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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 1-4346
SALOMON SMITH BARNEY HOLDINGS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 22-1660266
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OR ORGANIZATION)
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388 GREENWICH STREET, NEW YORK, NEW YORK 10013
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(212) 816-6000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
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9 1/2% TRUST PREFERRED STOCK (SM) ("TRUPS (SM)") UNITS OF SUBSIDIARY NEW YORK STOCK EXCHANGE
TRUST (AND REGISTRANT'S GUARANTY WITH RESPECT THERETO)
6.25% EXCHANGEABLE NOTES DUE 2001 NEW YORK STOCK EXCHANGE
6 5/8% NOTES DUE JUNE 1, 2000 NEW YORK STOCK EXCHANGE
SMITH BARNEY S&P 500 EQUITY LINKED NOTES DUE AUGUST 13, 2001 CHICAGO BOARD OPTIONS EXCHANGE AND NEW YORK STOCK EXCHANGE
SMITH BARNEY S&P 500 EQUITY LINKED NOTES DUE MARCH 11, 2002 CHICAGO BOARD OPTIONS EXCHANGE
NIKKEI 225 INDEX SECURITIES DUE AUGUST 20, 2002 NEW YORK STOCK EXCHANGE
SENIOR FLOATING INTEREST NOTES (FINS) DUE 2003 (MEDIUM-TERM NOTES, NEW YORK STOCK EXCHANGE
SERIES D)
RESETTABLE EXCHANGEABLE STANDARD & POOR'S 500 INDEX NOTES (SPINS) AMERICAN STOCK EXCHANGE
DUE 2001
U.S. DOLLAR INCREASE WARRANTS ON THE JAPANESE YEN EXPIRING AMERICAN STOCK EXCHANGE
JUNE 25, 1998
7.200% TRUST PREFERRED SECURITIES ("TRUPS(R)") OF SUBSIDIARY TRUST NEW YORK STOCK EXCHANGE
(AND REGISTRANT'S GUARANTY WITH RESPECT THERETO)
EQUITY LINKED NOTES BASED UPON THE DOW JONES INDUSTRIAL AVERAGE (SM) CHICAGO BOARD OPTIONS EXCHANGE
DUE SEPTEMBER 6, 2005
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
REDUCED DISCLOSURE FORMAT
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I (1)(a)
AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE REDUCED
DISCLOSURE FORMAT.
[COVER PAGE 1 OF 2 PAGES.]
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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 X NO
--- ---
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. /X/
BECAUSE THE REGISTRANT IS A WHOLLY OWNED SUBSIDIARY OF TRAVELERS GROUP INC.,
NONE OF THE REGISTRANT'S OUTSTANDING VOTING STOCK IS HELD BY NONAFFILIATES OF
THE REGISTRANT. AS OF THE DATE HEREOF, 1,000 SHARES OF THE REGISTRANT'S COMMON
STOCK, $.01 PAR VALUE, WERE ISSUED AND OUTSTANDING.
DOCUMENTS INCORPORATED BY REFERENCE: NONE
[COVER PAGE 2 OF 2 PAGES.]
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SALOMON SMITH BARNEY HOLDINGS INC.
ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 1997
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TABLE OF CONTENTS
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FORM 10-K
ITEM NUMBER PAGE
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PART I
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1. Business........................................................... 1
2. Properties......................................................... 13
3. Legal Proceedings.................................................. 13
4. Omitted Pursuant to General Instruction I
PART II
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5. Market for Registrant's Common Equity and
Related Stockholder Matters.................................. 17
6. Omitted Pursuant to General Instruction I
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 18
7A. Quantitative and Qualitative Disclosures About Market Risk......... 37
8. Financial Statements and Supplementary Data........................ 37
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................... 37
PART III
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10-13 Omitted Pursuant to General Instruction I
PART IV
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14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K.................................................. 38
Exhibit Index...................................................... 40
Signatures......................................................... 42
Index to Consolidated Financial Statements and Schedules........... F-1
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PART I
ITEM 1. BUSINESS.
