**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

**(mark one)**

 

**ý****             ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**FOR THE QUARTERLYPERIOD ENDED SEPTEMBER 30, 2003**

 

**or**

 

**o****             ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Commission file No. 0-30066**

 

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**SANDERSMORRIS HARRIS GROUP INC.**

(Exact name of registrant as specified in itscharter)

 

| **Texas**                                                       |   | **76-0583569**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                  |
| **600 Travis, Suite 3100**                                      |
| **Houston, Texas 77002**                                        |
| (Address of principal executive office)                         |
|                                                            |   |                                  |
| **(713) 993-4610**                                              |
| (Registrant’s telephone number,  including area code)      |

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 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. YES  ý          NO  o

 

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

 

The number of shares of the registrant’s Common Stock, par value $0.01per share, outstanding as of November 1, 2003, was 17,216,442.

 

 

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

 

# **INDEX**

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

 

1

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**PART I****.  FINANCIAL INFORMATION**

**Item 1****.  *Financial Statements***

 

**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEET**

(in thousands, except shareand per share amounts)

 
|                                                                                                                  |   | **September 30,  2003** |    | **December 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|-----------------------------|--------|
|                                                                                                                  |   | **(unaudited)**              |    |                        |   |
| **ASSETS**                                                                                                            |   |                         |    |                        |   |
| Cash  and cash equivalents                                                                                            |   | $                            | 31,353  |                        | $      | 34,890 |   |
| Receivables,  net of allowance of $400 and $295, respectively                                                         |   |                         |    |                        |   |
| Broker-dealers                                                                                                        |   | 1,398                        |    | 641                         |   |
| Customers                                                                                                             |   | 2,285                        |    | 2,026                       |   |
| Related  parties                                                                                                      |   | 6,358                        |    | 4,489                       |   |
| Other                                                                                                                 |   | 897                          |    | 719                         |   |
| Deposits  with clearing brokers                                                                                       |   | 1,053                        |    | 1,000                       |   |
| Securities  owned                                                                                                     |   | 23,696                       |    | 16,995                      |   |
| Securities  available for sale                                                                                        |   | 2,998                        |    | 3,064                       |   |
| Furniture  and equipment, net                                                                                         |   | 4,135                        |    | 4,021                       |   |
| Deferred  income taxes                                                                                                |   | 397                          |    | 638                         |   |
| Other  assets                                                                                                         |   | 2,012                        |    | 1,167                       |   |
| Goodwill,  net of accumulated amortization of $4,268                                                                  |   | 49,399                       |    | 47,673                      |   |
| Total  assets                                                                                                         |   | $                            | 125,981 |                        | $      | 117,323 |   |
|                                                                                                                  |   |                         |    |                        |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                         |   |                         |    |                        |   |
| Liabilities:                                                                                                          |   |                         |    |                        |   |
| Accounts  payable and accrued liabilities                                                                             |   | $                            | 13,639  |                        | $      | 15,308 |   |
| Securities  sold, not yet purchased                                                                                   |   | 458                          |    | 93                          |   |
| Other  liabilities                                                                                                    |   | 161                          |    | 190                         |   |
| Total  liabilities                                                                                                    |   | 14,258                       |    | 15,591                      |   |
|                                                                                                                  |   |                         |    |                        |   |
| Commitments  and contingencies                                                                                        |   |                         |    |                        |   |
|                                                                                                                  |   |                         |    |                        |   |
| Minority  interests                                                                                                   |   | 150                          |    | 421                         |   |
|                                                                                                                  |   |                         |    |                        |   |
| Shareholders’  equity:                                                                                           |   |                         |    |                        |   |
| Preferred  stock, $0.10 par value; 10,000,000 shares authorized; no shares issued and  outstanding                    |   | —                       |    | —                      |   |
| Common  stock, $0.01 par value; 100,000,000 shares authorized; 17,920,484 and  17,439,743 shares issued, respectively |   | 179                          |    | 174                         |   |
| Additional  paid-in capital                                                                                           |   | 113,062                      |    | 109,959                     |   |
| Receivables  for shares issued                                                                                        |   | (949                         | )       | (705                        | )      |
| Retained  earnings (accumulated deficit)                                                                              |   | 3,520                        |    | (3,367                      | )      |
| Accumulated  other comprehensive loss                                                                                 |   | (177                         | )       | (243                        | )      |
| Unearned  compensation                                                                                                |   | (779                         | )       | (1,392                      | )      |
| Treasury  stock at cost, 722,503 and 702,849 shares, respectively                                                     |   | (3,283                       | )       | (3,115                      | )      |
| Total  shareholders’ equity                                                                                      |   | 111,573                      |    | 101,311                     |   |
| Total  liabilities and shareholders’ equity                                                                      |   | $                            | 125,981 |                        | $      | 117,323 |   |

 

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

 

2

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF INCOME**

(in thousands, except shareand per share amounts)

(unaudited)

 

