaudited) |
|         |                                              |   |
|         |                                              | Condensed  Consolidated Statement of Cash Flows for the Nine Months

Ended September  30, 2002 and 2001 (unaudited) |
|         |                                              |   |
|         |                                              | Notes  to Condensed Consolidated Financial Statements (unaudited) |
|         |                                              |   |
| Item 2.      |                                              | Management’s  Discussion and Analysis of Financial Condition and Results of

Operations |
|         |                                              |   |
| Item 3.      |                                              | Quantitative  and Qualitative Disclosures About Market Risk |
|         |                                              |   |
| 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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| **PART I.  FINANCIAL INFORMATION**                |
|--------------------------------------------------------|
|                                                   |
| **Item 1.  *Financial Statements***               |
|                                                   |
| **SANDERS  MORRIS HARRIS GROUP INC. AND SUBSIDIARIES** |
| **CONDENSED CONSOLIDATED BALANCE SHEET**               |
| (in thousands, except  share and per share amounts)    |
| (unaudited)                                            |

 
|                                                                                                                 |   | **September  30,** |    | **December  31,** |   |
|----------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------|-------------------|--------|
|                                                                                                                 |   | **2002**           |    | **2001**          |   |
| **ASSETS**                                                                                                           |   |               |    |              |   |
| Cash and cash  equivalents                                                                                           |   | $                  | 31,392  |              | $      | 30,410 |   |
| Receivables, net  of allowance of $295 and $285, respectively                                                        |   |               |    |              |   |
| Broker-dealers                                                                                                       |   | 862                |    | 540               |   |
| Customers                                                                                                            |   | 1,407              |    | 1,918             |   |
| Related parties                                                                                                      |   | 4,015              |    | 6,688             |   |
| Other                                                                                                                |   | 844                |    | 631               |   |
| Deposits with  clearing brokers                                                                                      |   | 250                |    | 250               |   |
| Securities owned                                                                                                     |   | 12,944             |    | 12,153            |   |
| Securities  available for sale                                                                                       |   | 3,163              |    | 1,691             |   |
| Goodwill, net of  accumulated amortizationof $4,268                                                                  |   | 47,673             |    | 47,601            |   |
| Furniture and  equipment, net                                                                                        |   | 3,714              |    | 1,924             |   |
| Deferred income  taxes, net                                                                                          |   | 1,046              |    | 828               |   |
| Other assets                                                                                                         |   | 1,105              |    | 675               |   |
| Total assets                                                                                                         |   | $                  | 108,415 |              | $      | 105,309 |   |
|                                                                                                                 |   |               |    |              |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                       |   |               |    |              |   |
|                                                                                                                 |   |               |    |              |   |
| Liabilities:                                                                                                         |   |               |    |              |   |
| Accounts payable  and accrued liabilities                                                                            |   | $                  | 9,256   |              | $      | 8,538 |   |
| Securities sold,  not yet purchased                                                                                  |   | 69                 |    | 122               |   |
| Other  liabilities                                                                                                   |   | 205                |    | 315               |   |
| Total  liabilities                                                                                                   |   | 9,530              |    | 8,975             |   |
|                                                                                                                 |   |               |    |              |   |
| Commitments and  contingencies                                                                                       |   |               |    |              |   |
|                                                                                                                 |   |               |    |              |   |
| Minority  interests                                                                                                  |   | 96                 |    | 51                |   |
|                                                                                                                 |   |               |    |              |   |
| Shareholders’  equity:                                                                                          |   |               |    |              |   |
| Preferred stock,  $0.10 par value; 10,000,000 shares authorized;no shares issued and outstanding                     |   | —             |    | —            |   |
| Common stock,  $0.01 par value; 100,000,000 shares authorized;17,397,545 and 17,009,402 shares  issued, respectively |   | 174                |    | 170               |   |
| Additional  paid-in capital                                                                                          |   | 110,093            |    | 109,159           |   |
| Receivables for  shares issued                                                                                       |   | (657               | )       | (541              | )      |
| Accumulated  deficit                                                                                                 |   | (5,861             | )       | (8,766            | )      |
| Accumulated  other comprehensive loss                                                                                |   | (323               | )       | (57               | )      |
| Unearned  compensation                                                                                               |   | (1,574             | )       | (1,097            | )      |
| Treasury stock  at cost, 691,006 and 597,038 shares,respectively                                                     |   | (3,063             | )       | (2,585            | )      |
| Total  shareholders’ equity                                                                                     |   | 98,789             |    | 96,283            |   |
| Total  liabilities and shareholders’ equity                                                                     |   | $                  | 108,415 |              | $      | 105,309 |   |
|                                                                                                                 |   |               |    |              |   |
| The accompanying notes  are an integral part of the condensed consolidated financial statements.                     |   |

 

2

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| **SANDERS  MORRIS HARRIS GROUP INC. AND SUBSIDIARIES** |
|--------------------------------------------------------|
| **CONDENSED CONSOLIDATED STATEMENT  OF INCOME**        |
| (in thousands, except  share and per share amounts)    |
| (unaudited)                                            |

 
|                                                                                                       |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                                       |   | **September  30,**      |   | **September  30,**     |   |
|                                                                                                       |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Revenues:                                                                                                  |   |                    |   |                   |   |   |   |   |   |
| Commissions                                                                                                |   | $                       | 11,644 |                   | $      | 5,278 |   | $ | 32,676 |   | $ | 17,893 |   |
| Principal  transactions                                                                                    |   | 1,574                   |   | 1,175                  |   | 6,969 |   | 6,096 |   |
| Investment  banking                                                                                        |   | 1,318                   |   | 2,521                  |   | 9,080 |   | 9,453 |   |
| Fiduciary,  custodial and advisory fees                                                                    |   | 1,850                   |   | 1,561                  |   | 5,490 |   | 4,798 |   |
| Interest and  dividends                                                                                    |   | 471                     |   | 774                    |   | 1,359 |   | 1,982 |   |
| Other income                                                                                               |   | 562                     |   | 392                    |   | 1,877 |   | 1,147 |   |
| Total revenues                                                                                             |   | 17,419                  |   | 11,701                 |   | 57,451 |   | 41,369 |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Expenses:                                                                                                  |   |                    |   |                   |   |   |   |   |   |
| Employee  compensation and benefits                                                                        |   | 11,530                  |   | 9,002                  |   | 37,415 |   | 26,226 |   |
| Floor brokerage,  exchange and clearance fees                                                              |   | 1,047                   |   | 724                    |   | 3,034 |   | 2,444 |   |
| Communications  and data processing                                                                        |   | 1,190                   |   | 976                    |   | 3,094 |   | 2,826 |   |
| Occupancy                                                                                                  |   | 1,114                   |   | 1,109                  |   | 3,312 |   | 2,913 |   |
| Amortization of  goodwill                                                                                  |   | —                  |   | 562                    |   | — |   | 1,614 |   |
| Other general  and administrative                                                                          |   | 1,958                   |   | 1,833                  |   | 5,907 |   | 4,773 |   |
| Total expenses                                                                                             |   | 16,839                  |   | 14,206                 |   | 52,762 |   | 40,796 |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Income (loss)  before equity in income (loss) oflimited partnerships, income taxes and  minority interests |   | 580                     |   | (2,505                 | )      | 4,689 |   | 573 |   |
| Equity in income  (loss) of limited partnerships                                                           |   | (888                    | )      | 1,106                  |   | (71 | ) | 941 |   |
|                                                                                                       |   | (308                    | )      | (1,399                 | )      | 4,618 |   | 1,514 |   |
| Benefit  (provision) for income taxes                                                                      |   | 90                      |   | 278                    |   | (1,743 | ) | (1,336 | ) |
| Minority  interests in net loss of consolidatedcompanies                                                   |   | 52                      |   | 115                    |   | 30 |   | 197 |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Net income  (loss)                                                                                         |   | $                       | (166   | )                      | $      | (1,006 | ) | $ | 2,905 |   | $ | 375 |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Earnings (loss)  per share:                                                                                |   |                    |   |                   |   |   |   |   |   |
| Basic                                                                                                      |   | $                       | (0.01  | )                      | $      | (0.06 | ) | $ | 0.18 |   | $ | 0.02 |   |
| Diluted                                                                                                    |   | $                       | (0.01  | )                      | $      | (0.06 | ) | $ | 0.17 |   | $ | 0.02 |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Weighted average  common shares outstanding:                                                               |   |                    |   |                   |   |   |   |   |   |
| Basic                                                                                                      |   | 16,674,678              |   | 16,042,002             |   | 16,586,483 |   | 15,725,481 |   |
| Diluted                                                                                                    |   | 16,674,678              |   | 16,042,002             |   | 16,812,364 |   | 15,855,625 |   |
|                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| The accompanying notes are an integral part of 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 nine months ended September 30, 2002**                 |
| (in thousands, except  shares)                                    |
| (unaudited)                                                       |