THE COMPANY
Salomon Smith Barney Holdings Inc. ("SSBH"; formerly known as Salomon Inc)
provides investment banking, securities and commodities trading, brokerage,
asset management and other financial services through its subsidiaries. As used
in this Form 10-K, unless the context otherwise requires, "Salomon Smith Barney"
and the "Company" refer to SSBH and its consolidated subsidiaries. Investment
banking and securities trading activities are principally conducted by Salomon
Brothers Holding Company Inc ("SBHC") and Smith Barney Inc. ("Smith Barney") and
their subsidiaries and affiliated companies. Salomon Smith Barney provides
capital raising, advisory, research and brokerage services to its customers, and
executes proprietary trading strategies on its own behalf. Asset management
services are provided principally through Mutual Management Corp. (formerly
Smith Barney Mutual Funds Management Inc.) ("MMC"), Smith Barney and Salomon
Brothers Asset Management Inc. ("Salomon Brothers Asset Management"). The
Company's commodities trading business is conducted principally by Phibro Inc.
and its subsidiaries (collectively, "Phibro").
On November 28, 1997, a newly formed wholly owned subsidiary of Travelers Group
Inc. was merged into Salomon Inc ("Salomon"). Pursuant to the merger agreement,
stockholders of Salomon received shares of stock of Travelers Group Inc.
("Travelers Group") and Salomon became a wholly owned subsidiary of Travelers
Group. Also on November 28, Salomon and Smith Barney Holdings Inc. were merged
(the "Merger"), with SSBH continuing as the surviving corporation of the Merger.
The Consolidated Financial Statements of the Company included in this report
give retroactive effect to the Merger as a combination of entities under common
control in a transaction accounted for in a manner similar to a pooling of
interests. The pooling of interests method of accounting requires the
restatement of all periods presented as if Salomon and Smith Barney Holdings
Inc. had always been combined. See Note 1 of Notes to Consolidated Financial
Statements.
In May 1997, SSBH sold all of the outstanding stock of Basis Petroleum, Inc.
("Basis") to Valero Energy Corporation ("Valero"). Basis owned and operated
three oil refineries in the U.S. Gulf Coast region. Basis is presented as a
discontinued operation in the Company's Consolidated Financial Statements. See
Note 4 of Notes to Consolidated Financial Statements for additional information
about the sale of Basis.
Travelers Group, the Company's parent, is a diversified financial services
holding company engaged, through its subsidiaries, principally in four business
segments: (i) Investment Services (primarily through the Company), including
Asset Management; (ii) Consumer Finance Services; (iii) Property & Casualty
Insurance Services; and (iv) Life Insurance Services. The periodic reports of
Travelers Group provide additional business and financial information concerning
that company and its consolidated subsidiaries.
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The principal offices of the Company are located at 388 Greenwich Street, New
York, New York 10013, telephone number (212) 816-6000. The Company was
incorporated in Delaware in 1960.(1)
SALOMON SMITH BARNEY
Salomon Smith Barney is a global investment bank and broker-dealer that operates
through over 450 offices throughout the United States and 45 offices in 26
foreign countries. Its principal U.S. operating companies for the investment
banking, brokerage and trading operations are Smith Barney and Salomon Brothers
Inc ("SBI") in New York, as well as SBHC and Salomon Swapco Inc ("Swapco") in
New York, which act as counterparties for many of the derivative transactions to
which Salomon Smith Barney is a party, and The Robinson-Humphrey Company, LLC
("R-H"), a regional broker-dealer based in Atlanta. Salomon Forex Inc acts as
counterparty in many foreign exchange transactions. With approximately 10,300
Financial Consultants and approximately 875 institutional brokers, the Company
believes that it is currently the second largest brokerage firm in the United
States.
