SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------------------------------------------------- For Quarter Ended: Commission File Number: 000-19619 September 30, 1999 HOENIG GROUP INC. - ------------------------------------------------------------------------------ (Exact name of Registrant as specified in its charter) Delaware 13-3625520 - ------------------------------------ ------------------------ (State or other jurisdiction (I.R.S. Employer I.D. No.) of incorporation or organization) Reckson Executive Park 4 International Drive Rye Brook, NY 10573 - ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip Code) (914) 935-9000 - ------------------------------------------------------------------------------ (Registrant's telephone number, including area code) - ------------------------------------------------------------------------------ (Former name, former address and former fiscal year if changed since last report) Indicated 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 twelve 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 X No ----- ----- As of November 10, 1999, there were 8,618,173 shares of common stock, par value $.01 per share, outstanding. HOENIG GROUP INC. FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999 INDEX Page PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Statements of Financial Condition - September 30, 1999 and December 31, 1998 1 Consolidated Statements of Income - Three and Nine Months Ended September 30, 1999 and 1998 2 Consolidated Statements of Comprehensive Income - Nine Months Ended September 30, 1999 and 1998 3 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1999 and 1998 4 Notes to Unaudited Consolidated Financial Statements 5-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 16-17 PART II - OTHER INFORMATION Item 1. Legal Proceedings 18 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 Exhibit Index 20 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HOENIG GROUP INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION SEPTEMBER 30, 1999 AND DECEMBER 31, 1998 (UNAUDITED) September 30, 1999 December 31, 1998 ------------------ ----------------- ASSETS Cash and equivalents $ 23,400,980 $ 19,575,824 U.S. Government obligations, at market value 16,626,540 10,909,066 Receivables from correspondent brokers and dealers 14,568,154 8,179,525 Receivables from customers 8,437,656 78,864 Equipment, furniture and leasehold improvements, net of accumulated depreciation and amortization 1,740,560 1,704,407 Securities owned, at market value 4,619,951 9,016,826 Exchange memberships, at cost 1,321,235 1,321,235 Investment management fees receivable 1,840,342 1,963,374 Deferred research/services expense 1,606,099 1,153,861 Investment in limited partnerships 1,772,098 5,343,787 Other assets 3,276,808 4,092,770 ------------ ------------ Total Assets $ 79,210,423 $ 63,339,539 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Accrued research/services payable $ 9,271,946 $ 11,927,766 Accrued compensation 7,423,613 7,317,812 Payable to brokers and dealers 8,681,549 269,997 Payable to customers 7,262,228 1,688,298 Accrued expenses 1,046,378 1,474,478 Short-term bank loan payable 17,958 -- Other liabilities 1,232,756 644,003 ------------ ------------ Total Liabilities 34,936,428 23,322,354 ------------ ------------ STOCKHOLDERS' EQUITY Common Stock $.01 par value per share; Voting-authorized 40,000,000 shares, issued 10,883,950 shares in 1999 and 10,846,150 in 1998 108,840 108,462 Additional paid in capital 27,661,959 27,301,478 Accumulated other comprehensive loss (860,608) (883,750) Retained earnings 29,498,862 24,876,560 ------------ ------------ 56,409,053 51,402,750 Less restricted stock (37,500) (150,000) Less treasury stock at cost - 2,265,777 shares in 1999 and 2,202,911 shares in 1998 (12,097,558) (11,235,565) ------------ ------------ Total Stockholders' Equity 44,273,995 40,017,185 ------------ ------------ Total Liabilities and Stockholders' Equity $ 79,210,423 $ 63,339,539 ============ ============ SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1 HOENIG GROUP INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Nine Months Ended September 30, September 30, ------------- ------------- 1999 1998 1999 1998 ---- ---- ---- ---- REVENUES Gross commissions $19,793,163 $19,803,593 $60,880,396 $55,480,358 Investment management fees 2,036,124 1,789,005 5,975,677 5,727,181 Other (6,248) 27,721 17,856 122,975 ----------- ----------- ----------- ----------- Total operating revenues 21,823,039 21,620,319 66,873,929 61,330,514 EXPENSES Clearing, floor brokerage and exchange charges 2,552,935 2,524,795 8,100,435 7,115,892 Employee compensation 5,702,495 5,633,220 17,355,000 16,127,820 Independent research and services 8,845,124 8,003,410 26,683,984 24,636,086 Other 2,486,687 2,922,558 8,318,686 7,986,312 ----------- ----------- ----------- ----------- Total expenses 19,587,241 19,083,983 60,458,105 55,866,110 ----------- ----------- ----------- ----------- OPERATING INCOME 2,235,798 2,536,336 6,415,824 5,464,404 INVESTMENT INCOME AND OTHER Interest, dividends 545,961 424,643 1,485,235 1,353,422 Gain (loss) on investments, other (200,305) (907,758) 139,928 (767,869) ----------- ----------- ----------- ----------- Net investment income and other 345,656 (483,115) 1,625,163 585,553 Income before income taxes 2,581,454 2,053,221 8,040,987 6,049,957 Provision for income taxes 1,047,146 978,470 3,418,685 2,755,681 ----------- ----------- ----------- ----------- Net income $1,534,308 $ 1,074,751 $4,622,302 $ 3,294,276 ========== =========== ========== =========== NET INCOME PER SHARE Basic $ .18 $ .13 $ .54 $ .37 ========== =========== ========== =========== Diluted $ .16 $ .12 $ .49 $ .35 ========== =========== ========== =========== Weighted average shares outstanding Basic 8,611,783 8,572,743 8,604,941 8,897,316 ========= ========= ========= ========= Diluted 9,640,786 9,165,260 9,508,886 9,448,538 ========= ========= ========= ========= SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 2 HOENIG GROUP INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Nine Months Ended September 30, ------------------------------- 1999 1998 ---- ---- Net income $4,622,302 $3,294,276 Other comprehensive income, net of tax Foreign currency translation adjustment 43,005 41,803 Tax expense 19,863 19,037 ---------- ---------- 23,142 22,766 Comprehensive income $4,645,444 $3,317,042 ========== ========== SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 3 HOENIG GROUP INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30, ------------------------------- 