 
|                                                                                     |   | **Amounts** |       |       |   | **Shares** |           |
|------------------------------------------------------------------------------------------|--------|-------------|------------|------------|--------|------------|----------------|
|                                                                                     |   |        |       |       |   |       |           |
| **Common  stock**                                                                        |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | 170        |       |   |       | 17,009,402     |   |
| Stock issued  pursuant to employee benefit plan                                          |   | 4           |       |       |   | 388,143    |           |
| Balance, end of  period                                                                  |   | 174         |       |       |   | 17,397,545 |           |
| **Additional  paid-in capital**                                                          |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | 109,159    |       |   |       |           |   |
| Stock issued  pursuant to employee benefit plan                                          |   | 2,185       |       |       |   |       |           |
| Dividends                                                                                |   | (1,251      | )          |       |   |       |           |
| Balance, end of  period                                                                  |   | 110,093     |       |       |   |       |           |
| **Receivables  for shares issued**                                                       |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | (541       | )          |   |       |           |   |
| Collection of  receivable                                                                |   | 48          |       |       |   |       |           |
| Issuance of  restricted stock                                                            |   | (519        | )          |       |   |       |           |
| Amortization of  notes receivable                                                        |   | 355         |       |       |   |       |           |
| Balance, end of  period                                                                  |   | (657        | )          |       |   |       |           |
| **Accumulated  deficit**                                                                 |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | (8,766     | )          |   |       |           |   |
| Net income                                                                               |   | 2,905       |       | 2,905      |   |       |           |
| Balance, end of  period                                                                  |   | (5,861      | )          | 2,905      |   |       |           |
| **Accumulated  other comprehensive loss**                                                |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | (57        | )          |   |       |           |   |
| Net change in  unrealized depreciationon securities available for sale                   |   | (403        | )          | (403       | )      |       |           |
| Income tax  benefit on change                                                            |   | 137         |       | 137        |   |       |           |
| Balance, end of  period                                                                  |   | (323        | )          | (266       | )      |       |           |
| **Comprehensive  income**                                                                |   |        |       | 2,639      |   |       |           |
| **Unearned  compensation**                                                               |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | (1,097     | )          |   |       |           |   |
| Net issuance of  restricted stock                                                        |   | (966        | )          |       |   |       |           |
| Amortization of  unearned compensation                                                   |   | 489         |       |       |   |       |           |
| Balance, end of  period                                                                  |   | (1,574      | )          |       |   |       |           |
| **Treasury  stock**                                                                      |   |        |       |       |   |       |           |
| Balance,  beginning of year                                                              |   | $           | (2,585     | )          |   |       | (597,038       | ) |
| Acquisition of  treasury stock                                                           |   | (642        | )          |       |   | (131,244   | )              |
| Issuance of  treasury stock                                                              |   | 164         |       |       |   | 37,276     |           |
| Balance, end of  period                                                                  |   | (3,063      | )          |       |   | (691,006   | )              |
| **Total  shareholders’ equity and common shares outstanding**                       |   | **$**       | **98,789** | ** ** |   | ** ** | **16,706,539** | ** ** |
| The accompanying notes  are an integral part of these consolidated financial statements. |

 

4

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| **SANDERS  MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**     |
|------------------------------------------------------------|
| **CONDENSED CONSOLIDATED STATEMENT OF CASH  FLOWS**        |
| **For  the nine months ended September 30, 2002 and 2001** |
| (in thousands)                                             |
| (unaudited)                                                |