 
|                                                                                                 |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                 |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
| Revenues:                                                                                            |   |                                       |   |                                      |   |   |   |   |   |
| Commissions                                                                                          |   | $                                          | 12,807 |                                      | $      | 11,644 |   | $ | 38,441 |   | $ | 32,676 |   |
| Principal  transactions                                                                              |   | 4,444                                      |   | 1,574                                     |   | 10,393 |   | 6,969 |   |
| Investment  banking                                                                                  |   | 2,966                                      |   | 1,318                                     |   | 13,167 |   | 9,080 |   |
| Fiduciary,  custodial and advisory fees                                                              |   | 2,768                                      |   | 1,850                                     |   | 7,049 |   | 5,490 |   |
| Interest  and dividends                                                                              |   | 621                                        |   | 471                                       |   | 1,830 |   | 1,359 |   |
| Other  income                                                                                        |   | 569                                        |   | 562                                       |   | 1,846 |   | 1,877 |   |
| Total  revenues                                                                                      |   | 24,175                                     |   | 17,419                                    |   | 72,726 |   | 57,451 |   |
| Expenses:                                                                                            |   |                                       |   |                                      |   |   |   |   |   |
| Employee  compensation and benefits                                                                  |   | 14,380                                     |   | 11,530                                    |   | 44,809 |   | 37,415 |   |
| Floor  brokerage, exchange and clearance fees                                                        |   | 1,268                                      |   | 1,047                                     |   | 4,169 |   | 3,034 |   |
| Communications  and data processing                                                                  |   | 1,398                                      |   | 1,190                                     |   | 4,135 |   | 3,094 |   |
| Occupancy                                                                                            |   | 1,347                                      |   | 1,114                                     |   | 4,228 |   | 3,312 |   |
| Other  general and administrative                                                                    |   | 2,501                                      |   | 1,958                                     |   | 7,154 |   | 5,907 |   |
| Total  expenses                                                                                      |   | 20,894                                     |   | 16,839                                    |   | 64,495 |   | 52,762 |   |
| Income  before equity in income (loss) of limited partnerships, income taxes and  minority interests |   | 3,281                                      |   | 580                                       |   | 8,231 |   | 4,689 |   |
| Equity  in income (loss) of limited partnerships                                                     |   | 338                                        |   | (888                                      | )      | 3,191 |   | (71 | ) |
|                                                                                                 |   | 3,619                                      |   | (308                                      | )      | 11,422 |   | 4,618 |   |
| (Provision)  benefit for income taxes                                                                |   | (1,283                                     | )      | 90                                        |   | (4,478 | ) | (1,743 | ) |
| Minority  interests in net income (loss) of consolidated companies                                   |   | (33                                        | )      | 52                                        |   | (57 | ) | 30 |   |
|                                                                                                 |   |                                       |   |                                      |   |   |   |   |   |
| Net  income (loss)                                                                                   |   | $                                          | 2,303  |                                      | $      | (166 | ) | $ | 6,887 |   | $ | 2,905 |   |
|                                                                                                 |   |                                       |   |                                      |   |   |   |   |   |
| Earnings  (loss) per share:                                                                          |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                                                                                |   | $                                          | 0.13   |                                      | $      | (0.01 | ) | $ | 0.40 |   | $ | 0.18 |   |
| Diluted                                                                                              |   | $                                          | 0.13   |                                      | $      | (0.01 | ) | $ | 0.39 |   | $ | 0.17 |   |
|                                                                                                 |   |                                       |   |                                      |   |   |   |   |   |
| Weighted  average common shares outstanding:                                                         |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                                                                                |   | 17,179,476                                 |   | 16,674,678                                |   | 17,047,891 |   | 16,586,483 |   |
| Diluted                                                                                              |   | 17,669,969                                 |   | 16,674,678                                |   | 17,575,860 |   | 16,812,364 |   |

 

The accompanying notes arean integral part of the condensed consolidated financial statements.

 

3

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY**

**For thenine months ended September 30, 2003**

(in thousands, exceptshares)

(unaudited)

 

 
|                                                                    |   | **Amounts** |        |       |   | **Shares** |           |
|-------------------------------------------------------------------------|--------|-------------|-------------|------------|--------|------------|----------------|
|                                                                    |   |        |        |       |   |       |           |
| **Common stock**                                                        |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | 174         |       |   |       | 17,439,743     |   |
| Stock  issued pursuant to employee benefit plan                         |   | 5           |        |       |   | 480,741    |           |
| Balance,  end of period                                                 |   | 179         |        |       |   | 17,920,484 |           |
| **Additional paid-in capital**                                          |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | 109,959     |       |   |       |           |   |
| Stock  issued pursuant to employee benefit plan                         |   | 4,139       |        |       |   |       |           |
| Dividends                                                               |   | (1,036      | )           |       |   |       |           |
| Balance,  end of period                                                 |   | 113,062     |        |       |   |       |           |
| **Receivables for shares issued**                                       |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (705        | )          |   |       |           |   |
| Issuance  of restricted stock                                           |   | (813        | )           |       |   |       |           |
| Amortization  of notes receivable                                       |   | 569         |        |       |   |       |           |
| Balance,  end of period                                                 |   | (949        | )           |       |   |       |           |
| **Retained earnings (accumulated deficit)**                             |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (3,367      | )          |   |       |           |   |
| Net  income                                                             |   | 6,887       |        | 6,887      |   |       |           |
| Balance,  end of period                                                 |   | 3,520       |        | 6,887      |   |       |           |
| **Accumulated other comprehensive loss**                                |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (243        | )          |   |       |           |   |
| Net  change in unrealized depreciation on securities available for sale |   | 105         |        | 105        |   |       |           |
| Income  tax on change                                                   |   | (39         | )           | (39        | )      |       |           |
| Balance,  end of period                                                 |   | (177        | )           | 66         |   |       |           |
| **Comprehensive income**                                                |   |        |        | 6,953      |   |       |           |
| **Unearned compensation**                                               |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (1,392      | )          |   |       |           |   |
| Net  issuance of restricted stock                                       |   | (58         | )           |       |   |       |           |
| Amortization  of unearned compensation                                  |   | 671         |        |       |   |       |           |
| Balance,  end of period                                                 |   | (779        | )           |       |   |       |           |
| **Treasury stock**                                                      |   |        |        |       |   |       |           |
| Balance,  beginning of period                                           |   | $           | (3,115      | )          |   |       | (702,849       | ) |
| Acquisition  of treasury stock                                          |   | (168        | )           |       |   | (19,654    | )              |
| Balance,  end of period                                                 |   | (3,283      | )           |       |   | (722,503   | )              |
| **Total shareholders’ equity and common shares outstanding**       |   | **$**       | **111,573** | ** ** |   |       | **17,197,981** | ** ** |

 

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

 

4

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**SANDERSMORRIS HARRIS GROUP INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENT OF CASH FLOWS**