1999 1998 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 4,622,302 $ 3,294,276 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 865,218 978,366 Loss on Write-off of Fixed Assets 7,090 193,210 Foreign currency translation adjustment 23,142 22,766 Issuance of stock compensation 118,123 139,404 Issuance of restricted stock 112,500 -- Changes in assets and liabilities: Securities owned, net 4,396,875 843,208 Receivable from correspondent brokers and dealers (6,388,629) (3,429,205) Receivable from customers (8,358,792) 2,869,329 Investment management fees receivable 123,032 37,055 Payable to customers 5,573,930 2,103,465 Deferred research/services expense (452,238) (983,081) Other assets 538,770 (508,981) Payable to brokers and dealers 8,411,552 (3,017,019) Accrued research/services payable (2,655,820) 3,062,627 Accrued compensation 105,801 112,329 Accrued expenses (428,100) 427,395 Other liabilities 588,753 (100,309) ----------- ----------- Net cash provided by operations 7,203,509 6,044,835 CASH FLOWS FROM INVESTING ACTIVITIES: Investment in U.S. Government obligations (5,717,474) 7,838,360 Investment in limited partnerships, at equity 3,571,689 (4,522,829) Investment in securities -- (7,661,598) Purchases of equipment, furniture and leasehold improvements (631,269) (494,330) ----------- ----------- Net cash used in investing activities (2,777,054) (4,840,397) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock 269,325 212,779 Treasury stock purchased (1,094,474) (5,346,416) Issuance of treasury stock 205,892 202,522 Short-term bank loan payable 17,958 29,097 ----------- ----------- Net cash used in financing activities (601,299) (4,902,018) Net increase (decrease) in cash and equivalents 3,825,156 (3,697,580) Cash and equivalents beginning of period 19,575,824 20,468,926 ----------- ----------- Cash and equivalents end of period $23,400,980 $16,771,346 =========== =========== Supplemental disclosure of cash flow information: Interest paid $ 72,940 $ 90,190 =========== =========== Taxes paid $ 2,484,873 $ 2,532,796 =========== =========== SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 4 HOENIG GROUP INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (which include only normal recurring accruals) necessary to present fairly the consolidated financial position of Hoenig Group Inc. (the "Company") and its subsidiaries as of September 30, 1999 and December 31, 1998, and the consolidated results of operations, changes in comprehensive income and changes in cash flows for the periods ended September 30, 1999 and 1998. The consolidated financial statements included herein have been prepared by the Company without independent audit. Certain information normally included in the financial statements and related notes prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. The results of operations for the periods ended September 30, 1999 are not necessarily indicative of operating results for the full year. NOTE 2 - NET CAPITAL AND RESERVE REQUIREMENTS. Hoenig & Co., Inc. ("Hoenig"), the Company's principal operating subsidiary, is subject to the Uniform Net Capital Rule (Rule 15c3-1) which requires that Hoenig maintain net capital equal to the greater of $100,000 or one-fifteenth of aggregate indebtedness. At September 30, 1999, Hoenig's minimum required net capital was approximately $714,000, its net capital ratio was .69 to 1, and its actual net capital was approximately $15,410,000, which was approximately $14,696,000 in excess of regulatory requirements. Hoenig's Tokyo office (a branch of Hoenig) satisfied its September 30, 1999 capital requirement of approximately (yen)34,000,000 ($320,000). Hoenig & Company Limited ("Limited"), the Company's United Kingdom brokerage subsidiary, is required to maintain financial resources of at least 110% of its capital requirement (as defined). Limited's financial resources requirement at September 30, 1999 was approximately (pounds)425,000 ($700,000); it had actual capital of approximately (pounds)854,000 ($1,406,000), and excess financial resources at such date of approximately (pounds)429,000 ($706,000). Hoenig (Far East) Limited ("Far East"), the Company's Hong Kong brokerage subsidiary, is required to maintain liquid capital equal to the greater of HK$3,000,000 ($386,000) or 5% of average quarterly total liabilities. Far East's required liquid capital was approximately HK$12,150,000 ($1,564,000) at September 30, 1999, and it had actual liquid capital of approximately HK$53,227,000 ($6,850,000) and excess liquid capital of approximately HK$41,077,000 ($5,286,000). NOTE 3 - INVESTMENTS IN LIMITED PARTNERSHIPS. Axe-Houghton Associates, Inc., the Company's wholly-owned asset management subsidiary, is the general partner of two limited partnerships and maintains investments in each of the partnerships. Axe-Houghton's partnership investments were 19.0% ($604,444) and 0.51% ($46,919) at September 30, 1999. Axe-Houghton does not maintain control of the partnerships for consolidation purposes. These investments are accounted for under the equity method. During the periods presented, the Company also maintained investments in two unaffiliated multi-manager, market-neutral limited partnerships. These multi-manager limited partnerships, which are managed by professional money managers, make investments in other unaffiliated limited partnerships and funds which employ a variety of alternative investment strategies. These strategies include relative-value, event-driven, hedged-directional, convertible arbitrage, convertible hedging and basis spread trading. 