 
|                                                                                             |   | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
|                                                                                             |   |     |   |     |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                           |   |     |   |     |   |
| Net income                                                                                       |   | $        | 2,905  |     | $      | 375 |   |
| Adjustments to  reconcile net income to net cashprovided by operating activities:                |   |     |   |     |   |
| Realized (gain)  loss on securities available for sale                                           |   | (9       | )      | 1,256    |   |
| Depreciation                                                                                     |   | 625      |   | 883      |   |
| Amortization of  goodwill                                                                        |   | —   |   | 1,614    |   |
| Provision for  bad debts                                                                         |   | 188      |   | 493      |   |
| Compensation  expense related to amortization ofnotes receivable and unearned  compensation      |   | 844      |   | 90       |   |
| Deferred income  taxes                                                                           |   | (81      | )      | —   |   |
| Minority interests  in loss of consolidated companies                                            |   | (30      | )      | (197     | )      |
| Changes in  operating assets and liabilities:                                                    |   |     |   |     |   |
| Decrease in  receivables                                                                         |   | 2,461    |   | 668      |   |
| (Increase)  decrease in securities owned                                                         |   | (791     | )      | 293      |   |
| Increase in  other assets                                                                        |   | (430     | )      | (2       | )      |
| Decrease in  securities sold, not yet purchased                                                  |   | (53      | )      | (455     | )      |
| Decrease in  other liabilities                                                                   |   | (47      | )      | (1,828   | )      |
| Decrease in  payable to clearing broker-dealers                                                  |   | (63      | )      | (18      | )      |
| Increase  (decrease) in accounts payable and accrued liabilities                                 |   | 229      |   | (521     | )      |
| Net cash  provided by operating activities                                                       |   | 5,748    |   | 2,651    |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                           |   |     |   |     |   |
| Capital  expenditures                                                                            |   | (2,415   | )      | (549     | )      |
| Acquisitions,  net of cash acquired of $30                                                       |   | —   |   | (35      | )      |
| Proceeds from  sale of discontinued operations                                                   |   | —   |   | 205      |   |
| Purchase of  securities available for sale                                                       |   | (2,346   | )      | (829     | )      |
| Proceeds from  sales and maturities of securities available for sale                             |   | 480      |   | 1,886    |   |
| Net cash  provided by (used in) investing activities                                             |   | (4,281   | )      | 678      |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                           |   |     |   |     |   |
| Purchase of treasury  stock                                                                      |   | (642     | )      | (1,000   | )      |
| Collection of  receivable for shares issued                                                      |   | 48       |   | 40       |   |
| Proceeds from  shares issued                                                                     |   | 868      |   | 751      |   |
| Investment by  minority interest                                                                 |   | 75       |   | 86       |   |
| Distributions to  minority interests                                                             |   | —   |   | (33      | )      |
| Dividends paid                                                                                   |   | (834     | )      | —   |   |
| Net cash used in  financing activities                                                           |   | (485     | )      | (156     | )      |
| Net increase in  cash and cash equivalents                                                       |   | 982      |   | 3,173    |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                                |   | 30,410   |   | 25,059   |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                                      |   | $        | 31,392 |     | $      | 28,232 |   |
| Noncash investing  and financing activities:                                                     |   |     |   |     |   |
| Common stock  issued for acquisitions                                                            |   | —   |   | $        | 4,208  |   |
| Cash paid for  income taxes                                                                      |   | $        | 3,377  |     | $      | 657 |   |
|                                                                                             |   |     |   |     |   |
| The accompanying notes are an integral part of the  condensed consolidated financial statements. |   |

 

5

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### **Sanders Morris Harris GroupInc. and Subsidiaries**

**Notes****to Condensed Consolidated FinancialStatements**

**(unaudited)**

### ** **

### **1.**              BASISOF PRESENTATION

 

###### *Nature ofOperations*

Through itsoperating subsidiaries Pinnacle Management & Trust Co. (“PMT”), SandersMorris Harris Inc. (“SMH”) and SMH Capital Advisors (“SMCA”), the Companyprovides a broad range of financial services, including institutional, primeand retail brokerage, investment banking, other investment banking services,  merchant banking, financial advisory, trustrelated services, investment management and financial planning. The Companyserves a diverse group of institutional, corporate and individual clients.

 

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

 

###### *Consolidation*

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

 

In management’sopinion, the unaudited condensed consolidated financial statements include alladjustments necessary for a fair presentation of our consolidated financialposition at September 30, 2002, our results of operations for the three andnine months ended September 30, 2002 and 2001, and our cash flows for the ninemonths ended September 30, 2002 and 2001. All adjustments are of a normal recurring nature. Interim results arenot necessarily indicative of results for a full year.

 

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

 

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

SFAS No. 141 entitled “*Business Combinations”* was issued in June 2001 and becameeffective July 1, 2001.  SFAS No. 141requires that all business combinations be accounted for using the purchasemethod of accounting, which requires that acquisitions be recorded at fairvalue as of the date of acquisition. SFAS No. 142 entitled *“Goodwill andOther**Intangible Assets”*was also issued in June 2001, in concert with SFAS No. 141.  SFAS No. 142 became effective for us onJanuary 1, 2002.  As a result, the Companyceased all goodwill amortization and did not recognize $1.7 million of goodwillamortization expense that would have been recognized in the first nine monthsof 2002 under the previous accounting standards.

 

6

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

 
|                                            |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|-------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                            |   | **September  30,**      |   | **September  30,**     |   | **September  30,** |   | **September  30,** |   |
|                                            |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
| Reported net  income (loss)                     |   | $                       | (166   | )                      | $      | (1,006 | ) | $ | 2,905 |   | $ | 375 |   |
| Adjustment:                                     |   |                    |   |                   |   |   |   |   |   |
| Amortization of  goodwill                       |   | —                  |   | 562                    |   | — |   | 1,614 |   |
| Adjusted net  income (loss)                     |   | $                       | (166   | )                      | $      | (444 | ) | $ | 2,905 |   | $ | 1,989 |   |
|                                            |   |                    |   |                   |   |   |   |   |   |
| Reported net  income (loss) per share - basic   |   | $                       | (0.01  | )                      | $      | (0.06 | ) | $ | 0.18 |   | $ | 0.02 |   |
| Adjusted net  income (loss) per share - basic   |   | $                       | (0.01  | )                      | $      | (0.03 | ) | $ | 0.18 |   | $ | 0.13 |   |
|                                            |   |                    |   |                   |   |   |   |   |   |
| Reported net  income (loss) per share - diluted |   | $                       | (0.01  | )                      | $      | (0.06 | ) | $ | 0.17 |   | $ | 0.02 |   |
| Adjusted net  income (loss) per share - diluted |   | $                       | (0.01  | )                      | $      | (0.03 | ) | $ | 0.17 |   | $ | 0.13 |   |
|                                            |   |                    |   |                   |   |   |   |   |   |   |   |   |   |

 

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

 

As of the date ofadoption, the Company had unamortized goodwill in the amount of $47.6million.  Amortization expense relatedto goodwill was $2.2 million for the year ended December 31, 2001, $562,000 forthe three months ended September 30, 2001 and $1.6 million for the nine monthsended September 30, 2001.

 

*Reclassifications*

 

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

 

### **2.**              ACQUISITIONS

 

        On April 5, 2001, the Company acquired Kissinger FinancialServices, Inc. (“Kissinger”), a Baltimore, Maryland based financial planningfirm.  Kissinger was subsequently mergedinto SMH Capital Advisors.

 

 

7

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        The following summarized unaudited financial informationpresents the nine months ended September 30, 2001 as if the above transactionoccurred on January 1, 2001 compared to the actual results for the nine monthsended September 30, 2002:

 
|                        |   | **Nine  Months Ended**     |   |
|-----------------------------|--------|----------------------------|--------|
|                        |   | **September  30,**         |   |
|                        |   | **Actual**                 |   | **Proforma** |   |
|                        |   | **2002**                   |   | **2001** |   |
|                        |   | **(in  thousands, except** |   |
|                        |   | **per share  amounts)**    |   |
|                        |   |                       |   |   |   |
| Revenues                    |   | $                          | 57,451 |   | $ | 41,874 |   |
| Net income                  |   | 2,905                      |   | 288 |   |
|                        |   |                       |   |   |   |
| Basic earnings  per share   |   | $                          | 0.18   |   | $ | 0.02 |   |
| Diluted earnings  per share |   | $                          | 0.17   |   | $ | 0.02 |   |

 

        These unaudited pro forma amounts arederived from the historical financial information of the acquired business andreflect adjustments for amortization of intangible assets for 2001 and forincome taxes.  The unaudited pro formafinancial information does not necessarily represent results that would haveoccurred if the acquisition had taken place on the basis assumed above, nor arethey indicative of the results of future combined operations.

