SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(mark one)
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES |
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For the Fiscal Year Ended December 31, 2004, OR |
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES |
Commission File No. 0-30066
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Sanders Morris Harris Group Inc. |
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(Exact name of registrant as specified in its charter) |
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Texas |
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76-0583569 |
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(state or other jurisdiction of |
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(I.R.S. Employer |
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600 Travis, Suite 3100 |
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Houston, Texas 77002 |
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(Address of principal executive office) |
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Registrant’s telephone number, including area code: (713) 993-4610 |
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Securities Registered Pursuant to Section 12(b) of the Act: None |
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Securities Registered Pursuant to Section 12(g) of the Act: |
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Common Stock, $0.01 par value per share |
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(Title of Class) |
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o
The aggregate market value of the shares of Common Stock held by nonaffiliates of the registrant at June 30, 2004 was $185 million. For purposes of this computation, all executive officers, directors and 5% beneficial owners of the registrant were deemed to be affiliates. Such determination should not be deemed an admission that such officers, directors and beneficial owners are, in fact, affiliates of the registrant.
As of March 4, 2005, the registrant had 18,312,357 outstanding shares of Common Stock, par value $0.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant’s definitive Proxy Statement pertaining to the 2005 Annual Meeting of Shareholders (the “Proxy Statement”) is incorporated herein by reference into Part III of this Report.
INDEX
Sanders Morris Harris Group Inc., a Texas corporation formed in 1998 (“SMHG” or “the Company”), provides a broad range of financial and other professional services through its operating subsidiaries. Our financial and other professional services include institutional, prime and retail brokerage, principal trading, investment banking, merchant banking, financial advisory, trust related services, investment management, financial planning and sports representation and management. We serve a diverse group of institutional, corporate and individual clients.
On April 1, 2004, the Company acquired a 69% interest in Charlotte Capital. Employees of Charlotte Capital retained a 31% ownership interest in the firm. Charlotte Capital, based in Charlotte, North Carolina, manages assets for institutional investors in small cap value and small/mid cap value styles.
On November 23, 2004, the Company acquired a 50% interest in Select Sports Group (“SSG”), a sports representation and management services firm based in Houston, Texas.
The historical financial information contained in this document includes the results of operations and financial position of our current businesses from the dates of acquisition, except for our discontinued businesses.
Our business strategy is to (1) increase our investment management business; (2) increase our capital markets activities; (3) improve the profitability of our brokerage operations; (4) enhance the range of financial services we offer our clients; and (5) supplement internal growth with strategic acquisitions. We believe certain cross-selling opportunities exist among the financial services firms, and certain unquantified potential operating efficiencies are also available. The principal elements of our business strategy are:
• Increase Investment Management Business. We intend to grow through expansion of our investment management business, including prime brokerage and related services by improving the interface between our investment management operations and our various subsidiaries, and by increasing the assets under our management through acquisitions and internal growth.
• Increase Capital Markets Activities. We intend to increase our investment banking and merchant banking business by committing greater resources to companies, industries and geographic regions that management believes offer the greatest opportunities. We also believe that consolidation within the investment banking industry will offer greater opportunities for high caliber firms that maintain their local and industry-specific focus.
• Improve Profitability of Brokerage Operations. We intend to improve the profitability of our brokerage operations primarily by hiring additional experienced and productive financial advisors and by providing our financial advisors with specialized training as well as investment programs, information systems, support and access to the services of each of our financial services entities.
• Enhance Range of Financial Services. We seek to provide excellent investment advice suited to each client. To that end, our financial services subsidiaries have traditionally sought to attract and retain clients by offering a high level of personal service. We intend to increase that commitment by providing our clients with advanced account and investment information systems, flexibility in determining appropriate fee schedules for certain services based upon the level of client needs and an array of investment and financial planning services.