**For thenine months ended September 30, 2003 and 2002**

(in thousands)

(unaudited)

 
|                                                                                          |   | **2003** |   | **2002** |   |
|-----------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                        |   |     |   |     |   |
| Net  income                                                                                   |   | $        | 6,887  |     | $      | 2,905 |   |
| Adjustments  to reconcile net income to net cash (used in) provided by operating  activities: |   |     |   |     |   |
| Realized  gain on securities available for sale                                               |   | (8       | )      | (9       | )      |
| Depreciation                                                                                  |   | 869      |   | 625      |   |
| Provision  for bad debts                                                                      |   | 190      |   | 188      |   |
| Compensation  expense related to amortization of notes receivable and unearned compensation   |   | 1,240    |   | 844      |   |
| Deferred  income taxes                                                                        |   | 202      |   | (81      | )      |
| Minority  interests in income (loss) of consolidated companies                                |   | 57       |   | (30      | )      |
| Changes  in operating assets and liabilities:                                                 |   |     |   |     |   |
| (Increase)  decrease in receivables                                                           |   | (3,086   | )      | 2,461    |   |
| Increase  in securities owned                                                                 |   | (6,701   | )      | (791     | )      |
| Increase  in other assets                                                                     |   | (940     | )      | (430     | )      |
| Increase  (decrease) in securities sold, not yet purchased                                    |   | 365      |   | (53      | )      |
| Decrease  in other liabilities                                                                |   | (29      | )      | (110     | )      |
| (Decrease)  increase in accounts payable and accrued liabilities                              |   | (1,874   | )      | 229      |   |
| Net  cash (used in) provided by operating activities                                          |   | (2,828   | )      | 5,748    |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                        |   |     |   |     |   |
| Capital  expenditures                                                                         |   | (955     | )      | (2,415   | )      |
| Acquisition,  net of cash acquired of $142                                                    |   | (1,608   | )      | —   |   |
| Purchase  of securities available for sale                                                    |   | (1,173   | )      | (2,346   | )      |
| Proceeds  from sales and maturities of securities available for sale                          |   | 1,352    |   | 480      |   |
| Net  cash used in investing activities                                                        |   | (2,384   | )      | (4,281   | )      |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                        |   |     |   |     |   |
| Purchase  of treasury stock                                                                   |   | (168     | )      | (642     | )      |
| Collection  of receivable for shares issued                                                   |   | —   |   | 48       |   |
| Proceeds  from shares issued                                                                  |   | 3,273    |   | 868      |   |
| Investment  by minority interest                                                              |   | 38       |   | 75       |   |
| Distributions  to minority interests                                                          |   | (432     | )      | —   |   |
| Payments  of cash dividends                                                                   |   | (1,036   | )      | (834     | )      |
| Net  cash provided by (used in) financing activities                                          |   | 1,675    |   | (485     | )      |
| Net  (decrease) increase in cash and cash equivalents                                         |   | (3,537   | )      | 982      |   |
| CASH  AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                             |   | 34,890   |   | 30,410   |   |
| CASH  AND CASH EQUIVALENTS AT END OF PERIOD                                                   |   | $        | 31,353 |     | $      | 31,392 |   |
| Noncash  investing and financing activities:                                                  |   |     |   |     |   |
| Cash  paid for income taxes                                                                   |   | $        | 3,736  |     | $      | 3,377 |   |

 

The accompanying notes arean integral part of the condensed consolidated financial statements.

 

5

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

 

###### *Nature of Operations*

 

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

 

The Company merged with and acquired its operating subsidiaries in2003, 2001, 2000 and 1999.  Theacquisitions were accounted for using the purchase method.  All of the operating subsidiaries are 100%owned, (either directly or indirectly) by the Company, except Salient/PMT whichis 50% owned by the Company.

 

###### *Consolidation*

 

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

 

In management’s opinion, the unaudited condensed consolidated financialstatements include all adjustments necessary for a fair presentation of ourconsolidated financial position at September 30, 2003, our results ofoperations for the three and nine months ended September 30, 2003 and2002, and our cash flows for the nine months ended September 30, 2003 and2002.  All adjustments are of a normalrecurring nature. Interim results are not necessarily indicative of results fora full year.

 

These condensed consolidated financial statements and notes should beread in conjunction with the Company’s annual report on Form 10-K for the yearended December 31, 2002.

 

###### *Effects of RecentlyIssued Accounting Standards*

 

InJanuary 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51. *ThisInterpretation addresses the consolidation by business enterprises of variableinterest entities as defined in the Interpretation.  The Interpretation applies immediately to variable interests invariable interest entities created after January 31, 2003, and to variableinterests in variable interest entities obtained after January 31,2003.  In October 2003, the FASBdelayed this Interpretation’s implementation date for entities that existedprior to February 1, 2003.  Forsuch entities that existed prior to February 1, 2003, the effective dateis the first interim or annual reporting period ending after December 15,2003.  The application of thisInterpretation is not expected to have a material effect on the Company’sconsolidated financial statements.  TheInterpretation requires certain disclosures in financial statements issuedafter January 31, 2003 if it is reasonably possible that the Company willconsolidate or disclose information about variable interest entities when theInterpretation becomes effective.  TheCompany has identified one entity that would require consolidation under thisInterpretation.  The Company expectsconsolidation of this entity to increase the Company’s assets and liabilitiesby approximately $100,000 and have an insignificant effect on the other basicconsolidated financial statements.

 

InMay 2003, the FASB issued Statement of Financial Accounting Standard(SFAS) No. 150, *Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity. *SFAS No. 150 requires certainfinancial instruments that have characteristics of both liabilities and equityto be classified as a liability on the consolidated balance sheet.  SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first fiscal period beginning afterDecember 15, 2003.  The Companydoes not have any financial instruments affected by the adoption of SFAS No.150.