 

        During January 2002, the formerinstitutional equity unit of Sutro and Co. (the “New Institutional Group”) joinedthe Company.  This group complementedSanders Morris Harris’ existing institutional division by increasing our salesand trading base and by adding equity research in areas we did not previouslycover.

 

8

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

 

        Securitiesowned and securities sold, not yet purchased as of September 30, 2002 were asfollows:

 
|                                                |   |               |   | **Sold, Not  Yet** |   |
|-----------------------------------------------------|--------|--------------------|--------|--------------------|--------|
|                                                |   | **Owned**          |   | **Purchased**      |   |
|                                                |   | **(in thousands)** |   |
| Marketable:                                         |   |               |   |               |   |
| Corporate stocks  (cost $567)                       |   | $                  | 149    |               | $      | (69 | ) |
| Corporate bonds  and commercial paper (cost $1,446) |   | 1,390              |   | —             |   |
|                                                |   |               |   |               |   |
| Not readily  marketable:                            |   |               |   |               |   |
| Partnerships  (cost $4,079)                         |   | 6,743              |   | —             |   |
| Corporate stocks  and warrants (cost $3,402)        |   | 4,662              |   | —             |   |
|                                                |   | $                  | 12,944 |               | $      | (69 | ) |

 

        Securities not readily marketableinclude investment securities (a) for which there is no market on a securitiesexchange or no independent publicly quoted market, (b) that cannot be publiclyoffered or sold unless registration has been effected under the Securities Actof 1933, or (c) that cannot be offered or sold because of other arrangements,restrictions, or conditions applicable to the securities or to theCompany.  Not readily marketablesecurities consist of investments in limited partnerships, equities, optionsand warrants.  The investments inlimited partnerships are accounted for using the equity method, whichapproximates fair value, and principally consist of Environmental OpportunitiesFund, L.P., Environmental Opportunities Fund II, L.P., EnvironmentalOpportunities Fund II (Institutional), L.P., Corporate Opportunities Fund,L.P., Corporate Opportunities Fund (Institutional), L.P., Sanders OpportunityFund, L.P., Sanders Opportunity Fund (Institutional), L.P., TacticalOpportunities High Yield Fund, L.P., and Life Sciences Opportunity Fund, L.P.

 

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

** **
| Securities available for sale at September 30, 2002  were as follows: |
|-----------------------------------------------------------------------|
|                                                                  |

 
|                                    |   | **Amortized**      |   | **Gross  Unrealized** |   | **Estimated** |   |
|-----------------------------------------|--------|--------------------|--------|-----------------------|--------|---------------|--------|
|                                    |   | **Cost**           |   | **Gains**             |   | **Losses**    |   | **Fair Value** |   |
|                                    |   | **(in thousands)** |   |
|                                    |   |               |   |                  |   |          |   |   |   |
| U.S. Government  and agency obligations |   | $                  | 1,310  |                  | $      | 18            |   | $ | (2 | ) | $ | 1,326 |   |
| Corporate bonds                         |   | 100                |   | 5                     |   | —        |   | 105 |   |
| Marketable  equity securities           |   | 2,247              |   | 19                    |   | (534          | )      | 1,732 |   |
| Total                                   |   | $                  | 3,657  |                  | $      | 42            |   | $ | (536 | ) | $ | 3,163 |   |

 

9

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| The contractual maturities of debt securities  available for sale at September 30, 2002 were as follows: |
|----------------------------------------------------------------------------------------------------------|
|                                                                                                     |

 
| Due before 5  years                 |   | $   | 1,326  |   |
|-------------------------------------|--------|-----|--------|--------|
| Due after 5  years through 10 years |   | 105 |   |
|                                |   | $   | 1,431  |   |

 

Gross gains on sales ofsecurities available for sale were $23,000 and $130,000 for the nine monthsended September 30, 2002 and 2001, respectively.  Gross realized losses, including unrealized permanent impairmentlosses, on securities available for sale were $14,000 and $1.4 million for thenine months ended September 30, 2002 and 2001, respectively.

 

### **5.**              INCOMETAXES

 

        The differences between the effectivetax rate reflected in the income tax (benefit) provision from operations andthe statutory federal rate were as follows:

 
|                                    |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|-----------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                    |   | **September  30,**      |   | **September  30,**     |   |
|                                    |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
|                                    |   | **(in  thousands)**     |   | **(in  thousands)**    |   |
|                                    |   |                    |   |                   |   |   |   |   |   |
| Tax computed  using the statutory rate  |   | $                       | (87    | )                      | $      | (436 | ) | $ | 1,580 |   | $ | 582 |   |
| Nondeductible  amortization of goodwill |   | —                  |   | 191                    |   | — |   | 549 |   |
| State income  taxes and other           |   | (3                      | )      | (33                    | )      | 163 |   | 205 |   |
| Total                                   |   | $                       | (90    | )                      | $      | (278 | ) | $ | 1,743 |   | $ | 1,336 |   |

 

### ** **

### **6.**              COMMITMENTSAND CONTINGENCIES

 

        There were no firm underwritingcommitments open at September 30, 2002.

 

       The Company and its subsidiaries haveobligations under operating leases that expire by 2012 with initialnoncancelable terms in excess of one year.

 

        The Company is a party to various legalproceedings that are of an ordinary or routine nature incidental to itsoperations.  The Company believes it hasadequately reserved for such litigation matters and that they will not have amaterial adverse effect on the Company’s consolidated financial condition,results of operations, or cash flows.

 

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

 

10

----

 

### **7.**              EARNINGS(LOSS) PER COMMON SHARE

 

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

 
|                                                                                             |   | **Three  Months Ended September 30,**                   |   |
|--------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                                                                             |   | **2002**                                                |   | **2001** |   |
|                                                                                             |   | **(in  thousands, except share and per share amounts)** |   |
| Computation of  basic and diluted loss per commonshare for the three months ended  September 30: |   |                                                    |   |   |   |
| Net loss                                                                                         |   | $                                                       | (166   | ) | $ | (1,006 | ) |
| Weighted average  number of common shares outstanding                                            |   | 16,674,678                                              |   | 16,042,002 |   |
| Common shares  issuable under stock option plan                                                  |   | —                                                  |   | — |   |
| Less shares  assumed repurchased with proceeds                                                   |   | —                                                  |   | — |   |
| Weighted average  common shares outstanding                                                      |   | 16,674,678                                              |   | 16,042,002 |   |
| Basic and  diluted loss per common share                                                         |   | $                                                       | (0.01  | ) | $ | (0.06 | ) |
|                                                                                             |   |                                                    |   |   |   |

 
|                                                                                                |   | **Nine  Months Ended September 30,**                    |   |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|--------|
|                                                                                                |   | **2002**                                                |   | **2001** |   |
|                                                                                                |   | **(in  thousands, except share and per share amounts)** |   |
| Computation of  basic and diluted earnings per commonshare for the nine months ended  September 30: |   |                                                    |   |   |   |
| Net income                                                                                          |   | $                                                       | 2,905  |   | $ | 375 |   |
| Weighted average  number of common shares outstanding                                               |   | 16,586,483                                              |   | 15,725,481 |   |
| Common shares  issuable under stock option plan                                                     |   | 1,253,848                                               |   | 1,098,743 |   |
| Less shares  assumed repurchased with proceeds                                                      |   | (1,027,967                                              | )      | (968,599 | ) |
| Weighted average  common shares outstanding                                                         |   | 16,812,364                                              |   | 15,855,625 |   |
| Basic earnings  per common share                                                                    |   | $                                                       | 0.18   |   | $ | 0.02 |   |
| Diluted earnings  per common share                                                                  |   | $                                                       | 0.17   |   | $ | 0.02 |   |