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• Supplement Growth with Strategic Acquisitions. We plan to actively pursue opportunities to acquire or combine with other firms with complementary businesses to strengthen or expand our geographic or product offering base. Our management believes that attractive acquisition opportunities exist, particularly among smaller, specialized regional financial firms that want to affiliate with a larger company while still retaining their identity and entrepreneurial culture. In addition, we believe that the consolidation trend in the financial services industry will allow us to hire proven financial professionals who prefer the culture and opportunities inherent in a creative regional firm. Management believes that acquisitions may also allow us to realize cost benefits by leveraging our infrastructure.
We provide our financial and other professional services through our operating subsidiaries – Sanders Morris Harris Inc., Salient Capital Management, SMH Capital Advisors, Charlotte Capital, and Select Sports Group. The services offered by each of these entities are described below.
General. SMH provides a range of financial services including retail, institutional and prime brokerage, investment research, investment banking, merchant banking and market making. Additionally, SMH has organized and holds an interest in a number of proprietary funds that invest primarily in small to medium capitalization companies in a number of industries.
Private Client. Our strategic plan in the private client business is to attract and retain experienced financial advisors, especially those able to utilize our sophisticated investment programs. Our private client business is focused on high net worth individuals with whom we have developed and maintained relationships over time. As a full service broker, we offer our private clients brokerage services relating to corporate debt and equity securities, including the securities of companies followed by our research analysts, underwritings that we co-manage or in which we participate, private placements of securities in which we serve as placement agent, mutual funds, 401(k) plans, wrap-fee programs, money market funds and insurance products. Commissions are charged on agency transactions in exchange-listed securities and securities quoted on the Nasdaq National Market or in the over-the-counter market. In addition to retail commissions, we generate fee revenue from asset-based advisory services and managed accounts where the charges are based on a percentage of the assets held in the client’s account in lieu of commissions on a transaction-by-transaction basis.
We provide our private clients with a broad range of services delivered in a personalized, service-oriented manner. In addition to recommending and effecting transactions in securities, we provide other services to our retail clients that include portfolio strategy, investment research service, financial planning, assistance in the sale of restricted securities and tax, trust and estate advice. Clients can access their personal portfolio on-line and use our extensive research library.
We employ Series 7-licensed retail brokers who average over 15 years experience in the securities brokerage business. Additional Series 7-licensed retail brokers are affiliated with the Company through our Sanders Morris Harris Partners division. We generally do not hire inexperienced brokers or trainees to work as retail brokers. We believe we can attract and retain experienced brokers by providing them with a high level of support, a corporate culture that encourages performance, employee stock ownership, advanced technologies, competitive compensation packages and the opportunity for them and their clients to participate in private placements and public offerings of securities that we manage or underwrite. We have several inter-related supervisory, compliance, and regulatory checks designed to minimize the possibility of significant infractions. These programs are supplemented by ongoing compliance training. Our compliance department supplements line management’s oversight of our financial advisors.
Institutional Brokerage. Our institutional stock brokerage strategy is to provide equity research coverage and trading services focused on companies with a presence in the United States. Our clients are a broad array of institutions throughout North America, Europe and Asia. Areas of concentration include financial services, life sciences, oil and gas exploration and production, oilfield services, pipelines, entertainment and media, retailing and technology. We provide our institutional clients with research and execution trading services in both exchange-listed equity securities and equity securities quoted on Nasdaq. We also distribute to institutional clients equity securities from offerings that we co-manage or underwrite. Our institutional clients include banks, retirement funds, mutual funds, endowments, investment
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advisors and insurance companies. We perform institutional brokerage services from offices in Houston, New York, Los Angeles and San Francisco.
Investment Research. We use our proprietary equity research analysis to drive or assist a large portion of our business. This analysis is based on economic fundamentals, using tools such as price-to-earnings multiples, price-to-book value comparisons, both absolute and relative to historic norms, and our research department’s own earnings forecasts. We intend to rely primarily on our own research rather than on research products purchased from outside research organizations. All our research contains clear disclosure of possible conflicts and limitations.