5 During the first six months of 1999, the Company reduced its investments in these unaffiliated limited partnerships by a total of $3.6 million, by reducing its investment in one to approximately $1.1 million and withdrawing its $1.7 million investment in the other. The remaining investment represents less than a 5% interest in the respective partnership at September 30, 1999 and is accounted for at fair market value. NOTE 4 - FINANCIAL INSTRUMENTS. The Company maintains a diversified portfolio of investment grade preferred stock and U.S. Treasury futures used to hedge the preferred stock positions. This investment is managed by a professional money manager and uses or includes derivative financial instruments for the purpose of reducing exposure to certain investment risks, including interest rate fluctuations. This investment is accounted for at fair market value based upon available market information and valuations received from the manager. Changes in the market value, as well as gains or losses resulting from the termination or maturity of these instruments, are recognized as gains or losses on investments in the period in which they occur. During the three months ended September 30, 1999 the Company reduced its investment in this portfolio by $4.0 million to approximately $4.5 million as of September 30, 1999. The $4.0 million has been invested in U.S Treasury securities and money market funds. During 1998 and the first quarter 1999, the Company maintained an investment in a bank-sponsored deposit account which maintained investments in U.S. foreign equity indices, floating rate deposits, baskets of European equity securities and a U.S. Treasury zero coupon bond. The deposit account matured in March 1999, and the Company did not renew the investment. The Company does not hold financial instruments for trading purposes. NOTE 5 - STOCKHOLDERS' EQUITY. From January 1, 1999 through March 31, 1999, the Company repurchased 131,750 shares of Common Stock at an aggregate cost of $1.1 million under the Company's 1998 one million-share repurchase program. The Company did not repurchase any shares during second and third quarter 1999. As of September 30, 1999, the Company has repurchased a total of 397,462 shares under the 1998 repurchase program. As of September 30, 1999, the Company has repurchased a total of 2,397,462 shares under the 1998 repurchase program and two earlier repurchase programs. The Company purchased an additional 650,000 shares of Common Stock in December 1995 from the Estate of Ronald H. Hoenig pursuant to an agreement with Mr. Hoenig. The total cost of the purchases under the repurchase programs and the purchase from the Estate (net of 781,685 shares issued out of Treasury Stock) is $12,097,558. NOTE 6- EARNINGS PER SHARE. The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is similar to basic, but adjusts for the effect of potential common shares. The following table presents the computations and basic and diluted earnings per share for the periods indicated: 6 Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Net income available to common stockholders $1,534,308 $1,074,751 $4,622,302 $3,294,276 Weighted average shares outstanding 8,611,783 8,572,743 8,604,941 8,897,316 Effect of dilutive instruments Employee stock awards 1,029,003 592,517 903,945 551,222 ---------- ---------- ---------- ---------- Total weighted average diluted shares 9,640,786 9,165,260 9,508,886 9,448,538 ========== ========== ========== ========== Basic earnings per share $ .18 $ .13 $ .54 $ .37 ========== ========== ========== ========== Diluted earnings per share $ .16 $ .12 $ .49 $ .35 ========== ========== ========== ========== NOTE 7- COMMITMENTS AND CONTINGENCIES. In 1998, a former employee of Hoenig instituted an arbitration before NASD Regulation, Inc. against Hoenig and Fredric P. Sapirstein, Hoenig's Chairman and Chief Executive Officer. The former employee principally alleges that the defendants wrongfully terminated his employment in breach of an employment agreement and falsely stated the reason for his termination in a securities regulatory filing on Form U-5. The former employee is seeking approximately $2.2 million in compensatory damages against each of the defendants, plus punitive damages, liquidated damages, interest, reasonable attorneys' fees and modification of the Form U-5. The defendants have filed an answer, denying the former employee's allegations, and Hoenig has filed a counter-claim against the former employee seeking damages of not less than $220,000, based on the former employee's breach of his employment agreement with Hoenig. The defendants believe that they have meritorious defenses to the arbitration, and intend to vigorously oppose the claims and pursue the counter-claim against the former employee if the matter proceeds to an arbitration hearing. In the opinion of management, resolution of this matter is not expected to have a material adverse affect on the Company's financial condition, results of operations or cash flows. NOTE 8- SEGMENT REPORTING. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"), effective for fiscal years beginning after December 15, 1997, to assist financial statement users in assessing the performance of an enterprise and its prospects for future cash flows, and in making informed decisions about an enterprise. For the year ended December 31, 1998, the Company changed its reporting of business segments in accordance with SFAS No. 131. The Company has restated information regarding periods ended prior to December 31, 1998 to reflect this change. The Company has three reportable operating segments: domestic brokerage, international brokerage and asset management. The Company's brokerage segments provide independent third-party and proprietary research, global securities brokerage and other services primarily to institutional clients from its domestic (United States) and international (United Kingdom, Hong Kong and Tokyo) brokerage operations. In attributing commission revenues to its brokerage segments, the Company primarily relies on the geographic location of the customer. The Company's wholly-owned asset management subsidiary provides professional asset management to U.S. public and corporate employee benefit plans, investment partnerships and other U.S. institutional clients from its U.S. office. The accounting policies of the segments are the same as those described in Note 2 of the Notes to Consolidated Financial Statements contained in the Company's Annual Report on Form 10-K for the year 7 ended December 31, 1998. There have been no material changes to the Company's segment presentation in 1999. The Company evaluates performance based upon operating income or loss, not including interest and investment income, as well as certain intercompany expenses. The Company does not allocate certain corporate assets (goodwill and certain fixed assets) to its reportable segments. The following table illustrates significant financial data for each reportable segment for the periods indicated: THREE MONTHS ENDED DOMESTIC INTERNATIONAL SEPTEMBER 30, 1999 BROKERAGE BROKERAGE ASSET MGMT TOTAL - ------------------ --------- --------- ---------- ----- Revenues from external customers $15,044,782 $4,742,133 $2,036,124 $21,823,039 Segment operating income 2,245,130 271,046 715,598 3,231,774 Segment assets 31,613,203 30,686,394 6,363,084 68,662,681 ----------- ---------- ---------- ----------- THREE MONTHS ENDED DOMESTIC INTERNATIONAL SEPTEMBER 30, 1998 BROKERAGE BROKERAGE ASSET MGMT TOTAL - ------------------ --------- --------- ---------- ----- Revenues from external customers $16,257,292 $3,574,022 $1,789,005 $21,620,319 Segment operating income (loss) 3,541,537 (173,756) 574,870 3,942,651 Segment assets 30,547,657 17,057,631 4,809,425 52,414,713 ----------- ---------- ---------- ----------- NINE MONTHS ENDED DOMESTIC INTERNATIONAL SEPTEMBER 30, 1999 BROKERAGE BROKERAGE ASSET MGMT TOTAL - ------------------ --------- --------- ---------- ----- Revenues from external customers $47,013,158 $13,885,094 $5,975,677 $66,873,929 Segment operating income 7,402,820 192,003 1,931,061 9,525,884 ----------- ---------- ---------- ----------- NINE MONTHS ENDED DOMESTIC INTERNATIONAL SEPTEMBER 30, 1998 BROKERAGE BROKERAGE ASSET MGMT TOTAL - ------------------ --------- --------- ---------- ----- Revenues from external customers $44,254,215 $11,349,118 $5,727,181 $61,330,514 Segment operating income (loss) 7,677,562 (798,052) 1,995,673 8,875,183 ----------- ---------- ---------- ----------- Information for the Company's reportable segments as it relates to the consolidated totals is as follows: THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, -------------------------------- ------------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- OPERATING REVENUES: Domestic brokerage $15,044,782 $16,257,292 $47,013,158 $44,254,215 International brokerage 4,742,133 3,574,022 13,885,094 11,349,118 Asset management 2,036,124 1,789,005 5,975,677 5,727,181 ----------- ----------- ----------- ----------- Total operating revenues $21,823,039 $21,620,319 $66,873,929 $61,330,514 =========== =========== =========== =========== 8 THREE MONTHS ENDED SEPT. 30, NINE MONTHS ENDED SEPT. 30, ---------------------------- --------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- OPERATING INCOME (LOSS): Domestic brokerage $2,245,130 $3,541,537 $7,402,820 $7,677,562 International brokerage 271,046 (173,756) 192,003 (798,052) Asset management 715,598 574,870 1,931,061 1,995,673 General corporate (995,976) (1,406,315) (3,110,060) (3,410,779) ---------- ---------- ---------- ---------- Total operating income 2,235,798 2,536,336 6,415,824 5,464,404 Interest & investment income(loss) 345,656 (483,115) 1,625,163 585,553 ---------- ---------- ---------- ---------- Income before income taxes $2,581,454 $2,053,221 $8,040,987 $6,049,957 ========== ========== ========== ========== NOTE 9 - SUBSEQUENT EVENTS On November 4, 1999, the Company's Board of Directors authorized the management of the Company to repurchase up to one million shares of the Company's Common Stock from time to time in open-market and privately negotiated transactions subject to the availability of shares for repurchase at prices that the Company considers to be attractive. This repurchase program replaces the 1998 stock repurchase program, under which the Company had purchased a total of 397,462 shares as of November 4, 1999. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in this report that relate to future plans, events or performance are forward-looking statements. Such statements may include, but are not limited to, those relating to the effects of future growth, cost reduction measures taken to address operating losses in certain international operations, including the risk that restructuring Tokyo brokerage operations will not improve the profitability of international brokerage operations, industry consolidation, acquisition and expansion plans, strategic alliances, joint ventures and other business combinations, plans to address the Year 2000 issue and other technology issues, market risk, the Company's investment activities and its current equity capital requirements. Actual events might differ materially due to a variety of important factors that cannot be predicted with certainty. These factors involve risks and uncertainties relating to, among other things, general economic conditions, market fluctuations, competitive conditions within the brokerage and asset management businesses, stock market prices and trading volumes, changes in demand for asset management and securities brokerage services, the Company's ability to recruit and retain key employees, changes in U.S. and foreign securities laws and regulations, particularly regarding independent research and directed brokerage arrangements, trading and investment activities, litigation and other factors discussed throughout this report and in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. INTRODUCTION The Company provides global securities brokerage to institutional clients through its wholly-owned brokerage subsidiaries in the United States, United Kingdom, Hong Kong and Japan. The Company's wholly-owned subsidiary, Axe-Houghton Associates, Inc., provides professional asset management to U.S. public and corporate employee benefit plans, investment partnerships and other U.S. institutional clients from its offices in the United States. The Company's principal source of revenues is commissions earned for executing trades on behalf of its customers. The Company executes trades in equity securities on the world's major stock exchanges, 9 acting primarily as agent for its customers, and also executes trades in U.S. fixed income securities on an agency and riskless principal basis. The Company earns commissions in connection with four types of brokerage services: commissions received in connection with providing independent research and other services to investment managers; commissions received in exchange for paying expenses of, or commission refunds to, customers under directed brokerage arrangements; commissions received in connection with providing proprietary research; and commissions received for execution-only services. The Company's profit margin on execution-only brokerage and commissions earned in connection with providing proprietary research is higher than that on commissions earned in connection with independent research and directed brokerage arrangements because the Company does not incur direct expenses for research and other services in connection with such activities. The Company generally expects a certain amount of commissions for every $1 in independent research, other services and commission refunds provided under independent research and directed brokerage arrangements. This ratio is negotiated on an individual customer basis. Ratios continue to be under modest downward competitive pressure in most of the markets in which the Company conducts brokerage activities. The Company's earnings in any period are affected by its ability to earn commissions under independent research and