 

Stock optionsoutstanding of 210,000 and 50,000, respectively, have not been included indiluted earnings per common share for the nine months ended September 30, 2002and 2001 because their inclusion would have been antidilutive for the periodspresented.  All stock optionsoutstanding have not been included in diluted loss per share for the threemonths ended September 30, 2002 and 2001 because their inclusion would havebeen antidilutive for the periods presented.

 

### **8.**              BUSINESSSEGMENT INFORMATION

 

        TheCompany’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 of PMTand SMH Capital Advisors.   PMT is astate chartered trust company providing a variety of trust services, includinginvestment management, estate settlement and retirement planning.  SMH Capital Advisors provides financialplanning services to individuals and asset management services to investorswith an

 

11

----

 

emphasis on fixed income securities. The following summarizes certain financial information of eachreportable segment for the three and nine months ended September 30, 2002 and2001, respectively.

 

12

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|                                                                                                       |   | **Investment**   |   |           |   |          |   |             |   |
|------------------------------------------------------------------------------------------------------------|--------|------------------|--------|----------------|--------|---------------|--------|------------------|--------|
|                                                                                                       |   | **Banking  and** |   | **Asset**      |   | **Corporate** |   | **Consolidated** |   |
| **(in thousands)**                                                                                         |   | **Brokerage**    |   | **Management** |   | **and Other** |   | **Total**        |   |
| **Three  Months Ended September 30, 2002**                                                                 |   |             |   |           |   |          |   |             |   |
| Revenues                                                                                                   |   | $                | 15,886 |           | $      | 1,489         |   | $                | 44     |   | $ | 17,419 |   |
| Amortization of  goodwill                                                                                  |   | —           |   | —         |   | —        |   | —           |   |
| Other expenses                                                                                             |   | (14,943          | )      | (1,336         | )      | (560          | )      | (16,839          | )      |
| Income (loss)  before equity in loss oflimited partnerships, income taxes and  minority interests          |   | 943              |   | 153            |   | (516          | )      | 580              |   |
| Equity in loss  of limited partnerships                                                                    |   | (709             | )      | —         |   | (179          | )      | (888             | )      |
| Income (loss)  before income taxes andminority interests                                                   |   | $                | 234    |           | $      | 153           |   | $                | (695   | ) | $ | (308 | ) |
|                                                                                                       |   |             |   |           |   |          |   |             |   |
| **Three  Months Ended September 30, 2001**                                                                 |   |             |   |           |   |          |   |             |   |
| Revenues                                                                                                   |   | $                | 11,482 |           | $      | 114           |   | $                | 105    |   | $ | 11,701 |   |
| Amortization of  goodwill                                                                                  |   | (352             | )      | —         |   | (210          | )      | (562             | )      |
| Other expenses                                                                                             |   | (12,017          | )      | (1,035         | )      | (592          | )      | (13,644          | )      |
| Loss before  equity in income oflimited partnerships, income taxes and minority  interests                 |   | (887             | )      | (921           | )      | (697          | )      | (2,505           | )      |
| Equity in income  of limited partnerships                                                                  |   | 1,106            |   | —         |   | —        |   | 1,106            |   |
| Income (loss)  before income taxes andminority interests                                                   |   | $                | 219    |           | $      | (921          | )      | $                | (697   | ) | $ | (1,399 | ) |
|                                                                                                       |   |             |   |           |   |          |   |             |   |
|                                                                                                       |   | **Investment**   |   |           |   |          |   |             |   |
|                                                                                                       |   | **Banking and**  |   | **Asset**      |   | **Corporate** |   | **Consolidated** |   |
| **(in  thousands)**                                                                                        |   | **Brokerage**    |   | **Management** |   | **and Other** |   | **Total**        |   |
| **Nine  Months Ended September 30, 2002**                                                                  |   |             |   |           |   |          |   |             |   |
| Revenues                                                                                                   |   | $                | 53,005 |           | $      | 4,382         |   | $                | 64     |   | $ | 57,451 |   |
| Amortization of  goodwill                                                                                  |   | —           |   | —         |   |          |   | —           |   |
| Other expenses                                                                                             |   | (47,230          | )      | (3,757         | )      | (1,775        | )      | (52,762          | )      |
| Income (loss)  before equity in income (loss) oflimited partnerships, income taxes and  minority interests |   | 5,775            |   | 625            |   | (1,711        | )      | 4,689            |   |
| Equity in income  (loss) of limited partnerships                                                           |   | 36               |   | —         |   | (107          | )      | (71              | )      |
| Income (loss)  before income taxes and minority interests                                                  |   | $                | 5,811  |           | $      | 625           |   | $                | (1,818 | ) | $ | 4,618 |   |
|                                                                                                       |   |             |   |           |   |          |   |             |   |
| **Nine  Months Ended September 30, 2001**                                                                  |   |             |   |           |   |          |   |             |   |
| Revenues                                                                                                   |   | $                | 39,108 |           | $      | 1,953         |   | $                | 308    |   | $ | 41,369 |   |
| Amortization of  goodwill                                                                                  |   | (1,034           | )      | —         |   | (580          | )      | (1,614           | )      |
| Other expenses                                                                                             |   | (34,815          | )      | (2,753         | )      | (1,614        | )      | (39,182          | )      |
| Income (loss)  before equity in income oflimited partnerships, income taxes and  minority interests        |   | 3,259            |   | (800           | )      | (1,886        | )      | 573              |   |
| Equity in income  of limited partnerships                                                                  |   | 941              |   | —         |   | —        |   | 941              |   |
| Income (loss)  before income taxes andminority interests                                                   |   | $                | 4,200  |           | $      | (800          | )      | $                | (1,886 | ) | $ | 1,514 |   |
|                                                                                                       |   |             |   |           |   |          |   |             |   |
|                                                                                                       |   | **Investment**   |   |           |   |          |   |             |   |
|                                                                                                       |   | **Banking and**  |   | **Asset**      |   | **Corporate** |   | **Consolidated** |   |
| **(in  thousands)**                                                                                        |   | **Brokerage**    |   | **Management** |   | **and Other** |   | **Total**        |   |
| Total assets as  of September 30, 2002                                                                     |   | $                | 71,601 |           | $      | 5,899         |   | $                | 30,915 |   | $ | 108,415 |   |
| Total assets as  of December 31, 2001                                                                      |   | $                | 67,408 |           | $      | 5,997         |   | $                | 31,904 |   | $ | 105,309 |   |

 

 

13

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### **9.**              EMPLOYEEBENEFIT PLANS

 

Under its 1998 Incentive Plan, as amended, the Companyhas reserved 25% of the issued and outstanding Common Stock of the Company, or4,000,000 shares of Common Stock, whichever is greater, for the purpose ofissuing incentive awards under the Incentive Plan.  The Company had 1,570,000 shares of Common Stock available forgrant under the Incentive Plan at September 30, 2002.

