10-Q 1 a10-q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 Commission File No. 0-9377 ----------------- ----------- KINNARD INVESTMENTS, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Minnesota 41-0972952 -------------------------------------------------------------------------------- (State of incorporation) (I.R.S. Employer identification number) 920 Second Avenue South, Minneapolis, Minnesota 55402 -------------------------------------------------------------------------------- (Address of principal executive offices) (612)-370-2700 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) 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 at least the past 90 days. YES X No ----- ------ As of August 7, 2000, 4,975,281 shares of the Registrant's $0.02 par value common stock were issued and outstanding. KINNARD INVESTMENTS, INC. AND SUBSIDIARIES TABLE OF CONTENTS

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS KINNARD INVESTMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS)

See accompanying Notes to Consolidated Financial Statements. 3 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)

See accompanying Notes to Consolidated Financial Statements. 4 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)

See accompanying Notes to Consolidated Financial Statements. 5 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)

See accompanying Notes to Consolidated Financial Statements. 6 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (IN THOUSANDS)

See accompanying Notes to Consolidated Financial Statements. 7 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements of Kinnard Investments, Inc., (the "Company") have been prepared in conformity with generally accepted accounting principles and should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 1999. The results of operations for the three and six month periods ended June 30, 2000 are not necessarily indicative of the results to be expected for the year ending December 31, 2000. The consolidated statement of financial condition as of June 30, 2000 and other financial information for the three and six month periods ended June 30, 2000 and 1999, are unaudited, but management of the Company believes that all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the results of operations for the periods have been included. NOTE 2. BINDING ARBITRATION AWARD On December 10, 1999, the National Association of Securities Dealers ("NASD") issued a binding arbitration award for $16.6 million in favor of the Company and against Dain Rauscher Corporation ("Dain") and several of its investment executives who were wrongfully recruited by Dain from the Company from 1997 to 1999. NASD arbitration awards are not subject to appeal. While Dain has filed a motion with the Hennepin County District Court (the "Court") to vacate the arbitration panel's decision, the Company believes that vacature is unlikely due to the narrow grounds upon which a binding arbitration award may be vacated. Under both Federal and Minnesota Arbitration Acts, the Court must find evidence of fraud, corruption, misconduct or partiality on the part of the arbitration panel, or that the panel exceeded its powers in rendering its award decision. The award included compensatory damages of $9.1 million, punitive damages of $7.1 million and reimbursement of legal costs of $350 thousand. Under NASD Rules, Dain is required to pay interest on the unpaid settlement amount based on a statutory interest rate of 5.5%. Upon exhaustion of all vacature efforts, the Company anticipates recognizing up to $16.6 million in revenue from the settlement, plus interest income during the period that the settlement remains unpaid. Recognition of such revenue may result in additional compensation and income tax expense. 8 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2. BINDING ARBITRATION AWARD (CONTINUED) The following unaudited pro forma information has been prepared assuming that the binding arbitration settlement and related accrued interest had been recognized at the end of the period presented after the impact of certain adjustments to revenue, employee compensation based on current formulas and the related income tax effects thereof. PRO FORMA STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)

NOTE 3. OTHER COMMITMENTS AND CONTINGENT LIABILITIES John G. Kinnard and Company, Incorporated ("John G. Kinnard") is a defendant in various actions relating to its business, some of which involve claims for unspecified amounts. Although the resolution of these matters cannot be predicted with certainty, management believes that while their outcome may have a material effect on the earnings in a particular period, the outcome will not have a material adverse effect on the financial condition of the Company. NOTE 4. SEGMENTS The Company's reportable segments are: retail sales, equity capital markets, fixed income and other. The retail segment consists of various retail branch locations and the financial services division. Equity capital markets consists of equity trading, institutional sales, research and investment banking. Fixed income includes the origination, trading, and institutional sales of fixed income securities. Other consists of general corporate and administrative support functions. The Company does not provide balance sheet data for segment reporting as this data is not measured. 9 KINNARD INVESTMENTS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. SEGMENTS (CONTINUED) Information concerning operations in these segments of business is as follows:

NOTE 5. PENDING ACQUISITION On June 5, 2000, the Company entered into a definitive merger agreement with Stockwalk.com Group, Inc. (Stockwalk) and SW Acquisition, Inc., a subsidiary of Stockwalk, whereby the Company's securities brokerage and investment banking firms will be combined under the Stockwalk holding company. Under the terms of the merger agreement, the Company's shareholders will receive $6.00 in cash and a fraction of a share of Stockwalk common stock in exchange for each share of the Company's common stock that they own. The number of shares of Stockwalk common stock to be received will be determined based upon the average closing price of Stockwalk common stock for the 20 trading days ending on the trading day immediately prior to the date on which all of the conditions in the merger agreement have been satisfied. If the average closing price of Stockwalk common stock during the measurement period is between $9.00 and $15.00 per share, the Company's shareholders will receive one-half of a share of Stockwalk common stock together with $6.00 in cash for each share of the Company's common stock that they own. If the average closing price of Stockwalk common stock during the measurement period is above $15.00 per share, the Company's shareholders will receive a fraction of a share of Stockwalk common stock with a nominal value equal to $7.50, together with $6.00 in cash, for each share of the Company's common stock that they own. If the average closing price of Stockwalk common stock during the measurement period is less than $9.00 per share, the Company's shareholders will receive a fraction of a share of Stockwalk common stock with a nominal value equal to $4.50, together with $6.00 in cash, for each share of the Company's common stock that they own. The merger is subject to regulatory and shareholder approval, and is expected to be completed in the third quarter of 2000. The meeting of the Company's shareholders to approve the merger transaction has been scheduled for September 5, 2000. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. RESULTS OF OPERATIONS The following table sets forth a summary of second quarter increases (decreases) in segment revenue and expenses for 2000 versus 1999:

Quarterly and six-month operating revenues improved compared to last year due to increased retail sales force productivity and increased corporate finance transactions. A portion of the increase was offset by a decline in fixed income origination activity and losses in the investment account. Increased compensation expenses based on year-to-date profitability as well as investment portfolio losses and merger-related expenses contributed to a decrease in net income in the second quarter of 2000 compared to the second quarter of 1999. RETAIL SALES. The Retail Sales business segment consists of various branch locations and the financial services division. Revenue is generated primarily on commissions generated by the sale of financial products and services to individual investors. 11 The $1.3 million or 17.6% increase in retail revenues over the second quarter of 1999 and the $5.6 million or 40.1% increase over the six months ended June 30, 1999 were a result of increased transaction levels and improved investment executive productivity. Revenues from OTC principal and agency equity transactions and options, as well as revenues from corporate finance offerings increased significantly over the same period of the prior year. In addition, managed account fees increased over 50% compared to the first six months of last year as total assets in the managed account program continue to grow. The operating profit of Retail Sales in the six months ended June 30, 2000 was $3.9 million, an increase of $1.4 million or 58.7% over the first six months of 1999. The improvement in profits was commensurate with the increase in revenues. Operating leverage on fixed costs within retail increased as salaries and benefits expenses were flat versus the prior year, while certain fixed costs were reduced as a result of closing unprofitable branch offices. EQUITY CAPITAL MARKETS. Equity Capital Markets consists of equity trading, institutional sales, research and investment banking. Investment banking includes the fees earned on public equity underwritings, private placements and merger and acquisition transactions. The increase in Equity Capital Markets revenue was the result of a $1.6 million or 98% increase in trading revenue from $1.7 million in the first six months of 1999 to $3.3 million in the six months ended June 30, 2000. Investment banking revenues increased substantially as the Company generated $321,000 in revenue from the E-Funds public offering in the second quarter of 2000, and generated additional revenue from several private placement offerings completed during the second quarter of 2000. There were no significant investment banking transactions in the first six months of 1999. The timing and magnitude of investment banking activity can vary significantly from period to period based on market conditions and investor appetite for new equity offerings. Equity Capital Markets group operating income of $1,296,000 in the first six months of 2000 compares to an operating loss of $480,000 in the first six months of 1999. The increase is primarily the result of higher trading and investment banking revenues offset by commission expense and other variable compensation expense. Salaries expense for the group declined significantly from the first six months of 1999 as a more focused strategy for corporate finance and research was implemented in the first six months of 2000. FIXED INCOME. Fixed Income includes the origination, trading and institutional sale of fixed income securities. The Fixed Income group results are driven largely by the activity of the originations department which raises capital for municipal and corporate clients located primarily in the Upper Midwest. Fixed Income revenues decreased by $804,000 or 20.7% from the first six months of 1999. Fixed income origination revenue decreased $448,000 from the first six months of 1999 as a result of a decrease in the number and size of bond originations. Revenues for the institutional sales and trading of other fixed income securities were down reflecting the continued trend of low volume for originations and sales activities which started in the fourth quarter of 1999. Fixed income operating income decreased $413,000 from the first six months of 1999 reflecting the lower revenues for both originations and trading partially offset by lower incentive compensation and occupancy costs. CORPORATE. Corporate consists of the Company's investment portfolio and various administrative functions including Accounting, Human Resources and Marketing, which are required to support revenue generating business units. The operating loss in Corporate increased by $1.0 million or 60.4% as a result of losses on the investment account during the first six months of 2000. The net loss on the investment account of $591,000 in the six month period ended June 30, 2000 compares to a net gain of $872,000 in the first six months of 1999. The Company's investment account has historically been a volatile source of income, and may change significantly from period to period. A portion of the losses versus the comparable period of 1999 were offset by operating cost savings of $700,000 from the first six months of 1999. Incentive compensation and benefits costs based on Company profitability increased for the six months ended June 30, 2000 versus the same period last year commensurate with increases in corporate profitability over the same period. LIQUIDITY AND CAPITAL RESOURCES OPERATING ACTIVITIES A large portion of the Company's assets are cash and assets readily convertible to cash. The liquid portions of the Company's trading and investment securities are stated at quoted market values and are readily marketable. The less liquid 12 OPERATING ACTIVITIES (CONTINUED) portions of trading and investment securities, which totaled $1,144,000 at June 30, 2000, are stated at fair value, which is determined by management consistent with prior pricing practices. Between December 31, 1999 and June 30, 2000 trading securities decreased $3.6 million and securities sold but not yet purchased decreased by $330,000. Both long and short inventories are generally maintained to facilitate customer transactions rather than for market speculation. Based on the Company's current liquidity positions, available bank line and operating plans, it is anticipated that the Company has sufficient resources to meet the cash requirements of its operations in the foreseeable future. INVESTING ACTIVITIES The Company's investment account is invested in fixed income securities, publicly traded equity securities and privately placed equity securities. Equity securities, including warrants and private placement securities, are frequently held as a form of compensation for past investment banking services performed by the Company. The Company may utilize outside advisors to manage a portion of the investment portfolio consistent with the Company's investment policy. The value of certain securities held in the investment account may fluctuate significantly, with the resulting valuation changes being reported as net gains or losses on the investment account. These fluctuations in value may have a material impact on reported earnings. FINANCING ACTIVITIES John G. Kinnard maintains two discretionary credit facilities in order to meet short-term operating needs totaling $10 million. At December 31, 1999 and June 30, 2000 there were no outstanding balances under these facilities. During the first six months of 2000, the Company repurchased no shares of its common stock. For the full year of 1999, a total of 760,000 shares were repurchased at a cost of $3.6 million. Remaining shares authorized by the Board of Directors for repurchase at June 30, 2000 are 1,231,491. CAUTIONARY STATEMENTS The Company wishes to caution investors of the following factors which could affect the Company's results of operations and cause such results to differ materially from those anticipated in forward-looking statements made in this document elsewhere by or on behalf of the Company: volatility in the securities markets, risks in the ownership and underwriting of securities, consolidation in the financial services industry, volatility in earnings and losses of investment securities, competition, government regulation, customer litigation and arbitration, and off-balance-sheet credit and market risks. For a more complete discussion of these and other factors, see the Company's Annual Report on Form 10-K for the year ended December 31, 1999. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary market risk exposure of the Company is the impact that market and interest rate volatility may have on the value of financial securities and underwriting commitments. The Company manages this risk exposure through a process of internal controls, due diligence and management review. Position limits for trading and inventory controls are established and monitored on an ongoing basis. The trading inventory is turned over frequently throughout the year. Securities held in the investment portfolio are guided by an investment policy and are reviewed on a regular basis. Current and proposed underwriting and other banking commitments are subject to due diligence reviews by the appropriate business unit as well as by senior management. The Company has evaluated its financial securities and underwriting commitments at June 30, 2000 and assessed the related market risk. This inventory is turned over frequently throughout the year. Based on this evaluation, in the opinion of management, the market risk associated with the Company's financial securities may have a material effect on the earnings in a particular period, but will not have a material adverse effect on the financial condition of the Company. 13 PART II. OTHER INFORMATION ITEM 1 . LEGAL PROCEEDINGS See Note 2 in Notes to Consolidated Financial Statements contained in Part I above and incorporated herein by reference. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS 11 Statement Regarding Computation of Per Share Earnings 27 Financial Data Schedule (filed in electronic format only) (b) REPORTS ON FORM 8-K The following reports on Form 8-K were filed during the second quarter of 2000: - The Company filed a Current Report on Form 8-K dated June 7, 2000, announcing that it had entered into an Agreement and Plan of Merger, dated June 5, 2000, with Stockwalk.com Group, Inc. 14 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. KINNARD INVESTMENTS, INC. /s/ PAUL H. PERSEKE ---------------------------- Paul H. Perseke Chief Financial Officer and Treasurer (duly authorized officer and principal financial and accounting officer) Dated: August 9, 2000 15 KINNARD INVESTMENTS, INC. (Commission File Number: 0-9377) EXHIBIT INDEX for Form 10-Q for the quarterly period ended June 30, 2000 EXHIBIT ------- 11 Statement Regarding Computation of Per Share Earnings (filed in electronic form only) 27 Financial Data Schedule (filed in electronic form only) 16

KINNARD INVESTMENTS INC 10-Q