Prime Brokerage. The brokerage industry has developed a service known as prime brokerage in which a professional investor, usually a hedge fund, maintains a cash or margin account with a prime broker which provides trade execution, clearing, bookkeeping, reporting, custodial, securities borrowing, financing, research and fund raising services. We also maintain several proprietary trading accounts. We share in the profits or losses of these accounts and receive the commission generated in them. The accounts are designed to diversify the risks, thus limiting potential losses or gains.
Fixed Income Department. Through our fixed income division, we provide brokerage and principal trading services to institutional clients relating primarily to fixed-income securities, such as municipal securities, U.S. government and agency securities, mortgage-related securities, including those issued through Government National Mortgage Association, Federal National Mortgage Association and Federal Home Loan Mortgage Corp., and corporate investment-grade and high-yield bonds. Commissions are charged on all institutional securities transactions based on rates formulated by SMH. These services are available to institutional clients of our financial advisors.
Rather than trading a wide variety of securities in direct competition with Wall Street firms, we have developed a niche strategy to trade primary U.S. government securities, certain mortgage related securities and collateralized mortgage obligations. In our trading activities, we generally deal with institutional clients. We buy and sell round-lot and odd-lot positions, and act as market-maker in those positions. Many of our counterparties in these transactions are other broker-dealers.
We are also active as a secondary market broker for residential, consumer and commercial loans, and derive revenue from the placement of mortgage loans and servicing.
Investment Banking and Underwriting Activities. Our investment banking strategy is to build a balanced mix of corporate securities underwriting, private financings and financial advisory services. We focus on middle market companies. We believe the number and dollar amount of underwritings and private placements in which we participate will contribute significantly to increased public and industry awareness of our company, and will result in increased demand for our investment banking and corporate advisory services.
We regularly participate in corporate securities distributions as a member of an underwriting syndicate or of a selling group in public offerings managed by other underwriters, including national and regional firms. Our syndicate department coordinates the distribution of co-managed equity underwritings, accepts invitations to participate in underwritings managed by other investment banking firms and allocates our selling allotments to our various sales units.
We also serve as placement agent or financial advisor in private placements of securities under a variety of fee structures depending on the amount and type of capital raised, including cash and equity contingent fees, cash and equity non-contingent fees, adjustable cash and equity fees or a combination of two or more of the foregoing. Our officers and directors often invest in the securities involved in private placements on the same basis as other investors, where suitable and permitted by applicable law and regulations. We believe these co-investments create an identity of interest with our investors, and thus benefit them.
Our financial advisory services include advising on mergers, acquisitions and divestitures, fairness opinions, and financing strategies. We also provide valuations, litigation support and financial consulting services. These financial advisory services are typically provided to emerging or middle market companies in the southwestern United States.
Proprietary Funds. SMH has organized a number of private equity funds for the purpose of purchasing, selling and investing in securities, primarily in equity or equity-linked securities, interest-bearing debt securities and debt securities convertible into common stock. We invest primarily in small to medium capitalization companies, both public and
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private, that we believe are either significantly undervalued relative to their growth potential, or that have substantial prospects for capital growth. Companies in which we invest belong to a number of industries, including environmental, industrial services, healthcare, technology, medical, life sciences, energy and others.
We hold an interest in these funds and also earn management fees ranging from 1% to 2% per annum of total commitments, net assets or capital contributions during the investment period of the fund. We also receive incentive compensation ranging from 10% to 20% of the limited partnership profit above specified hurdle rates. We have agreed to compensate the managers of these funds and employees designated by the managers through a combination of salaries and incentives based on the profitability of the funds. We account for our interests in all of these funds using the equity method, which approximates fair value.
Merchant Banking. Our merchant banking activities focus on providing private equity capital for middle-market growth companies. These middle-market companies comprise a broad range of industries, including business services, communications, computing, distribution, direct marketing of electronic financial services, energy, information technology, Internet, media entertainment, retail, specialty chemicals and biotechnology. These transactions may take a variety of forms, such as buyouts, growth buildups, expansion capital and venture capital financings.