Salomon Smith Barney also maintains branches, subsidiaries, representative
offices or other operations in Australia, Bahrain, Canada, the Cayman Islands,
China, France, Germany, Hong Kong, India, Ireland, Israel, Italy, Japan,
Republic of Korea, Mexico, the Netherlands, Russia, Singapore, Spain,
Switzerland, Taiwan, Thailand and the United Kingdom, and affiliates in
Argentina, Brazil, Indonesia and Republic of Korea. The principal operating
companies for these international operations are Salomon Brothers International
Limited ("SBIL"), Salomon Brothers Asia Limited ("SBAL"), Salomon Brothers Hong
Kong Limited ("SBHK") and Salomon Brothers AG ("SBAG"). SBIL is based in London
and primarily acts as a dealer and market maker in fixed income and equity
securities and related products, including derivative instruments, in the
international capital markets, as well as an underwriter and provider of
corporate finance services. SBAL, based in Tokyo, and SBHK, based in Hong Kong,
act as agent and for their own account in trading of fixed income and equity
securities, primarily in securities of issuers based in Japan and the Asia
Pacific region, respectively. SBAG, a German bank based in Frankfurt with
branches in Tokyo and Milan, acts as a broker and dealer in primarily domestic
German fixed income and equity securities and related products, including
derivative instruments, as well as an underwriter and provider of corporate
finance advisory services to international clients.
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(1) Certain items in this Form 10-K, including certain matters discussed under
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations" (the "MD&A"), are forward-looking statements. The matters
referred to in such statements could be affected by the risks and uncertainties
involved in the Company's business, including the effect of economic and market
conditions, the level and volatility of interest rates and currency values, the
impact of current or pending legislation and regulation and the other risks and
uncertainties detailed in "Outlook" in the MD&A.
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INVESTMENT BANKING AND TRADING
Salomon Smith Barney's global investment banking services encompass a full range
of capital market activities, including the underwriting and distribution of
debt and equity securities for United States and foreign corporations and for
state, local and other governmental and government sponsored authorities. The
Company frequently acts as an underwriter or private placement agent in
corporate and public securities offerings and provides alternative financing
options through bank and bridge loans. It also provides financial advice to
investment banking clients on a wide variety of transactions including mergers
and acquisitions, divestitures, leveraged buyouts, financial restructurings and
a variety of cross-border transactions.
Salomon Smith Barney executes securities and commodity futures brokerage
transactions on all major United States securities and futures exchanges and
major international exchanges on behalf of customers and for its own account.
The Company's significant capital base and extensive distribution capabilities
also enable it to provide liquidity to investors across a broad range of markets
and financial instruments, and to execute capital-intensive transactions on
behalf of its customers and for its own account. It executes transactions in
large blocks of exchange-listed stocks, usually with institutional investors,
and often acts as principal to facilitate these transactions. It makes markets,
buying and selling as principal, in over 1,550 equity securities traded on the
NASDAQ system. Additionally, the firm makes markets in convertible and preferred
stocks, warrants and other equity securities.
Salomon Smith Barney also engages in principal transactions in fixed income
securities. Through its subsidiaries, it is a major dealer in government
securities in New York, London, Frankfurt and Tokyo. Salomon Smith Barney makes
inter-dealer markets and trades as principal in corporate debt and equity
securities, including those of United States and foreign corporate issuers,
United States and foreign government and agency securities, mortgage-related
securities, whole loans, municipal and other tax-exempt securities, commercial
paper and other money market instruments as well as emerging market debt
securities and foreign exchange. It also enters into repurchase and reverse
repurchase agreements to provide financing for itself and its customers, and
engages in securities lending and borrowing transactions.
Salomon Smith Barney is a major participant in the over-the-counter ("OTC")
market for derivative instruments involving a wide range of products, including
interest rate, equity and currency swaps, caps and floors, options, warrants and
other derivative products. It also creates and sells various types of structured
securities. The Company's ability to execute transactions is enhanced by its
established presence in international capital markets, its use of information
technology and quantitative risk management tools, its research capabilities,
and its knowledge and experience in various derivative markets.
Salomon Smith Barney also trades for its own account in various markets
throughout the world, and uses many different strategies involving a broad
spectrum of
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financial instruments and derivative products. Historically, these trading
strategies have primarily involved the fixed income securities of the G-7
countries, but they also involve the trading of fixed income securities globally
(including emerging markets) as well as currencies and equities. Because these
trading strategies are often designed with time horizons of one year or more,
profits or losses reported in interim periods can be volatile and may not
reflect the ultimate success or failure of these strategies. For a discussion of
certain of the risks involved in Salomon Smith Barney's securities trading and
investment activities, and the firm's strategies to manage these risks, see Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
RETAIL BROKERAGE AND RELATED SERVICES
The Private Client Division provides investment advice and financial planning
and brokerage services for over five million client accounts, primarily
through the network of Salomon Smith Barney Financial Consultants.