directed brokerage arrangements on a timely basis, because revenues are recorded only when earned, and related expenses are recorded when incurred. The timing of the receipt of commissions could cause variations in earnings from year to year and quarter to quarter. The Company's second largest source of revenues is investment management fees earned by Axe-Houghton, the Company's asset management subsidiary, in connection with the provision of asset management services to institutional clients. Investment management fee revenues are a function of assets under management and the management fee charged. The profit margin on the Company's asset management business is higher than those on the Company's brokerage activities and also varies with the types of asset management services provided by the Company. The amount of assets under management is affected by numerous factors, including the ability to attract and retain clients and investment personnel, investment performance results, the number and variety of investment disciplines offered and the capacity limitations of such disciplines (such as small capitalization growth equities), the market performance of particular investment disciplines, as well as the performance of the securities markets generally. Certain of the Axe-Houghton investment professionals who manage small capitalization growth equity assets are employed under contracts expiring on December 31, 2000. For the year ended December 31 1998, the Company changed its reporting of business segments in accordance with new Statement of Financial Accounting Standards No. 131 ("Disclosures About Segments of an Enterprise and Related Information") and to reflect the restructuring of the Company's brokerage operations in Japan. The Company has three reportable operating segments -- domestic brokerage, international brokerage and asset management -- and has restated information for periods ending prior to December 31, 1998 to reflect this change. In determining whether brokerage commissions earned are domestic or international, the Company primarily relies on the geographic location of the customer. 10 THREE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS SEPTEMBER 30, 1998 The Company's operating income before income taxes for the three months ended September 30, 1999 decreased 11.8% to $2.2 million, as compared to $2.5 million during the same period in 1998. The decrease in operating income for the three months ended September 30, 1999 is primarily attributable to a 36.6% decrease in the operating income of the Company's domestic brokerage operations, offset by an increase in the operating income of international brokerage operations to $0.3 million from a loss of $0.2 million for the third quarter 1998. The Company's net income for the three months ended September 30, 1999 increased 42.8% to $1.5 million, versus $1.1 million during the third quarter 1998. Operating revenues increased 9.4% to $21.8 million for the three months ended September 30, 1999 from $21.6 million during the same period in 1998. This increase resulted primarily from a 32.7% increase in operating revenues from international brokerage operations. Operating revenues from international brokerage operations represented 21.7% of the operating revenues during the three months ended September 30, 1999, as compared to 16.5% during the same period in 1998. Operating revenues from asset management for the three months ended September 30, 1999 increased 13.8% to $2.0 million as compared to $1.8 million during the same period in 1998. Operating revenues from the Company's domestic brokerage operations for the three months ended September 30, 1999 decreased 7.5% to $15.0 million as compared to $16.2 million in 1998. Operating income before income taxes of the Company's domestic brokerage operations decreased 36.6% to $2.2 million in the third quarter 1999, as compared to $3.5 million in the third quarter 1998, primarily due to a decrease in operating revenues coupled with an increase in independent research and services expenses for the three months ended September 30, 1999. Operating revenues from international brokerage operations increased 32.7% to $4.7 million during the three months ended September 30, 1999, as compared to $3.6 million during the same period in 1998 due to an increase in commission revenues of the Company's Hong Kong operations. International brokerage operations had operating income of $0.3 million in the third quarter 1999, as compared to an operating loss of $0.2 million in the third quarter 1998. Investment management fee revenues increased 13.8% for the three months ended September 30, 1999 to $2.0 million, as compared to $1.8 million during the same period in 1998. Total assets under management were $3.9 billion as of September 30, 1999 as compared to $4.0 billion as of June 30, 1999 and $3.9 billion as of September 30, 1998. Management fee revenues increased 13.8% during the third quarter 1999 as compared to the same period in 1998, primarily due to an increase in small capitalization growth equities assets under management, which are managed at the Company's highest fee rate. Assets managed in small capitalization growth equities increased 51.6% to $782.2 million as of September 30, 1999 from $516.0 million as of September 30, 1998. Small capitalization growth equity assets under management were $812.0 million as of June 30, 1999. Operating income of the Company's asset management operations for the third quarter 1999 increased 24.5% to $0.7 million from $0.6 million during the same period in 1998. Expenses related to independent research and other services provided to the Company's brokerage clients, including commission refunds, during the three months ended September 30, 1999 increased 10.5% to $8.8 million from $8.0 million during the third quarter 1998. These expenses were 44.7% of commission revenues during the third quarter 1999, as compared to 40.4% during the third quarter 1998. These expenses increased as a percentage of commission revenues in the third quarter 1999 primarily due to (1) the timing of research expenses incurred relative to the receipt of commissions earned and (2) a decrease in execution-only commissions for the three months ended September 30, 1999. 