 

6

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###### *Compensation*

 

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

 

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

 

The followingtable illustrates the effect on net income (loss) as if the Company had appliedthe fair value recognition provisions of SFAS No. 123 as amended by SFAS No.148:

 
|                                                                                                                                          |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                                                          |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
| Net  income (loss) as reported                                                                                                                |   | $                                          | 2,303  |                                      | $      | (166 | ) | $ | 6,887 |   | $ | 2,905 |   |
| Deduct:  Total stock based employee compensation expense determined under fair value  based method for all awards, net of related tax effects |   | (123                                       | )      | (144                                      | )      | (361 | ) | (614 | ) |
| Pro  forma net income (loss)                                                                                                                  |   | $                                          | 2,180  |                                      | $      | (310 | ) | $ | 6,526 |   | $ | 2,291 |   |
|                                                                                                                                          |   |                                       |   |                                      |   |   |   |   |   |
| Earnings  (loss) per share                                                                                                                    |   |                                       |   |                                      |   |   |   |   |   |
| Basic-as  reported                                                                                                                            |   | $                                          | 0.13   |                                      | $      | (0.01 | ) | $ | 0.40 |   | $ | 0.18 |   |
| Basic-pro  forma                                                                                                                              |   | $                                          | 0.13   |                                      | $      | (0.02 | ) | $ | 0.38 |   | $ | 0.14 |   |
|                                                                                                                                          |   |                                       |   |                                      |   |   |   |   |   |
| Diluted-as  reported                                                                                                                          |   | $                                          | 0.13   |                                      | $      | (0.01 | ) | $ | 0.39 |   | $ | 0.17 |   |
| Diluted-pro  forma                                                                                                                            |   | $                                          | 0.12   |                                      | $      | (0.02 | ) | $ | 0.37 |   | $ | 0.14 |   |

 

*Reclassifications*

 

Certain reclassificationshave been made to the 2002 condensed consolidated financial statements toconform them with the 2003 presentation.  The reclassifications had no effect on retained earnings (accumulateddeficit), results of operations or cash flows as previously reported.

 

 

**2.****              ACQUISITIONS**

 

On May 2, 2003, the Company acquired a 50% ownership interest inthe Salient companies.  Additionally,the Company acquired a 23.15% profits interest in The Endowment Fund, a relatedentity.  The former owners of Salientand The Endowment Fund received cash payments totaling $1.75 million and maylater receive an additional $250,000 cash payment and up to 1,200,000 commonshares if Salient/PMT operations exceed specified performance levels.   The Salient companies and PinnacleManagement & Trust

 

7

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Company (“PMT”) werecontributed to Salient/PMT, which entity’s Class A limited partner units arejointly owned by the Company and the former owners of Salient.  Additionally, the Company received Class Blimited partner units of Salient/PMT, which in the event of a liquidation orsale of Salient/PMT entitle the Company to first receive proceeds equal to thenet asset value of PMT as of May 2, 2003, (approximately $4.4 million)with the remaining proceeds to be divided equally among the owners of the ClassA units.  The Salient companies provideinvestment advisory services to individuals and institutions.  The Endowment Fund is a diversified fund offunds using fund managers that specialize in a variety of investmentapproaches.  The acquisitions wereaccounted as a purchase, and accordingly, the financial information of theSalient companies and The Endowment Fund has been included in the Company’sconsolidated financial statements from May 2, 2003.  The purchase price of approximately $1.8million exceeded the fair market value of identifiable net assets byapproximately $1.7 million, which has been recorded as goodwill.  The Company uses the consolidation method toaccount for its investment in Salient/PMT.

 

Proforma financial information is not presented as the acquisitionwould have had an immaterial impact on the actual historical financialinformation if completed at the beginning of the periods.

 

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

 

Securitiesowned and securities sold, not yet purchased as of September 30, 2003 wereas follows:

 
|                                                |   | **Owned**          |   | **Sold, Not Yet  Purchased** |   |
|-----------------------------------------------------|--------|--------------------|--------|------------------------------|--------|
|                                                |   | **(in thousands)** |   |
| Marketable:                                         |   |               |   |                         |   |
| U.S.  Government and agency (cost $658)             |   | $                  | 658    |                         | $      | — |   |
| Corporate  stocks (cost $1,178)                     |   | 409                |   | 458                          |   |
| Corporate  bonds and commercial paper (cost $2,383) |   | 3,215              |   | —                       |   |
|                                                |   | 4,282              |   | 458                          |   |
| Not  readily marketable:                            |   |               |   |                         |   |
| Partnerships  (cost $5,490)                         |   | 12,471             |   | —                       |   |
| Corporate  stocks and warrants (cost $2,560)        |   | 6,943              |   | —                       |   |
|                                                |   | $                  | 23,696 |                         | $      | 458 |   |

 

Securities not readily marketable include investment securities (a) forwhich there is no market on a securities exchange or no independent publiclyquoted market, (b) that cannot be publicly offered or sold unless registrationhas been effected under the Securities Act of 1933, or (c) that cannot beoffered or sold because of other arrangements, restrictions, or conditionsapplicable to the securities or to the Company.  Not readily marketable securities consist of investments inlimited partnerships, equities, options and warrants.  The investments in limited partnerships are accounted for usingthe equity method, which approximates fair value, and principally consist ofEnvironmental Opportunities Fund, L.P., Environmental Opportunities Fund II,L.P., Environmental Opportunities Fund II (Institutional), L.P., CorporateOpportunities Fund, L.P., Corporate Opportunities Fund (Institutional), L.P.,Sanders Opportunity Fund, L.P., Sanders Opportunity Fund (Institutional), L.P.,Tactical Opportunities High Yield Fund, L.P., Life Sciences Opportunity Fund,L.P., Life Sciences Opportunity Fund (Institutional), L.P., Life SciencesOpportunity Fund II, L.P. and Life Sciences Opportunity Fund (Institutional)II, L.P.