 

**Stock Options**

 

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

 

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

 

Effective January 2, 2001, the Company adopted the CIPunder its Incentive Plan in which eligible employees may purchase shares of theCompany’s restricted common stock at a price equal to 66.7% of the 20-dayaverage of the closing sales prices for a share of the Company’s common stock,ending on the day prior to the date the shares are issued.  The CIP was amended effective November 1,2001 to include eligible consultants as potential participants under theprogram.

 

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

 
| The following summarizes certain information related  to the CIP for the three and nine months endedSeptember 30, 2002 and 2001: |
|----------------------------------------------------------------------------------------------------------------------------------|

 
|                                   |   | **Three  Months Ended**            |   | **Nine  Months Ended**             |   |
|----------------------------------------|--------|------------------------------------|--------|------------------------------------|--------|
|                                   |   | **September  30,**                 |   | **September  30,**                 |   |
|                                   |   | **2002**                           |   | **2001**                           |   | **2002** |   | **2001** |   |
|                                   |   | **(in  thousands, except shares)** |   | **(in  thousands, except shares)** |   |
|                                   |   |                               |   |                               |   |   |   |   |   |
| Number of shares  issued               |   | 53,419                             |   | 114,191                            |   | 368,954 |   | 254,293 |   |
| Value of shares  issued                |   | $                                  | 325    |                               | $      | 572 |   | $ | 2,066 |   | $ | 1,489 |   |
| Additions to  unearned compensation    |   | 251                                |   | 108                                |   | 966 |   | 503 |   |
| Additions to  notes receivable         |   | —                             |   | 235                                |   | 519 |   | 235 |   |
| Amortization of  unearned compensation |   | 200                                |   | 36                                 |   | 489 |   | 61 |   |
| Amortization of  notes receivable      |   | 122                                |   | 29                                 |   | 355 |   | 29 |   |
|                                        |        |                                    |        |                                    |        |  |  |  |  |  |  |  |  |

 

 

14

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### **10.  RELATEDPARTIES**

 

The Company had receivables from related partiestotaling $4.0 million at September 30, 2002, primarily consisting of $924,000of unpaid management fees earned on the Company’s investments in limitedpartnerships and $2.6 million of notes receivable from employees andconsultants.

 

 

15

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

 

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

 

**General**

 

        Weprovide diversified financial services through our subsidiaries, includinginstitutional, prime and retail brokerage, investment banking, merchantbanking, financial advisory, trust related services, investment management andfinancial planning. All of these activities are highly competitive and aresensitive to many factors outside our control, including those factors listedunder “Factors Affecting Forward-Looking Statements.”

 

        We closely monitor our operatingenvironment to enable us to respond promptly to market cycles. In addition, weseek to lessen earnings volatility by controlling expenses, increasingfee-based business and developing new revenue sources. Nonetheless, operatingresults for any specific period should not be considered representative offuture performance.

 

        On April 5, 2001, we acquired KissingerFinancial Services, Inc. (“Kissinger”). Kissinger, based in Baltimore, Maryland, provides financial planningservices to individuals.  Theacquisition was accounted for under the purchase method, and thus, thefinancial information for Kissinger has been included in our consolidatedfinancial statements from April 5, 2001.

 

        On January 2, 2002, the formerinstitutional equity unit of Sutro & Co. (the “New Institutional Group”)joined Sanders Morris Harris.  Thefinancial information for the New Institutional Group has been included in ourconsolidated financial statements from January 1, 2002.

 

**Components of Revenues and Expenses**

 

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

 

        *Expenses.*      Our expenses consist of (1) employeecompensation and benefits, (2) brokerage and clearing costs, and (3) otherexpenses.  Compensation and benefitshave both a variable component based on revenue production and a fixedcomponent.  The variable componentincludes institutional and retail sales commissions, bonuses, overrides, andtrading desk incentives.  Retail andinstitutional commissions are based on a competitive commission schedule.  The investment banking group and theresearch group receive a salary and discretionary bonus as compensation.  The fixed component includes administrativeand executive salaries, payroll taxes, employee benefits and temporary employeecosts.  Compensation and benefits is ourlargest expense item and includes wages, salaries and benefits. During thefirst nine months of 2002, compensation and benefits represented 71% of totalexpenses, and 65% of total revenues compared to 64% of total expenses, and 63%of total revenues during the comparable period in 2001.

 

        Brokerage and clearance expenses includeclearing and trade execution costs associated with the retail, prime andinstitutional brokerage business at SMH. SMH clears its transactions primarily through the Pershing Division ofDonaldson, Lufkin and Jenrette Securities Corporation, a Credit Suisse FirstBoston Company, and other clearing brokers.

 

16

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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, quotes, market data andsoftware program providers.

 

Amortization expense in 2001 reflects the amortization of the goodwillrecorded through mergers and acquisitions.

 

**Resultsof Operations**

 

*ThreeMonths Ended September 30, 2002 Compared to Three Months Ended September 30,2001*

 

The January 2, 2002 addition of the NewInstitutional Group is reflected in our operating results for the three monthsended September 30, 2002, but not for the comparable third quarter in 2001.

 

Total revenues rose 48.7% to$17.4 million in 2002 from $11.7 million in 2001 primarily due to an increasein commission revenue resulting from the addition of the former institutionalequity professionals of the New Institutional Group and growth in revenues fromprime brokerage services.  Additionally, the 2001 period was adversely affected by the events ofSeptember 11, 2001 and the subsequent disruption to the capital markets(including closure of the markets for four days during the period).  Total expenses for the period increased18.3% to $16.8 million from $14.2 million in the previous year primarily due tocompensation expenses related to the increase in revenues, and to the increasein other expenses associated with the addition of the New InstitutionalGroup.  Equity in income (loss) oflimited partnerships declined from income of $1.1 million during the thirdquarter of 2001 to a loss of $888,000 during the third quarter of 2002, due todecreases in the Company’s share of the values of securities held in theinvestment portfolios of the limited partnerships managed by the Company.  Net loss for the three month period endedSeptember 30, 2002 declined to $166,000 from $1 million in 2001.  Approximately $562,000 of the reduced netloss is attributable to a goodwill charge incurred in 2001 without acorresponding charge during 2002.  Basicand diluted loss per share was $(0.01) for the three months ended September 30,2002 compared to $(0.06) for the same period in 2001.