Market Making. We make markets, buying and selling as principal, in securities quoted on Nasdaq or in the over-the-counter markets. In lieu of commissions, we generate revenue in return for the risk we assume based on the markup or markdown of each transaction. Principal transactions with clients are generally effected at a net price within or equal to the current interdealer price plus or minus a markup or markdown. The trading department’s objective is to facilitate sales to clients and to other dealers, not to generate profits based on trading for our proprietary account.
Revenues from principal transactions depend on the general trend of prices and the level of activity in the securities market, employee skill in market-making activities and inventory size. Trading activities carried out as a principal require a commitment of capital, and create an opportunity for profit and risk of loss due to market fluctuations. At December 31, 2004, we made markets in the common stock or equity securities of 131 companies that were quoted on Nasdaq and in the over-the-counter market.
The level of positions carried in our market making accounts fluctuates significantly depending on the firm’s assessment of economic and market conditions, the allocation of capital among various stocks, client demand, underwriting commitments and market trading volume. The aggregate value of our inventories is limited by certain net capital requirements under the Exchange Act.
We have established procedures designed to reduce the systemic risks of our market making activities. Our trading inventory positions and profit and loss statements are reviewed daily by senior management of SMH and quarterly by its board of directors. However, these procedures may not prevent losses, which could have a material adverse effect on SMH’s business, financial condition, results of operations or cash flows.
Financial Planning. We provide specialized financial services and products to high net-worth individuals and institutions through our affiliation with a select group of independent registered representatives. The services provided by this division, which we call Sanders Morris Harris Partners (“SMHP”), include investment management, estate planning and retirement planning. The financial planners who affiliate with us are able to offer their clients a broad range of new investment opportunities through several exclusive investment programs offered by SMH, Salient Capital Management, and SMH Capital Advisors.
Financial Advisory Services. Salient/PMT provides financial advisory services to affluent families, families or individuals with concentrated stock positions, and smaller institutions. In analyzing a particular client’s needs, we assess the client’s goals and objectives, risk tolerance, and asset base. Then we develop an investment policy statement, which includes an asset allocation that focuses on diversification and risk-adjusted returns. Finally, we allocate capital from each asset class to one or more managers that we select based on assets under management, track record, management continuity, and adherence to style. Once a client’s assets are allocated among a group of managers, we monitor performance and constantly assess whether a manager is managing the capital consistent with its mandate.
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Family Office Services. Salient/PMT provides a variety of services typically offered in a family office to families with significant assets. These services entail providing advice as it relates to everyday and extraordinary issues relating to affluent families and include estate planning, assisting clients with business decisions, household budgeting, and capital project planning.
Proprietary Funds. Salient/PMT has organized several private equity funds for the purpose of purchasing, selling and investing in securities. These funds often use professional investment managers selected by Salient/PMT based on performance, investment style and focus, and other criteria.
The Endowment Fund (“TEF”) is 23.15% owned by SMHG with the balance owned by the former owners of Salient and The Endowment Fund. TEF has approximately $300 million in assets under management using a variety of investment approaches.
Trust, Investment Management and Related Services. Through Pinnacle Trust Co., LTA (“PMT”), we provide a variety of trust services, including investment management, estate settlement, retirement planning, mineral interest management, real estate, and other administrative services, such as custody of assets and record keeping. We meet with each client to develop investment management strategies that are consistent with the client’s needs and investment objectives. Consideration is given to the client’s financial and investment objectives, risk tolerance, investment restrictions and time horizon. We believe this total investment management approach provides clients with increased diversification, reduced risk and greater control over their portfolios.
We license trust accounting software that provides our clients with many additional benefits, including flexible statement packages and access to account information on the Internet through a link established between Salient/PMT’s “home page” and the licensor of the software’s database.
Salient/PMT’s revenues are derived from both transactional commissioned-based arrangements and investment management and fiduciary fees based on a percentage of assets under administration. At December 31, 2004, PMT had approximately $755 million of assets under administration. The management fee charged is based on rate schedules that are changed from time to time. Rates vary depending on the services being provided and the amount of assets involved.