 

8

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**4.****              SECURITIES AVAILABLEFOR SALE**

 

Securities available forsale at September 30, 2003 were as follows:

 
|                                    |   | **Amortized**      |   | **Gross Unrealized** |   | **Estimated** |   |
|-----------------------------------------|--------|--------------------|--------|----------------------|--------|---------------|--------|
|                                    |   | **Cost**           |   | **Gains**            |   | **Losses**    |   | **Fair Value** |   |
|                                    |   | **(in thousands)** |   |
|                                    |   |               |   |                 |   |          |   |   |   |
| U.S.  Government and agency obligations |   | $                  | 1,546  |                 | $      | 20            |   | $ | — |   | $ | 1,566 |   |
| Marketable  equity securities           |   | 1,733              |   | 5                    |   | (306          | )      | 1,432 |   |
| Total                                   |   | $                  | 3,279  |                 | $      | 25            |   | $ | (306 | ) | $ | 2,998 |   |

 

 

The contractual maturitiesof debt securities available for sale at September 30, 2003, were asfollows:

 
| Due  before 5 years                  |   | $   | 1,261  |   |
|--------------------------------------|--------|-----|--------|--------|
| Due  after 25 years through 30 years |   | 305 |   |
| Total                                |   | $   | 1,566  |   |

 

Gross gains on sales of securities available for sale were $36,000 forthe nine months ended September 30, 2003 and $23,000 for the nine monthsended September 30, 2002.  Grossrealized losses on securities available for sale were $28,000 for the ninemonths ended September 30, 2003 and $14,000 for the nine months endedSeptember 30, 2002.

 

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

 

The differences between the effective tax rate reflected in the incometax provision (benefit) from operations and the statutory federal rate were asfollows:

 
|                                   |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|----------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                   |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                   |   | **(in thousands)**                         |   | **(in thousands)**                        |   |
|                                   |   |                                       |   |                                      |   |   |   |   |   |
| Tax  computed using the statutory rate |   | $                                          | 1,219  |                                      | $      | (87 | ) | $ | 3,864 |   | $ | 1,580 |   |
| State  income taxes and other          |   | 64                                         |   | (3                                        | )      | 614 |   | 163 |   |
| Total                                  |   | $                                          | 1,283  |                                      | $      | (90 | ) | $ | 4,478 |   | $ | 1,743 |   |

 

**6.****              COMMITMENTS ANDCONTINGENCIES**

 

There were no firm underwriting commitments open at September 30,2003.

 

The Company and its subsidiaries have obligations under operatingleases that expire by 2013 with initial noncancelable terms in excess of oneyear.

 

The Company is a party to various legal proceedings that are of anordinary or routine nature incidental to its operations.  The Company believes it has adequatelyreserved for such litigation matters and that they

 

9

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will not have a materialadverse effect on the Company’s consolidated financial position, results ofoperations, or cash flows.

 

The Company has uncommitted financing arrangements with clearing brokerswho finance customer accounts, certain broker-dealer balances and firm tradingpositions.  Although these customeraccounts and broker-dealer balances are not reflected on the consolidatedbalance sheet for financial accounting and reporting purposes, the Company hasgenerally agreed to indemnify these clearing brokers for losses they maysustain in connection with the accounts, and therefore, retains risk on theseaccounts.  The Company is required tomaintain certain cash or securities on deposit with its clearing brokers.

 

**7.****              EARNINGS (LOSS) PERCOMMON SHARE**

 

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

 
|                                                                                                            |   | **Three Months Ended September 30,**              |   |
|-----------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                                                                                            |   | **2003**                                               |   | **2002** |   |
|                                                                                                            |   | **(in thousands, except share and per share amounts)** |   |
| Computation  of basic and diluted income (loss) per common share for the three months  ended September 30: |   |                                                   |   |   |   |
| Net  income (loss)                                                                                              |   | $                                                      | 2,303  |   | $ | (166 | ) |
| Weighted  average number of common shares outstanding                                                           |   | 17,179,476                                             |   | 16,674,678 |   |
| Common  shares issuable under stock option plan                                                                 |   | 1,056,694                                              |   | — |   |
| Less  shares assumed repurchased with proceeds                                                                  |   | (566,201                                               | )      | — |   |
| Weighted  average common shares outstanding                                                                     |   | 17,669,969                                             |   | 16,674,678 |   |
| Basic  income (loss) per common share                                                                           |   | $                                                      | 0.13   |   | $ | (0.01 | ) |
| Diluted  income (loss) per common share                                                                         |   | $                                                      | 0.13   |   | $ | (0.01 | ) |

 
|                                                                                                    |   | **Nine Months Ended September 30,**               |   |
|---------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|
|                                                                                                    |   | **2003**                                               |   | **2002** |   |
|                                                                                                    |   | **(in thousands, except share and per share amounts)** |   |
| Computation  of basic and diluted income per common share for the nine months ended  September 30: |   |                                                   |   |   |   |
| Net  income                                                                                             |   | $                                                      | 6,887  |   | $ | 2,905 |   |
| Weighted  average number of common shares outstanding                                                   |   | 17,047,891                                             |   | 16,586,483 |   |
| Common  shares issuable under stock option plan                                                         |   | 1,051,693                                              |   | 1,253,848 |   |
| Less  shares assumed repurchased with proceeds                                                          |   | (523,724                                               | )      | (1,027,967 | ) |
| Weighted  average common shares outstanding                                                             |   | 17,575,860                                             |   | 16,812,364 |   |
| Basic  income per common share                                                                          |   | $                                                      | 0.40   |   | $ | 0.18 |   |
| Diluted  income per common share                                                                        |   | $                                                      | 0.39   |   | $ | 0.17 |   |

 

 

Outstanding stock options (50,000 for the three months endedSeptember 30, 2003; 55,000 for the nine months ended September 30,2003; 1,463,848 for the three months ended September 30, 2002; and 210,000for the nine months ended September 30, 2002) have not been included indiluted earnings (loss) per common share because their inclusion would havebeen antidilutive for the periods presented.