11 Clearing, floor brokerage and exchange charges increased 1.1% to $2.6 million during the three months ended September 30, 1999 from $2.5 million during the same period in 1998. These expenses represented 12.9% of commissions earned in the third quarter 1999 and 12.7% of commissions earned in the third quarter 1998. The increase in these expenses as a percentage of commissions is primarily due to an increase in the percentage of commissions earned in certain Asian markets, where such expenses are charged at higher rates than comparable U.S. equity trades. Employee compensation increased 1.2% to $5.7 million for the three months ended September 30, 1999 from $5.6 million for the same period in 1998. This resulted primarily from an increase in discretionary and performance-based bonus compensation expense for the three months ended September 30, 1999. All other expenses decreased 14.9% to $2.5 million in the three months ended September 30, 1999, as compared to $2.9 million during the same period in 1998. This resulted primarily from a decrease in consulting and marketing related expenses and the absence of write-offs for certain fixed assets that the Company incurred during the third quarter 1998. Net investment income and other for the third quarter ended September 30, 1999 increased to $0.3 million, as compared to a loss of $0.5 million during the same period in 1998. This increase was attributed to realized and unrealized losses of $0.9 million incurred on the Company's investments during the third quarter of 1998. NINE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS SEPTEMBER 30, 1998 The Company's operating income before income taxes for the nine months ended September 30, 1999 increased 17.4% to $6.4 million, as compared to $5.5 million during the same period in 1998. The increase in operating income for the nine months ended September 30, 1999 is primarily attributable to a an increase in operating income from international brokerage operations to $0.2 million from a loss of $0.8 million during the same period in 1998. The Company's net income for the nine months ended September 30, 1999 increased 40.3% to $4.6 million, as compared to $3.3 million during the same period in 1998. Operating revenues increased 9.0% to $66.9 million for the nine months ended September 30, 1999 from $61.3 million during the same period in 1998. This increase resulted primarily from a 6.2% increase in operating revenues from domestic brokerage operations and a 22.3% increase in operating revenues from international brokerage operations. Operating revenues from international brokerage operations represented 20.8% of the operating revenues during the nine months ended September 30, 1999, as compared to 18.5% during the same period in 1998. Operating revenues from asset management for the nine months ended September 30, 1999 increased 4.3% to $6.0 million, as compared to $5.7 million for the same period in 1998. Operating revenues from the Company's domestic brokerage operations for the nine months ended September 30, 1999 increased 6.2% to $47.0 million, as compared to $44.3 million in 1998 due to increased trading activity. Operating income of the Company's domestic brokerage operations decreased 3.6% to $7.4 million in the nine months ended September 30, 1999, as compared to $7.7 million in 1998, primarily due to an increase in discretionary and performance based compensation in the nine months ended September 30, 1999. Operating revenues from international brokerage operations increased 22.3% to $13.9 million during the nine months ended September 30, 1999, as compared to $11.3 million during the same period in 1998 as a result of increased commission revenues earned by the Company's Hong Kong brokerage operations. Operating income from international brokerage operations increased to $0.2 million during the nine months ended 12 September 30, 1999, as compared to an operating loss of $0.8 million during the same period in 1998. Operating income of international brokerage operations for the nine months ended September 30, 1999 includes non-recurring operating expenses of approximately $0.3 million related to the previously announced restructuring of the Company's brokerage operations in Tokyo, Japan, which was substantially completed as of March 31, 1999. The Tokyo office focuses primarily on sales and marketing activities, and the Company's Hong Kong operations are responsible for the execution and settlement of transactions in Japanese equities. Investment management fee revenues increased 4.3% to $6.0 million during the nine months ended September 30, 1999, as compared to $5.7 million during the same period in 1998. This increase in investment management fee revenues is due to an increase in the percentage of assets managed in small capitalization growth equities assets, which assets are managed at the Company's highest fee rate. Assets managed in small capitalization growth equities increased 51.6% to $782.2 million as of September 30, 1999 (20.2% of total assets under management as of September 30, 1999) from $516.0 million (13.2% of total assets under management as of September 30, 1998). Operating income of the Company's asset management operations for the nine months ended September 30, 1999 decreased to $1.9 million from $2.0 million during the same period in 1998, primarily due to an increase in compensation expense for the nine months ended September 30, 1999. Expenses related to independent research and other services provided to the Company's brokerage clients, including commission refunds, during the nine months ended September 30, 1999 increased 8.3% to $26.7 million from $24.6 million during the same period in 1998. These expenses were 43.8% of commission revenues during the nine months ended September 30, 1999, as compared to 44.4% during the same period in 1998. These expenses increased at a lower rate than commission revenues in the nine months ended September 30, 1999, primarily due to an increase in commissions resulting from execution-only brokerage during the first six months of 1999, as well as the timing of research expenses incurred relative to the receipt of commission revenues. Clearing, floor brokerage and exchange charges increased 13.8% to $8.1 million during the nine months ended September 30, 1999 from $7.1 million during the same period in 1998. These expenses represented 13.3% of commissions earned during the nine months ended September 30, 1999 and 12.8% of commissions earned in the same period in 1998. The increase in these expenses as a percentage of commissions is primarily due to an increase in the percentage of commissions earned in certain Asian markets, where such expenses are charged at higher rates than comparable U.S. equity trades. Employee compensation increased 7.6% to $17.4 million for the nine months ended September 30, 1999 from $16.1 million for the same period in 1998. This resulted primarily from an increase in discretionary and performance-based bonus compensation expense for the nine months ended September 30, 1999. All other expenses increased 4.2% to $8.3 million in the nine months ended September 30, 1999, as compared to $8.0 million during the same period in 1998. This resulted primarily from an increase in market data, consulting and year 2000-related expenses. Net investment income and other for the nine months ended September 30, 1999 increased to $1.6 million, as compared to $0.6 million during the same period in 1998. This increase in investment income and other reflects the absence of realized and unrealized losses of $0.9 million which the Company incurred during the third quarter of 1998. 