 

Commissions revenueincreased to $11.6 million in 2002 from $5.3 million in 2001, primarily as aresult of the addition of the New Institutional Group and growth in revenuesfrom prime brokerage services. Principal transactions revenue totaled $1.6 million in 2002 versus $1.2million in 2001.   Revenues from fixedincome brokerage declined to $1.4 million during the third quarter of 2002 from$3.0 million during the comparable prior year quarter due to the reduced impacton the mortgage-related securities market caused by stabilizing interest ratesin the current year, compared to declining interest rates during 2001.  The decline in fixed income revenues wasoffset by an improvement in net gains (losses) on the Company’s investmentportfolios.  During 2001, the Companyrecognized permanent impairment losses on its securities available for saleportfolio of $1.1 million.  Investmentbanking revenue declined to $1.3 million in 2002 from $2.5 million in 2001,principally due to a decline in fees earned from other investment bankingservices.  Revenues from fiduciary,custodial and advisory fees increased to $1.9 million in 2002 from $1.6 millionin 2001, reflecting an increase in fees earned from asset-based advisoryservices.  Interest and dividend incomedeclined to $471,000 in 2002 from $774,000 in the same period last yearreflecting a decline in interest rates from 2001 to 2002.  Other income increased from $392,000 during2001 to $562,000 during 2002, due to an increase in interest earned on theCompany’s cash balances and customer credit balances at its clearing brokers.

 

During the three monthsended September 30, 2002, employee compensation and benefits, increased to $11.5million from $9.0 million in the same period last year due to the increase inrevenues and the addition of the New Institutional Group.  Floor brokerage, exchange and clearance feesincreased to $1.0 million in 2002 from $724,000 in 2001 reflecting increasedclearing and execution costs resulting from the additional trading volumeattributable to the New Institutional Group and to the growth in revenues fromprime brokerage services.  Communicationand data processing costs increased to $1.2 million in 2002 from $1.0 millionin the same period last year reflecting the increase in personnel and tradingvolumes related to the New Institutional Group.   Occupancy costs totaled $1.1 million in both 2002 and 2001.  Due to adoption of SFAS No. 142 on January1, 2002, the Company no longer amortizes goodwill.  During the third quarter of 

 

 

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2001, goodwill amortization totaled$562,000.  Other general andadministrative expenses increased to $2.0 million from $1.8 million mainly dueto the addition of the New Institutional Group.

 

The effective tax rate fromoperations was 35.2% (benefit) for the three months ended September 30, 2002compared to 21.7% (benefit) for the three months ended September 30, 2001.  Our effective tax rate for the three monthsended September 30, 2001 differs from that of the third quarter of 2002 mainlydue to the inclusion of nondeductible goodwill amortization.

 

 

###### *NineMonths Ended September 30, 2002 Compared to Nine Months Ended September 30,2001*

 

**         **Kissinger wasacquired on April 5, 2001, hence its operating results are not included in theCompany’s financial statements for the first three months of 2001.  The data for the nine months ended September30, 2002 reflects the operating results of Kissinger for the entireperiod.  The January 2, 2002 addition ofthe New Institutional Group is reflected in our operating results for the ninemonths ended September 30, 2002, but not for the comparable period in 2001.

 

          Total revenues rose 38.9% to $57.5 million in 2002 from$41.4 million in 2001 primarily due to an increase in revenues resulting fromthe addition of the New Institutional Group, the acquisition of Kissinger andrevenue growth from prime brokerage services. Total expenses for the period increased 29.4% to $52.8 million from$40.8 million in the previous year, principally due to compensation expensesrelated to the increase in revenues, and to the increase in other expensesassociated with the addition of the New Institutional Group and the acquisitionof Kissinger.  Equity in income (loss)of limited partnerships declined from income of $941,000 during the first ninemonths of 2001 to a loss of $71,000 during the first three quarters of 2002.  This decline was caused by the Company’sshare of reductions in the values of securities held in the investmentportfolios of the limited partnerships managed by the Company.  Net income for the nine months endedSeptember 30, 2002 increased to $2.9 million in 2002 from $375,000 in2001.  Approximately $1.6 million of theincrease in net income is attributable to goodwill amortization incurred in2001 without any corresponding amortization charge during 2002.  Basic and diluted earnings per share was $0.18and $0.17, respectively, for the nine months ended September 30, 2002 comparedto $0.02 for the same period in 2001.

 

          Commissions revenue increased to $32.7 million in 2002 from$17.9 million in 2001, primarily as a result of the addition of the NewInstitutional Group and growth from prime brokerage services.  Principal transactions revenue totaled $7.0million in 2002 versus $6.1 million in 2001. A decline in fixed income brokerage revenues to $5.6 million during thefirst three quarters of 2002, from $6.7 million during the prior year periodwas offset by an improvement in net gains (losses) on the Company’s investmentportfolios.  During 2001, the Companyrecognized permanent impairment losses on its securities available for saleportfolio of $1.3 million.  Investmentbanking revenue declined to $9.1 million in 2002 from $9.5 million in2001.  Revenues from fiduciary,custodial and advisory fees increased from $4.8 million in 2001 to $5.5 millionin 2002, mainly due to an increase in fees earned from asset-based advisoryservices. Interest and dividend income declined to $1.4 million in 2002 from$2.0 million in the same period last year reflecting a decline in interestrates from 2001 to 2002.  Other incomeincreased to $1.9 million in 2002 from $1.1 million in 2001, due to an increasein interest earned on the Company’s cash balances and customer credit balancesat the Company’s clearing brokers.

 

          During the nine months ended September 30, 2002, employeecompensation and benefits increased to $37.4 million from $26.2 million in the same period last year due to theincrease in revenues resulting from the addition of the New Institutional Groupand the acquisition of Kissinger.  Floorbrokerage, exchange and clearance fees increased to $3.0 million in 2002 from$2.4 million in 2001, reflecting increased clearing and execution costsresulting from the additional trading volume attributable to the NewInstitutional Group and to growth in revenues from prime brokerage.   Communication and data processing coststotaled $3.1 million for the nine months ended September 30, 2002 compared to$2.8 million in the prior year period reflecting the increase in personnel andtrading volumes related to the New Institutional Group.  Occupancy costs increased to $3.3 million in2002 from $2.9 million in 2001 primarily due to the additional rent expense for

 

 

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office leases for the NewInstitutional Group and Kissinger.  Dueto adoption of SFAS 142 on January 1, 2002, the Company no longer amortizesgoodwill.   During the first threequarters of 2001, goodwill amortization totaled $1.6 million.  Other general and administrative expensesincreased to $5.9 million from $4.8 million mainly due to the addition of theNew Institutional Group and the acquisition of Kissinger.

 

          The effective tax rate from operations was 37.5% for thenine months ended September 30, 2002 compared to 78.1% for the nine monthsended September 30, 2001.  Our effectivetax rate exceeds the federal statutory income tax rate primarily as a result ofnondeductible goodwill amortization in 2001 and state income taxes for both2002 and 2001.