 

 

**8.****              BUSINESS SEGMENTINFORMATION**

 

The Company’s businesses operate in two reportable businesssegments.  The Company’s investmentbanking and brokerage segment includes the operations of SMH.  SMH is an investment banking and

 

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brokerage firm whose activitiesprimarily include securities underwriting, other investment banking services, private placements, andinstitutional, prime and retail brokerage. The Company’s investment management segment includes the operations ofSalient/PMT and SMCA.   Salient/PMT is astate chartered trust company which provides investment advisory, investmentmanagement, and a variety of trust services to individuals, trusts andinstitutions.  SMCA provides financialplanning services to individuals and asset management services to investorswith an emphasis on fixed income securities. The following summarizes certain financial information of eachreportable segment for the three and nine months ended September 30, 2003and 2002, respectively.

 
| **(in  thousands)**                                                                                  |   | **Investment  Banking and  Brokerage** |   | **Investment  Management** |   | **Corporate  and Other** |   | **Consolidated  Total** |   |
|------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|----------------------------|--------|--------------------------|--------|-------------------------|--------|
| **Three Months Ended September 30, 2003**                                                       |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                             |   | $                                      | 21,280 |                       | $      | 2,145                    |   | $                       | 750    |   | $ | 24,175 |   |
| Expenses                                                                                             |   | (18,722                                | )      | (1,674                     | )      | (498                     | )      | (20,894                 | )      |
| Income  before equity in income of limited partnerships, income taxes and minority  interests        |   | 2,558                                  |   | 471                        |   | 252                      |   | 3,281                   |   |
| Equity  in income of limited partnerships                                                            |   | 221                                    |   | —                     |   | 117                      |   | 338                     |   |
| Income  before income taxes and minority interests                                                   |   | $                                      | 2,779  |                       | $      | 471                      |   | $                       | 369    |   | $ | 3,619 |   |
|                                                                                                 |   |                                   |   |                       |   |                     |   |                    |   |
| **Three Months Ended September 30, 2002**                                                       |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                             |   | $                                      | 15,886 |                       | $      | 1,489                    |   | $                       | 44     |   | $ | 17,419 |   |
| Expenses                                                                                             |   | (14,943                                | )      | (1,336                     | )      | (560                     | )      | (16,839                 | )      |
| Income  (loss) before equity in loss of limited partnerships, income taxes and  minority interests   |   | 943                                    |   | 153                        |   | (516                     | )      | 580                     |   |
| Equity  in loss of limited partnerships                                                              |   | (709                                   | )      | —                     |   | (179                     | )      | (888                    | )      |
| Income  (loss) before income taxes and minority interests                                            |   | $                                      | 234    |                       | $      | 153                      |   | $                       | (695   | ) | $ | (308 | ) |
|                                                                                                 |   |                                   |   |                       |   |                     |   |                    |   |
| **Nine Months Ended September 30, 2003**                                                        |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                             |   | $                                      | 66,043 |                       | $      | 5,618                    |   | $                       | 1,065  |   | $ | 72,726 |   |
| Expenses                                                                                             |   | (58,620                                | )      | (4,525                     | )      | (1,350                   | )      | (64,495                 | )      |
| Income  (loss) before equity in income of limited partnerships, income taxes and  minority interests |   | 7,423                                  |   | 1,093                      |   | (285                     | )      | 8,231                   |   |
| Equity  in income of limited partnerships                                                            |   | 2,778                                  |   | —                     |   | 413                      |   | 3,191                   |   |
| Income  before income taxes and minority interests                                                   |   | $                                      | 10,201 |                       | $      | 1,093                    |   | $                       | 128    |   | $ | 11,422 |   |
|                                                                                                 |   |                                   |   |                       |   |                     |   |                    |   |
| **Nine Months Ended September 30, 2002**                                                        |   |                                   |   |                       |   |                     |   |                    |   |
| Revenues                                                                                             |   | $                                      | 53,005 |                       | $      | 4,382                    |   | $                       | 64     |   | $ | 57,451 |   |
| Expenses                                                                                             |   | (47,230                                | )      | (3,757                     | )      | (1,775                   | )      | (52,762                 | )      |
| Income  (loss) before equity in income of limited 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 |   |

 
| **(in thousands)**                          |   | **Investment****Banking  andBrokerage** | ** ** | **InvestmentManagement** | ** ** | **Corporateand Other** | ** ** | **ConsolidatedTotal** | ** ** |
|---------------------------------------------|--------|-----------------------------------------|------------|--------------------------|------------|------------------------|------------|-----------------------|------------|
| Total  assets as of September 30, 2003 |   | $                                       | 87,483     |                     | $          | 7,362                  |       | $                     | 31,136     |   | $ | 125,981 |   |
| Total  assets as of December 31, 2002  |   | $                                       | 80,614     |                     | $          | 6,701                  |       | $                     | 30,008     |   | $ | 117,323 |   |

 

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**9.****              EMPLOYEE BENEFITPLANS**

 

Under its 1998 Incentive Plan, as amended, the Company has reserved 25%of the issued and outstanding Common Stock of the Company, or 4,000,000 sharesof Common Stock, whichever is greater, for the purpose of issuing incentiveawards under the Incentive Plan.  TheCompany had 1,554,602 shares of Common Stock available for grant under theIncentive Plan at September 30, 2003.