Investment Management Services. Through SMCA, we provide several different investment management services to investors who prefer managed accounts as a major part of their investment portfolios. The portfolios are tailored to each client’s financial and investment objectives, with a risk tolerance profile that can range from maximum potential yield to maximum potential security. Through the Douglas-Noyes division of SMCA we provide investment management portfolios concentrated in mid and large cap equities with a potential for growth. Our SMCA division in Ft. Worth invests primarily in fixed income securities, mainly high yield bonds. Our revenues are derived primarily from investment management and fiduciary fees based on a percentage of assets under administration.
Financial Planning Services. Through the Kissinger division of SMCA, we provide financial planning and investment management services to individuals. When preparing a financial portfolio for a client, we first determine the client’s near term and long range goals and objectives. Then we prepare a thorough review of the person’s assets, liabilities, income, expenses, taxes and savings. We also assess the client’s insurance protection and estate planning. Finally, we develop an overall financial strategy and assist the client in its implementation. Our proprietary monitoring software enables us to produce regular financial updates for the client. The quarterly reports provide the client and us with periodic feedback on the progress towards realizing the client’s financial goals. Kissinger derives revenues from fees charged to the clients for the preparation of financial plans and for monitoring services. Additionally, Kissinger earns commissions from investment and insurance products sold to the clients.
Charlotte Capital
Investment Management Services. Through Charlotte Capital, we provide investment management services to institutional investors using small cap value and small/mid cap value styles. The investment team follows a structured investment process built on fundamental, independent research and pursues a deep absolute value investment style. Its process begins with a series of quantitative screens using fundamental analysis that focuses on management motivation, growth catalysts and intrinsic value. Portfolios are fully diversified and sector exposure is limited.
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Select Sports Group, “SSG”
Sports Management. SSG provides sports representation and management services to professional athletes in contract negotiation, marketing and endorsements, public relations, legal counseling and related areas. SSG receives fees from its athlete clients for the representation and management services provided.
Investment Advisory Services. SSG clients have access to SMHG’s investment programs in the areas of stocks, bonds, private equity and specialized investment vehicles. Additionally, SMHG provides a deal-screening program that reviews the numerous investment opportunities offered to professional athletes, and combines the best deals into a fund that is made available to other athletes who wish to participate. SMHG owns 50% of SSG.
For financial information with respect to our business segments, see Note 19 to the Consolidated Financial Statements.
Other than the proprietary funds, our investment service business is conducted on an individual client basis. In many cases, one of our registered broker employees holds a limited power of attorney permitting discretionary agency and certain other transactions on a client’s behalf. Our officers and directors often invest in the same securities as our retail and institutional clients, where suitable and as permitted by applicable law and regulations. We believe co-investment creates an identity of interest that is generally beneficial, particularly in investments we develop or where we play a major ongoing role.
Clients of our broker-dealer subsidiary, SMH, vary according to the nature of the services provided. Our retail brokerage services are generally focused on high net worth individuals. SMH’s investment banking, underwriting, investment research and principal transaction activities are targeted at emerging and middle market companies throughout the United States. Our institutional and prime brokerage services are offered to institutions and hedge funds throughout the United States, Europe and Asia. These institutional clients consist mostly of pension funds, money managers, mutual and hedge funds, insurance companies, commercial banks and thrift companies.
Salient/PMT provides services to institutions, high net worth individuals and their estates and trusts, 401(k) and other employee-directed company sponsored retirement plans and charitable and other non-profit corporations.
Our investment advisory and financial planning subsidiary, SMCA, provides investment management and financial planning services to clients consisting mainly of mid to high net worth investors.
SSG provides services to professional athletes, principally professional football players.
The marketing efforts of SMH are conducted throughout SMH’s 12 offices and through its independent registered representatives who affiliate with SMH through its SMHP division. SMH targets its client groups through mailings, telephone calls, in-person presentations and firm-sponsored workshops. Due to the nature of our business, our regional name recognition and the reputation of our management, business is obtained through referrals from other investment bankers or initiated directly by the client, as well as through senior level calling programs.