A significant portion of Salomon Smith Barney's revenues is generated from the
commissions that it earns as a broker for its clients in the purchase and sale
of securities. Financing customers' securities transactions provides Salomon
Smith Barney with an additional source of income. While credit losses may arise
as a result of this financing activity, to date such losses have not been
material. The Financial Consultants also sell proprietary mutual funds and a
large number of mutual funds sponsored and managed by unaffiliated entities,
and Salomon Smith Barney receives commissions and other sales and services
revenues from these activities.
Qualified Salomon Smith Barney Financial Consultants also offer individual
insurance products, primarily variable annuities. These products include, among
others, Travelers Life and Annuity's Vintage Life(R) and Vintage Annuity(R),
single premium variable annuity and universal life products, 401(k) Blueprint(R)
and Travelers Target Maturity(R), a market value-adjusted fixed annuity.
The Company's Corporate Client Group provides retirement plan services and stock
plan services to a wide variety of corporations. These services involve the
management of defined benefit and defined contribution plan products such as
401(k) plans, as well as the administration of stock option and other
stock-based benefit plans.
In addition to more traditional brokerage services, Salomon Smith Barney
Financial Consultants also deliver the programs and services offered by Salomon
Smith Barney's Consulting Group ("CG"). CG, which has become an area of
specialization for many Salomon Smith Barney Financial Consultants, provides a
variety of investment management and consulting services to institutional and
individual clients. CG sponsors a number of different "wrap fee" programs, in
which CG and Salomon Smith Barney typically provide a range of services, such as
an analysis of the client's financial situation, investment needs and risk
tolerance; a recommendation and ongoing monitoring of the performance and
suitability of the investment manager(s) retained; and securities execution,
custody, reporting and recordkeeping. In such programs, the client generally
pays a single bundled fee for these
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services. CG also offers "wrap fee" programs in which separate accounts are
managed by selected, specially trained Salomon Smith Barney Financial
Consultants. Assets in the Financial Consultant managed programs at December 31,
1997, totaled $11.6 billion, as compared to $7.9 billion and $5.6 billion at
year-end 1996 and 1995, respectively. In addition, CG provides traditional
investment management consulting services to institutions, including assisting
clients in formulating investment objectives and policies and in selecting
investment management firms for the day-to-day management of client portfolios.
As of December 31, 1997, the Company provided consulting services with respect
to externally managed client assets aggregating approximately $49.2 billion,
excluding the TRAK(R) program described below, as compared to approximately
$37.5 billion at December 31, 1996 and approximately $30.5 billion at December
31, 1995.
Salomon Smith Barney's TRAK(R) program provides clients with non-discretionary
asset allocation advice based on the client's identification of investment
objectives and risk tolerances. TRAK(R) clients include both individuals and
institutions, including participant-directed 401(k) plans. Clients can choose to
allocate assets among the CG Capital Markets funds, a series of 13 mutual funds
each corresponding to a particular asset class and investment style, or from
among the selected fund offerings of 37 no-load or load-waived mutual fund
families (including Smith Barney proprietary funds) corresponding to the same
asset class and investment style criteria. At December 31, 1997, TRAK(R) assets
exceeded $10.5 billion, as compared to approximately $6.6 billion at December
31, 1996 and approximately $4.8 billion at December 31, 1995. Salomon Smith
Barney also offers a separate offshore TRAK(R) program to non-resident alien
clients, which includes client investment in a series of asset class/investment
style funds domiciled outside the United States.