13 LIQUIDITY AND CAPITAL RESOURCES At September 30, 1999, the Company had cash, U.S. Government obligations, net accounts receivable and other net investments of $55.3 million. All receivables from correspondent brokers and dealers are fully collectible, and no provision for uncollectibles is required. The Company believes that its current capital resources and liquidity, plus additional funds generated by operations, will be sufficient to meet current and future operating needs. During the nine months ended September 30, 1999, the Company repurchased 131,750 shares of its common stock (all in the first quarter) under the 1998 stock repurchase program at a total cost of $1.1 million. These repurchases have not had a material effect on the Company's liquidity or capital resources. On November 4, 1999, the Company announced a new one million share stock repurchase program, which replaced the 1998 stock repurchase program. YEAR 2000 READINESS DISCLOSURE The year 2000 issue ("Y2K Issue") is the result of computer systems and applications that currently use two digits rather than four to recognize a particular year. The Y2K Issue affects the Company's information technology ("IT") systems (i.e., computer systems, network elements and software applications), as well as other business systems that have time-sensitive programs or microprocessors ("non-IT systems") that may not properly reflect or recognize the year 2000. The failure to reflect or recognize dates after 1999 could cause the Company's IT and non-IT systems to fail or cause errors which could lead to disruptions in operations or increased costs. Such failures could, for example, limit the Company's ability to execute trades, cause settlement of trades to fail, lead to incomplete or inaccurate accounting, recording or processing of securities trades, result in the generation of erroneous results or give rise to uncertainty about the Company's exposure to certain risks. If not remedied, potential risks include business interruption or shutdown, financial loss, regulatory actions, reputational harm and legal liability. The Company's operating subsidiaries are regulated by the Securities and Exchange Commission ("SEC") and comparable foreign regulators, as well as by NASD Regulation, Inc. and securities exchanges of which its subsidiaries are members. The Company's principal operating subsidiary, Hoenig & Co., Inc., is a U.S. registered broker-dealer and New York Stock Exchange member. As such, Hoenig & Co. has submitted a written certification to the NYSE confirming the achievement of certain milestones by June 30, 1999. As a member of The Stock Exchange of Hong Kong, Hoenig (Far East) Limited was required to meet similar milestones by March 31, 1999 and has filed periodic status reports regarding its Y2K preparedness. Hoenig & Co. also has filed with the SEC a Form BD-Y2K, which details its progress with respect to the Y2K Issue, and a copy of its accounting firm's report with respect to AICPA Statement of Position 98-8 regarding Y2K readiness. The Company's U.S. registered investment adviser, Axe-Houghton Associates, has filed a Form ADV-Y2K with the SEC, detailing its Y2K efforts and state of preparedness. The Company developed a five-phase program for addressing the Y2K Issue, which consists of the following: o Phase I is defining the Y2K Issue and what constitutes Y2K compliance and educating Company personnel about the Y2K Issue. o Phase II is identifying those systems which may be affected by the Y2K Issue. o Phase III is developing action plans to address the Y2K Issue for identified systems. 14 o Phase IV is the testing of the action plans intended to resolve the Y2K Issue. o Phase V is the implementation of the action plans. As of July 31, 1999, the Company completed Phases I through V of its Plan with respect to existing internal IT and non-IT systems in its U.S. operations. It has completed Phases I through IV and has completed 95% of Phase V with respect to existing internal IT and non-IT systems in its international operations. Based on current information, the Company expects to complete Phase V of its Plan with respect to internal systems in its international operations by November 30, 1999. The Company has successfully tested for Y2K compliance its mission critical systems in the United States and its international operations (Phase IV). Such testing includes internal testing, industry-wide testing, point-to-point testing with third parties and integration testing. Hoenig (Far East) Limited was the Company's only brokerage subsidiary that was required to participate in industry-wide testing. Hoenig (Far East) Limited achieved successful results in the industry-wide tests conducted by The Stock Exchange of Hong Kong in March 1999. The Company has developed and continues to refine contingency plans for its mission critical IT and non-IT systems to timely address any potential Y2K problems. These plans define alternate services or products to be used (e.g., market data systems) or alternate processes to be followed in the event that a mission critical system fails. The failure to develop and implement adequate contingency plans could have a material adverse effect on the Company's financial condition, results of operations and cash flows. Notwithstanding the Company's efforts to make contingency plans, there may not be readily available alternatives for the services provided by the Company's clearing brokers, securities exchanges and utilities. Even if the Company succeeds in addressing the Y2K Issue with respect to its internal systems, it can be materially adversely affected by the failures of third parties to remediate their own Y2K problems. These third parties include trading counter-parties, financial intermediaries, securities exchanges, depositories, clearing brokers and agencies, clearing