 

**Liquidity and Capital Resources**

 

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

 

        AtSeptember 30, 2002, we had approximately $31.4 million in cash and cashequivalents, which together with receivables from broker-dealers, deposits withclearing brokers, marketable securities owned, and securities available forsale represented about 44.9% of our total assets at the end of the thirdquarter.

 

        For the nine months ended September 30,2002, net cash provided by operations totaled $5.7 million versus $2.7 millionduring the first nine months of 2001. Other liabilities, consisting of net liabilities of discontinuedoperations, declined by $1.8 million during the nine months ended September 30,2001, principally due to the sale of the remaining assets of Spires and thepayment of final expenses associated with the disposition of EngineeredSystems, Inc.  Accounts receivabledeclined by $2.5 million during the first nine months of 2002, primarily due topayments of management fees owed to the Company by the limited partnerships, andthe payment and amortization of notes receivable from other related parties.

 

        Capital expenditures for the first threequarters of 2002 were $2.4 million, mainly for the purchase of furniture andcomputer equipment and software, as well as for leasehold improvements,necessary for our growth.  During thefirst nine months of 2002, we reacquired 131,244 of our common shares at atotal cost of approximately $642,000.

 

        At September 30, 2002, SMH, ourregistered broker-dealer subsidiary, was in compliance with the net capitalrequirements of the Securities and Exchange Commission’s Uniform Net CapitalRules and had capital in excess of the required minimum.  PMT was in compliance with the TexasDepartment of Banking net capital requirement and had capital in excess of therequired minimum.

 

        We are a party to various legalproceedings that are of an ordinary or routine nature incidental to ouroperations.  We believe we haveadequately reserved for such litigation matters and that they will not have a materialadverse effect on our consolidated financial condition, results of operations,or cash flows.

 

 

**FactorsAffecting Forward–Looking Statements**

 

This quarterly report on Form 10–Q includes“forward–looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities andExchange Act of 1934, as amended (the “Acts”). These forward–lookingstatements may relate to such matters as anticipated financial performance,future revenues or earnings, business prospects, projected ventures, newproducts, anticipated market performance and similar matters. The PrivateSecurities Litigation Reform Act of 1995 provides a safe harbor for forward–lookingstatements. To comply with the safe harbor, the Company cautions readers that avariety of factors could cause the Company’s actual results to differmaterially from the anticipated results or other expectations expressed in theCompany’s forward–looking statements. These risks and uncertainties, manyof 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 

 

 

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business; (4) general economic conditions, both domestic and foreign,especially in the regions where the Company does business; (5) changes in therate of inflation and related impact on securities markets; (6) competitionfrom existing financial institutions and other new participants in thesecurities markets; (7) legal developments affecting the litigation experienceof the securities industry; (8) successful implementation of technologysolutions; (9) changes in valuations of the Company’s trading and warrantportfolios resulting from mark-to-market adjustments; (10) dependence on keypersonnel and (11) demand for the Company’s services. The Company does notundertake to publicly update or revise any forward–looking statements.

 

**Item 3*****.  Quantitative and Qualitative DisclosuresAbout Market Risk***

 

**MarketRisks**

 

At September 30, 2002,PMT had equity securities under management with a fair value of $382million.  PMT’s fee income for the ninemonths ended September 30, 2002 would have been reduced by approximately$128,000 assuming a hypothetical 10% decrease in the value of its equitysecurities under management.  PMT’ssecurities available for sale are recorded at a fair value of approximately$3.2 million at September 30, 2002. These securities are subject to equity price risk.  These securities have an original cost of$3.7 million.  At September 30, 2002,the unrealized decline in market value totaling $494,000, less tax benefit of$171,000, has been included as a separate component of shareholders’ equity.

 

Management evaluates therealizability of securities available for sale to determine if a decline invalue is other than temporary.  Suchevaluation considers the length of time and the extent to which market valuehas been less than cost, the financial condition and near-term prospects of theissuer, and the intent and ability of the Company to retain its investment inthe issuer for a period of time sufficient to allow for any anticipatedrecovery in market value.  Managementbelieves the unrealized losses are temporary at September 30, 2002.  However, a write-down accounted for as a realizedloss may be necessary in the future.

 

        The Company’s trading equity and debtsecurities are marked to market on a daily basis.  At September 30, 2002, the Company’s trading equity and debtsecurities were recorded at a fair value of approximately $1.5 million.  These trading equity and debt securities aresubject to equity price risk.  This riskwould amount to approximately $154,000 based on a potential loss in fair valuefrom a hypothetical 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 andProcedures*

 

*    *   Our management, including our Chief Executive Officer and ChiefFinancial Officer, have conducted an evaluation of the effectiveness of ourdisclosure controls and procedures (as defined in Rule 13a-14(c) promulgatedunder the Securities and Exchange Act of 1934, as amended) as of a date (the“Evaluation Date”) within 90 days prior to the filing date of this report.  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures are effective for timely gathering,analyzing and disclosing the information we are required to disclose in ourreports filed under the Securities Exchange Act of 1934, as amended.  There have been no significant changes madein our internal controls or in other factors that could significantly affectour internal controls subsequent to the Evaluation Date.

 

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**PART II.   OTHER INFORMATION**

 

**Item 1****.  *LegalProceedings***

 

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

 

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**Item 6**.  ***Exhibitsand 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).                |
|                  |   |                                                                                                                                                                                                                |
| *99.1                 |   | Certification  Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                   |
|                  |   |                                                                                                                                                                                                                |
| *99.2                 |   | Certification  Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                   |
|                  |   |                                                                                                                                                                                                                |

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* Filed herewith.

 

 

(b) Reports onForm 8–K.

 

On August 28,2002, the Company filed a current report on Form 8-K relating to thedeclaration by its board of directors of a cash dividend in the amount of$0.025 per share of common stock.

 

On September 19,2002, the Company filed a current report on Form 8-K for the purpose ofupdating the description of its capital stock.

 

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

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

 

 

**Date:      November 11, 2002**

 

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**CERTIFICATIONS**

I, Ben T. Morris, certifythat:

1.     I have reviewed this quarterly report onForm 10-Q of Sanders Morris Harris Group Inc.;

2.     Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading with respectto the period covered by this quarterly report;

3.     Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

4.     The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

a)      designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this quarterly report isbeing prepared;

b)      evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c)      presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

a)      all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)      any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

6.     The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

Date:       November 11, 2002

 
| /s/ BEN T. MORRIS       |   |
|-------------------------|--------|
| Ben T. Morris           |
| Chief Executive Officer |

 

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I, Rick Berry, certifythat:

1.     I have reviewed this quarterly report onForm 10-Q of Sanders Morris Harris Group Inc.;

2.     Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

3.     Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results of operationsand cash flows of the registrant as of, and for, the periods presented in thisquarterly report;

4.     The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

a)      designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b)      evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c)      presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

a)      all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)      any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

6.     The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

Date:       November 11, 2002

 
| /s/ RICK BERRY          |   |
|-------------------------|--------|
| Rick Berry              |
| Chief Financial Officer |

 

 

 

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