SALOMON SMITH BARNEY ASSET MANAGEMENT
The Company provides discretionary and non-discretionary asset management
services to a wide array of mutual funds and institutional and individual
investors, with respect to domestic and foreign equity and debt securities,
municipal bonds, money market instruments, and related options and futures
contracts. The Company receives ongoing fees, generally stated as a percentage
of the client's assets, from asset management clients. At December 31, 1997,
client assets managed by Salomon Smith Barney Asset Management were
approximately $152.5 billion, as compared to approximately $126.5 billion at
December 31, 1996 and approximately $107.1 billion at December 31, 1995. These
amounts include managed accounts with assets of approximately $54.1 billion at
December 31, 1997, $44.5 billion at December 31, 1996 and $35.2 billion at
December 31, 1995.
The table on the next page shows the aggregate assets in, and number of, mutual
funds managed by Salomon Smith Barney Asset Management at December 31 for each
of the last three years.
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MUTUAL FUND ASSETS UNDER MANAGEMENT
DECEMBER 31,
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1997 1996 1995
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(Dollars in billions)
NO. OF NO. OF NO. OF
FUNDS ASSETS FUNDS ASSETS FUNDS ASSETS
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Money market 15 $46.5 13 $41.6 13 $35.8
Mutual funds 124 48.7 120 38.1 121 34.3
Annuities 26 3.2 25 2.3 26 1.8
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Total 165 $98.4 158 $82.0 160 $71.9
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Smith Barney Asset Management
At December 31, 1997, Smith Barney sponsored 68 mutual funds (open-end
investment companies), including taxable and tax-exempt money market funds,
equity funds, taxable fixed income funds and tax-exempt fixed income funds
distributed primarily through Salomon Smith Barney Financial Consultants and the
PFS sales force, affiliates of the Company. MMC serves as the primary investment
manager to these mutual funds, as well as to eleven closed-end investment
companies, the shares of which are listed for trading on one or more securities
exchanges. In addition, at December 31, 1997, Salomon Smith Barney managed 26
mutual fund portfolios serving as funding vehicles for variable annuity
contracts, including certain variable annuities and other individual products of
the Travelers Life and Annuity unit of Travelers Group, which are sold by
Salomon Smith Barney Financial Consultants. Smith Barney Asset Management also
sponsors and manages ten mutual funds domiciled outside the United States, which
are offered to Salomon Smith Barney's non-resident alien client base as well as
to the general public.
In December 1997, the Company acquired the mutual fund advisory contracts for
the Common Sense(R) Trust from Van Kampen American Capital. This series of
mutual funds is marketed exclusively by the PFS sales force, and had $5.9
billion in assets at December 31, 1997. In January 1998 the name of these funds
was changed to Concert Investment Series(SM).
Smith Barney Asset Management also provides separate account discretionary and
non-discretionary investment management services to a wide variety of individual
and institutional clients, including private and public retirement plans,
endowments, foundations, banks, central banks, insurance companies, other
corporations and governmental agencies. Client relationships may be introduced
either through Salomon Smith Barney's network of Financial Consultants or
independently of that network.
Smith Barney Asset Management also sponsors and oversees the portfolios of a
large number of unit investment trusts, which are unmanaged investment
companies, the portfolios of which are generally static. Such unit investment
trusts may hold domestic and foreign equity and debt securities, including
municipal bonds. Certain trusts are sponsored and
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overseen solely by Smith Barney Asset Management; other trusts are jointly
sponsored through a syndicate of major broker-dealers of which Smith Barney is a
member. At December 31, 1997, outstanding unit trust assets held by Smith
Barney's clients were approximately $11.8 billion, as compared to approximately
$8.6 billion at December 31, 1996 and approximately $7.2 billion at December 31,
1995.
Salomon Brothers Asset Management
Salomon Brothers Asset Management provides separate account discretionary and
non-discretionary investment management services to pension funds, investment
companies, endowments, foundations, banks, central banks, insurance companies,
other corporations, governmental agencies and individuals. Client relationships
may be introduced through traditional independent consultant evaluations as well
as through the individual and institutional client relationships of SBI.