houses, commercial banks and various vendors, including providers of market data and pricing services, telecommunication services and other utilities. In particular, in some international markets where the Company conducts business, the level of awareness and remediation efforts relating to the Y2K Issue are believed to be less advanced than in the United States, and it is more difficult to obtain information from third parties about their Y2K readiness. As is true for other companies, the Company is vulnerable to Y2K failures beyond its control, particularly with respect to utility and transportation service providers. The Company has hired consultants on an as-needed basis to assist Company personnel in effecting the Company's Y2K program. In order to focus attention on the Y2K Issue, management has deferred certain other technology projects, but this deferral is not expected to have a material adverse effect on the Company's financial condition, results of operations or cash flows. Based on current information, the Company believes that it will spend a total of approximately $800,000 TO $950,000 to complete the five-phase Y2K program and address the Y2K Issue, which includes the costs of software replacements and corrections, additional hardware and hardware upgrades, internal allocations for employee time, consulting fees and additional personnel needed to implement contingency plans. The increase in anticipated Y2K costs reflects increased consulting expenses incurred by the company during the third quarter 1999. The Company does not expect these costs to be material to its financial condition, results of operations or cash flows in a given period. The Company has funded, and will continue to fund, Y2K costs through operating cash flows. Y2K costs are expensed as they are incurred. The total amount of Y2K expenses incurred through October 31, 1999 was $732,990. 15 The costs of addressing the Y2K Issue and anticipated dates for completing the Company's Y2K program are based on management's best estimates, which were derived using numerous assumptions of future events, including the continued availability of certain resources, third-party modification plans and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, the ability of third parties to address the Y2K Issue, the availability of cost-effective alternatives or replacements for third-party products and services which are not Y2K compliant and similar uncertainties. IMPACT OF INFLATION The Company's business is not capital intensive, and management believes that the financial results as reported would not have been significantly affected had such results been adjusted to reflect the effects of inflation and price changes. However, inflation affects the cost of operations, particularly salaries and related benefits. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK All of the Company's investments are subject to certain market risks. Market risk represents the risk of loss that may result from a potential change in the market value, cash flows and earnings of an investment and related derivatives as a result of fluctuations in interest rates, foreign exchange rates and equity prices. Market risk is inherent in investments that contain derivative and non-derivative financial instruments. The Company has established procedures to manage its exposure to market fluctuations and changes in the market value of its investments. The Company is exposed to foreign currency risk arising from exchange rate fluctuations on its foreign denominated bank accounts, which are used in its international brokerage operations. The Company's primary exposure is in Japanese Yen, U.K. Pounds Sterling and Hong Kong dollars. The Company mitigates its foreign exchange exposure by maintaining foreign currency balances only to the extent necessary to meet the operational needs of its international subsidiaries. For information regarding the Company's exposure to certain market risks, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. Significant changes which have occurred since December 31, 1998 are as follows: During the first six months of 1999, the Company reduced its investments in unaffiliated limited partnerships (valued at $4.6 million at December 31, 1998) by approximately $3.6 million by withdrawing its $1.7 million investment from one of the partnerships and reducing its investment in the other to approximately $1.1 million. Further information regarding these investments is hereby incorporated by reference to Note 3 of the Notes to Unaudited Consolidated Financial Statements contained in this report. The Company's investment in a bank-sponsored deposit account matured in March 1999 (valued at $1.0 million at December 31, 1998), and the Company did not renew the investment. During the third quarter of 1999, the Company reduced its investment in the diversified 16 portfolio of preferred stock and U.S. Treasury futures by $4.0 million to approximately $4.5 million. The funds previously invested in the limited partnerships, deposit account and diversified portfolio of preferred stock and U.S. Treasury futures have been invested in U.S. Treasury securities and money market funds. 17 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There have been no material developments in the arbitration instituted by Lawrence W. Gallo, a former employee of Hoenig & Co., Inc., before the NASD Regulation Inc. against Hoenig & Co. and Fredric P. Sapirstein, Hoenig & Co.'s Chairman and Chief Executive Officer. Additional information regarding this arbitration is hereby incorporated by reference to Note 7 of the Notes to Unaudited Consolidated Financial Statements contained in this report. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS 27.1 Financial Data Schedule (B) REPORTS ON FORM 8-K The Registrant did not file any reports on Form 8-K during the quarter ended September 30, 1999. 18 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 the undersigned, thereunto duly authorized. Hoenig Group Inc. Date: November 10, 1999 By: /s/ Fredric P. Sapirstein -------------------------------- Fredric P. Sapirstein, Chairman and Chief Executive Officer Date: November 10, 1999 By: /s/ Alan B. Herzog -------------------------------- Alan B. Herzog, Chief Operating Officer and Chief Financial Officer 19 EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 27.1 Financial Data Schedule 20 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HOENIG GROUP INC. SEPTEMBER 30, 1999 FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND NOTES THERETO. -----END PRIVACY-ENHANCED MESSAGE---