 

**Stock Options**

 

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

 

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

 

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

 

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

 

The following summarizes certain information related to the CIP for thethree and nine months ended September 30, 2003 and 2002.

 
|                                   |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|----------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                   |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                   |   | **(in thousands, except shares)**          |   | **(in thousands, except shares)**         |   |
|                                   |   |                                       |   |                                      |   |   |   |   |   |
| Number  of shares issued               |   | 10,077                                     |   | 53,419                                    |   | 102,855 |   | 368,954 |   |
| Value  of shares issued                |   | $                                          | 89     |                                      | $      | 325 |   | $ | 874 |   | $ | 2,066 |   |
| Additions  to unearned compensation    |   | 1                                          |   | 251                                       |   | 58 |   | 966 |   |
| Additions  to notes receivable         |   | 85                                         |   | —                                    |   | 813 |   | 519 |   |
| Amortization  of unearned compensation |   | 191                                        |   | 200                                       |   | 671 |   | 489 |   |
| Amortization  of notes receivable      |   | 185                                        |   | 122                                       |   | 569 |   | 355 |   |
|                                        |        |                                            |        |                                           |        |  |  |  |  |  |  |  |  |

 

**10.****       RELATED PARTIES**

 

The Company had receivables from related parties totaling $6.4 millionat September 30, 2003, consisting primarily of $1.8 million of unpaidmanagement fees earned on the Company’s investments in limited partnerships and$4.3 million of notes receivable from employees and consultants.

 

12

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

 

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

 

**General**

 

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

 

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

 

**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.  We alsoearn interest on the cash held and dividends received from the equitysecurities held by us for our corporate capital accounts and have realized andunrealized gains (or losses) on securities in our inventory account.  Interest income results from interest earnedon our inventories of fixed income securities prior to sale, and from interestand dividends earned on investments in our capital accounts.

 

*Expenses.*                   Ourexpenses consist of (1) employee compensation and benefits, (2) brokerage andclearing costs, and (3) other expenses. Compensation and benefits have both a variable component based onrevenue production and a fixed component. The variable component includes institutional and retail salescommissions, bonuses, overrides, and trading desk incentives.  Retail and institutional commissions arebased on a competitive commission schedule. The investment banking group and the research group receive a salary anddiscretionary bonus as compensation. The fixed component includes administrative and executive salaries,payroll taxes, employee benefits and temporary employee costs.  Compensation and benefits is our largestexpense item and includes wages, salaries and benefits. During the thirdquarter of 2003, compensation and benefits represented 69% of total expenses,and 59% of total revenues compared to 68% of total expenses, and 66% of totalrevenues during the comparable period in 2002.   During the first nine months of 2003, compensation and benefitsrepresented 69% of total expenses, and 62% of total revenues compared to 71% oftotal expenses, and 65% of total revenues during the comparable period in 2002.

 

Brokerage and clearance expenses include clearing and trade executioncosts associated with the retail, prime and institutional brokerage business atSMH.  SMH clears its transactionsprimarily through the Pershing Division of Bank of New York Co. and otherclearing brokers.

 

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

 

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**Results of Operations**

 

*Three Months EndedSeptember 30, 2003 Compared to Three Months Ended September 30, 2002*

 

Total revenues increased 39% to $24.2 millionin the third quarter of 2003 from $17.4 million for the same quarter in 2002mainly due to increases in prime brokerage services and asset managementactivities.  Total expenses for the same2003 period increased 24% to $20.9 million from $16.8 million in the samequarter of the previous year mainly from increases in employee compensation andbenefits from higher salaries, commissions, and bonuses paid on revenueincreases.  Equity in income (loss) oflimited partnerships increased from a loss of $888,000 during the third quarterof 2002 to $338,000 during the third quarter of 2003, due to increases in thevalues of securities held in the investment portfolios of the limited partnershipsmanaged by the Company.  Net income(loss) for the three month period ended September 30, 2003 increased to$2.3 million from a loss of $166,000 in the same period in 2002.  Basic and diluted income per share was $0.13for the three months ended September 30, 2003 compared to a loss of  $0.01 for the same period in 2002.

 

Commissions revenue increased to $12.8million in the third quarter of 2003 from $11.6 million in 2002, primarily as aresult of increased trading volume related to the growth of both the number andsize of prime broker accounts. Principal transactions revenue totaled $4.4 million for the 2003 periodversus $1.6 million in the third quarter of 2002, principally due to increasesin revenues from fixed income trading and increases in the values of securitiesowned by the Company.  Investmentbanking revenue increased to $3.0 million during the third quarter of 2003 from$1.3 million in the same period of 2002, principally due to an increase in feesearned from private placement and syndicate transactions.  Revenues from fiduciary, custodial andadvisory fees increased to $2.8 million in the third quarter of 2003 from $1.9million in same quarter of 2002 primarily due to increases in the size of investmentportfolios we manage.  Interest anddividend income increased to $621,000 in 2003 from $471,000 in the same periodlast year.

 

During the three months endedSeptember 30, 2003, employee compensation and benefits, increased to $14.4million from $11.5 million in the same period last year reflecting salaries,commissions and bonuses paid on the revenue increases.  Floor brokerage, exchange and clearance feesincreased to $1.3 million in the third quarter of 2003 from $1.0 million in thesame quarter of 2002 reflecting increased clearing and execution costsresulting from the additional trading volume attributable to the growth inrevenues from prime brokerage services. Other general and administrative expenses increased to $2.5 millionduring the third quarter of 2003 from $2.0 million in the third quarter of lastyear mainly due to the growth in the prime brokerage division.  Occupancy and communication costs increaseddue to an acquisition, increased personnel and trading volumes.

 

The effective tax rate from operations was35.8% for the three months ended September 30, 2003 compared to 35.2%(benefit) for the three months ended September 30, 2002.

 

*Nine Months EndedSeptember 30, 2003 Compared to Nine Months Ended September 30, 2002*

 

Total revenues increased 26% to $72.7 millionin the first nine months of 2003 from $57.5 million for the same period in2002, principally due to increases in prime brokerage services, investmentbanking and asset management activities. Total expenses for the same 2003 period increased 22% to $64.5 million from$52.8 million in the same period of the previous year mainly from increases inemployee compensation and benefits from higher salaries, commissions, andbonuses paid on revenue increases. Equity in income of limited partnerships increased from a loss of$71,000 during the first nine months of 2002 to $3.2 million during the firstnine months of 2003, due to increases in the values of securities held in theinvestment portfolios of the limited partnerships managed by the Company.  Net income for the nine month period endedSeptember 30, 2003 increased to $6.9 million from $2.9 million in the sameperiod in 2002.  Basic income per sharewas $0.40 for the nine months ended September 30, 2003 compared to $0.18for the same period in 2002.  Dilutedincome per share was $0.39 for the nine months ended September 30, 2003,compared to $0.17 for the same period in 2002.