At December 31, 1997, Salomon Brothers Asset Management sponsored 18 mutual
funds and investment companies, including taxable and tax-exempt money market
funds, equity funds, taxable fixed income funds and tax-exempt fixed income
funds distributed primarily through dealer agreements with a variety of national
and regional brokerage firms, including Smith Barney. Salomon Brothers Asset
Management serves as investment manager to these mutual funds, as well as to 16
closed-end investment companies, the shares of which are listed for trading on
one or more securities exchanges. Salomon Brothers Asset Management also manages
16 mutual funds domiciled outside the United States, which are offered to
Salomon Smith Barney's non-resident alien client base as well as to the general
public.
TRUST SERVICES
Certain subsidiaries of Travelers Group are chartered as trust companies and
provide a full range of fiduciary services with a particular emphasis on
personal trust services. Another Travelers Group subsidiary offers a broad range
of trustee services for qualified retirement plans, with particular emphasis on
the 401(k) plan market. Each of these trust companies is subject to the
supervision of the state banking authority where it was chartered and uses the
distribution network of Salomon Smith Barney to market its services. Salomon
Smith Barney provides certain advisory and support services to the trust
companies and receives fees for such services. Certain subsidiaries of SSBH also
operate a private trust services business that is licensed as a bank and trust
company in the Cayman Islands.
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PHIBRO AND OTHER
Phibro conducts a global commodities dealer business through its principal
offices in Westport (Connecticut), London and Singapore. Commodities traded
include crude oil, refined oil products, natural gas, electricity, metals and
various soft commodities. In December 1997, Phibro began implementing a
downsizing plan that will significantly reduce the scope of some of its
activities. In 1996, Phibro discontinued trading coal, coke and fertilizers.
Phibro makes extensive use of futures markets and is a participant in the OTC
derivatives market. Its principal competitors are major integrated oil
companies, other commodity trading companies, certain investment banks and other
financial institutions.
As a dealer, Phibro's strategy is to focus on taking positions in commodities on
a longer-term horizon while also engaging in counterparty flow business on a
short-term basis. Phibro's operating results are subject to a high degree of
volatility, particularly on a quarterly basis, due to the predominance of
directional positions in commodities that have a longer-term horizon until
realization. Thus, results are better evaluated over the longer term.
For a summary of the Company's operations by geographic area, see Note 5 of
Notes to Consolidated Financial Statements.
DERIVATIVES AND RISK MANAGEMENT
Derivative instruments are contractual commitments or payment exchange
agreements between counterparties that "derive" their value from some underlying
asset, index, interest rate or exchange rate. The Company enters into various
bilateral financial contracts involving future settlement, which are based upon
a predetermined principal or par value (referred to as the "notional" amount).
Such instruments include swaps, swap options, caps and floors, futures
contracts, forward purchase and sale agreements, option contracts and warrants.
Derivatives activities, like Salomon Smith Barney's other ongoing business
activities, give rise to market, credit and operational risks, although the
Company also uses derivative instruments to manage these risks in its other
businesses. For a more complete discussion of Salomon Smith Barney's use of
derivative financial instruments and certain of the related risks, see Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Notes 2, 3, 7, 15 and 16 of Notes to Consolidated Financial
Statements.
COMPETITION
The businesses in which Salomon Smith Barney is engaged are highly competitive.
The principal factors affecting competition in the investment banking and
brokerage industry are the quality and ability of professional personnel and the
relative prices of services and products offered. In addition to competition
from other investment banking firms, both domestic and international, and
securities brokerage companies and discount securities brokerage operations,
including regional firms in the United States, there has been increasing
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competition from other sources, such as commercial banks, insurance companies
and other major companies that have entered the investment banking and
securities brokerage industry, in many cases through acquisitions. Certain of
those competitors may have greater capital and other resources than the Company.
The Federal Reserve Board has substantially removed the barrier originally
erected by the Glass-Steagall Act restricting investment banking activities of
commercial banks and their affiliates, by permitting certain commercial banks to
engage, through affiliates, in the underwriting of and dealing in certain types
of securities, subject to certain limitations. Proposed legislation has been
introduced in Congress from time to time that would modify certain other
provisions of the Glass-Steagall Act and other laws and regulations affecting
the financial services industry. The potential impact of such legislation on the
Company's businesses cannot be predicted at this time.