Salient/PMT conducts its marketing and business development efforts on a company-wide basis. All Salient/PMT employees are encouraged to be actively involved in business development efforts through maintenance of professional and personal relationships and active involvement in community events. Salient/PMT markets to specific client groups through mailings, telephone calls, multi-media client presentations and company-sponsored or co-sponsored workshops and seminars. Additionally, Salient/PMT has entered into strategic alliances with a major credit union, a regional accounting firm and a regional bank that provide for sharing of expenses and the payment of referral fees for new business.
SMCA conducts its marketing and business development efforts to specific client groups through mailings, telephone calls, multi-media client presentations, alliances with professional organizations and company-sponsored or
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co-sponsored workshops and seminars. The seminars are sponsored by the firm, local employers, government agencies, and local colleges and universities.
Charlotte Capital markets its services to institutional clients through direct calls on plan sponsors, consulting firms and intermediates.
We believe cross-selling opportunities exist among our various subsidiaries based on the relationships developed by the individual companies.
Existing and potential clients can also gain a variety of information about our firm and the services we provide through our internet websites at www.smhgroup.com; www.smhhou.com; www.salientpartners.com; www.smhpartners.com; www.pinnacletrust.com; www.cummermoyers.com and www.kissingernet.com.
Our broker-dealer subsidiary uses the services of clearing brokers. Currently, we clear transactions, and carry accounts for clients, primarily through Pershing LLC, a member of BNY Securities Group and a subsidiary of The Bank of New York, under a fully disclosed clearing arrangement. Pershing serves as clearing broker in most transactions; however, we also use other clearing brokers. These clearing brokers also provide us with information necessary to generate commission runs, transaction summaries and data feeds for various reports, including compliance and risk management, execution reports, trade confirmations, monthly account statements, cashiering functions and handling of margin accounts. We believe these arrangements produce clearing costs that are competitive within the industry.
We have uncommitted financing arrangements with our clearing brokers that finance our customer accounts, certain broker-dealer balances and firm trading positions. Although these customer accounts and broker-dealer balances are not reflected on our balance sheet for financial accounting reporting purposes, we have generally agreed to indemnify these clearing brokers for losses they may sustain in connection with the accounts. Therefore, we retain risk on these accounts. We are required to maintain certain cash or securities on deposit with our clearing broker.
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are made available free of charge on our internet website, www.smhgroup.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to the SEC.
Our financial service business is affected by general economic conditions. The improvement in the economy, as well as in the overall stock market has had a positive impact on our equity commission revenues and on underwriting fees derived from public offerings. During 2004, the increase in interest rates caused a decrease in residential loan refinancing, which had a negative impact on that portion of our business that derives its income from fixed-income securities. We believe that a stronger economy will be favorable to our equity business.
Our revenues relating to asset-based advisory services and managed accounts are typically from fees based on the market value of assets under management. Consequently, significant fluctuations in the values of securities, which can occur with changes in interest rates or changes in other economic factors, may materially affect the amount of assets under management, and thus, our revenues and profitability.
Our financial services business and the securities business in general are highly competitive. The principal competitive factors influencing our financial services business are:
• professional staff,
• reputation in the marketplace,
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• existing client relationships, and
• ability to commit capital to client transactions and a mix of market capabilities.
We compete directly with national and regional full service broker-dealers and, to a lesser extent, with discount brokers, dealers, and other investment banking firms, investment advisors and commercial banks. We also compete for investment management and fiduciary services with commercial banks, private trust companies, mutual fund companies, insurance companies and others. The financial services industry has become considerably more concentrated as many securities firms have either ceased operations or been acquired by or merged into other firms. Many of these larger firms have significantly greater financial and other resources than we do and can offer their customers more product offerings, lower pricing, broader research capabilities, access to international markets and other products and services we do not offer, which may give these firms a competitive advantage over us.