 

Commissions revenue increased to $38.4million in the first nine months of 2003 from $32.7 million in 2002, primarilyas a result of increased trading volume related to the growth of both thenumber and size of prime broker accounts. Principal transactions revenue totaled $10.4 million for the 2003 periodversus $7.0 million in 2002, primarily due to increases in revenues from fixedincome trading and to gains in the values of

 

14

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warrantsawarded to the Company for investment banking services.  Investment banking revenue increased to$13.2 million during the first nine months of 2003 from $9.1 million in thesame period of 2002, principally due to an increase in fees earned from privateplacement and syndicate transactions. Revenues from fiduciary, custodial and advisory fees increased to $7.0million in the first nine months of 2003 from $5.5 million in same period of2002 reflecting growth in the amount of assets managed by the Company.  Interest and dividend income increased to$1.8 million in 2003 from $1.4 million in the same period last year.

 

During the nine months endedSeptember 30, 2003, employee compensation and benefits, increased to $44.8million from $37.4 million in the same period last year, reflecting salaries,commissions and bonuses paid on increased revenues.    Floor brokerage, exchange and clearance fees increased to $4.2million in the first three quarters of 2003 from $3.0 million in the sameperiod of 2002 reflecting increased clearing and execution costs resulting fromthe additional trading volume attributable to the growth in revenues from primebrokerage services.  Communication anddata processing costs increased to $4.1 million in 2003 from $3.1 million inthe same period last year resulting primarily from increased personnel andtrading volumes related to the prime brokerage division.   Occupancy costs totaled $4.2 million duringthe first nine months of 2003, compared to $3.3 million in the prior yearperiod.  Other general andadministrative expenses increased to $7.2 million during the first nine monthsof 2003 from $5.9 million in the first nine months of last year mainly due tothe growth in the prime brokerage division.

 

The effective tax rate from operations was39.4% for the nine months ended September 30, 2003 compared to 37.5% forthe nine months ended September 30, 2002.

 

**Liquidity and CapitalResources**

 

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

 

At September 30, 2003, we had approximately $31.4 million in cashand cash equivalents, which together with receivables from broker-dealers,deposits with clearing brokers, marketable securities owned, and securitiesavailable for sale represented about 32.6% of our total assets at the end ofthe third quarter.

 

For the nine months ended September 30, 2003, net cash used inoperations totaled $2.8 million versus net cash provided by operations of $5.7million during the first nine months of 2002. Accounts receivable increased by $3.1 million during the nine monthsended September 30, 2003, principally due to increases in revenues andnotes receivable from employees. Securities owned increased by $6.7 million during the first nine monthsof 2003 primarily due to increases in the values of the Company’s investmentsincluding the limited partnerships managed by the Company and warrants held bythe Company that were received as part of investment banking transactions.

 

Capital expenditures for the first nine months of 2003 were $955,000,mainly for the purchase of furniture and computer equipment and software, aswell as for leasehold improvements necessary for our growth.  During the first nine months of 2003, wereacquired 19,654 of our common shares at a total cost of approximately$168,000.

 

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

 

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

 

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**Factors AffectingForward-Looking Statements**

 

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

 

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

 

**MarketRisks**

 

At September 30, 2003, PMT had equity securities under managementwith a fair value of $539 million. PMT’s fee income for the nine months ended September 30, 2003 wouldhave been reduced by approximately $152,000 assuming a hypothetical 10%decrease in the value of its equity securities under management.  PMT’s securities available for sale arerecorded at a fair value of approximately $3.0 million at September 30,2003.  These securities are subject toequity price risk.  These securitieshave an original cost of $3.3 million. At September 30, 2003, the unrealized decline in market valuetotaling $281,000, less tax benefit of $104,000, has been included as aseparate component of shareholders’ equity.

 

Management evaluates the realizability of securities available for saleto determine if a decline in value is other than temporary.  Such evaluation considers the length of timeand the extent to which market value has been less than cost, the financialcondition and near-term prospects of the issuer, and the intent and ability ofthe Company to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in market value.  Management believes the unrealized lossesare temporary at September 30, 2003. However, a write-down accounted for as a realized loss may be necessaryin the future.

 

The Company’s trading equity and debt securities are marked to marketon a daily basis.  At September 30,2003, the Company’s trading equity and debt securities were recorded at a fairvalue of approximately $4.3 million. These trading equity and debt securities are subject to equity pricerisk.  This risk would amount toapproximately $430,000 based on a potential loss in fair value from ahypothetical 10% decrease in the market value of such equity and debt securities.  The actual equity price risk related to thetrading equity and debt securities may differ substantially.

 

 

**Item4****.  *Controls and Procedures***

 

Our management, including our Chief ExecutiveOfficer and Chief Financial Officer, have conducted an evaluation of theeffectiveness of our disclosure controls and procedures as of the end of thequarter covered by this report.  Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that our disclosure controls and procedures are effective fortimely gathering, analyzing and disclosing the information we are required todisclose in our reports filed under the Securities Exchange Act

 

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of 1934,as amended.  There have been no changesin our internal control over financial reporting that occurred during thequarter covered by this report that materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

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

 

**Item1.  *LegalProceedings**              ***

 

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

 

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

 

(a) Exhibits

 

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

 

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

 

 

(b) Reports on Form 8-K.

 

On August 13, 2003, the Company filed a current report on Form 8-Krelating to (i) the declaration by its board of directors of a cash dividend inthe amount of $0.03 per share of common stock, and (ii) the Company’s earningsreport for the quarter ended June 30, 2003.

 

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**SIGNATURES**

 

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

 

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

 

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