Competitors of the Salomon Brothers and Smith Barney mutual funds and asset
management groups include a large number of mutual fund management and sales
companies, asset management firms and banks. Competition in mutual fund sales
and investment management is based on investment performance, service to clients
and product design.
REGULATION
Certain U.S. and non-U.S. subsidiaries are subject to various securities and
commodities regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the jurisdictions in which they operate.
SSBH's principal regulated subsidiaries are discussed below.
Certain of SSBH's subsidiaries are registered as broker-dealers and as
investment advisers with the U.S. Securities and Exchange Commission (the "SEC")
and as futures commission merchants and as commodity pool operators with the
Commodity Futures Trading Commission ("CFTC"). SBI, Smith Barney and R-H are
members of the New York Stock Exchange, Inc. (the "NYSE") and other principal
United States securities exchanges, as well as the National Association of
Securities Dealers, Inc. ("NASD") and the National Futures Association ("NFA"),
a not-for-profit membership corporation designated as a registered futures
association by the CFTC. SBI, Smith Barney and R-H are registered as
broker-dealers in all 50 states, the District of Columbia and Puerto Rico, and
in addition are registered as investment advisers in certain states that require
such registration. Smith Barney is also a registered broker-dealer in Guam.
Smith Barney and SBI are also reporting dealers to the Federal Reserve Bank of
New York and members of the principal United States futures exchanges. SBI,
Smith Barney and R-H are subject to extensive regulation, primarily for the
benefit of their customers, including minimum capital requirements, which are
promulgated and enforced by, among others, the SEC, the CFTC, the NFA, the NYSE,
various self-regulatory organizations of which these subsidiaries are members
and the securities administrators of the 50 states, the District of Columbia and
Puerto Rico and, in Smith Barney's case, Guam. The SEC and the CFTC also require
certain registered broker-dealers (including SBI and Smith Barney) to maintain
records concerning certain financial and
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securities activities of affiliated companies that may be material to the
broker-dealer, and to file certain financial and other information regarding
such affiliated companies.
Salomon Smith Barney's operations abroad are conducted through various
subsidiaries, principally SBIL in London, SBAL in Tokyo and SBAG in Frankfurt.
Its activities in the United Kingdom, which include investment banking, trading,
brokerage and asset management services, are subject to the Financial Services
Act 1986, which regulates organizations that conduct investment businesses in
the United Kingdom (including imposing capital and liquidity requirements), and
to the rules of the Securities and Futures Authority and the Investment
Management Regulatory Organisation. SBAL is a licensed foreign securities
company in Japan and, as such, its activities in Japan are subject to Japanese
law applicable to non-Japanese securities firms and are regulated by the
Japanese Ministry of Finance. SBAG is a German bank, principally engaged in
securities trading and investment banking and is regulated by Germany's Banking
Supervisory Authority. These and other subsidiaries of SSBH are also members of
various securities and commodities exchanges and are subject to the rules and
regulations of those exchanges. Salomon Smith Barney's other offices are also
subject to the jurisdiction of local financial services regulatory authorities.
In connection with the mutual funds business, SSBH and its subsidiaries must
comply with regulations of a number of regulatory agencies and organizations,
including the SEC, the NASD and regulatory agencies in the United Kingdom and
Germany. SSBH is the direct or indirect parent of investment advisers registered
and regulated under the Investment Advisers Act of 1940, and of companies that
distribute shares of mutual funds pursuant to distribution agreements subject to
regulation under the Investment Company Act of 1940. Under those Acts, the
advisory contracts between SSBH's investment adviser subsidiaries and the mutual
funds they serve ("Affiliated Funds"), as well as the mutual fund distribution
agreements, would automatically terminate upon an assignment of such contracts
by the investment adviser or the fund distribution company, as the case may be.
Such an assignment would be presumed to have occurred if any party were to
acquire more than 25% of Travelers Group's voting securities. In that event,
consent to the assignment from the shareholders of the Affiliated Funds involved
would be needed for the advisory and distribution relationships to continue. In
addition, Smith Barney, SBI, MMC, Salomon Brothers Asset Management and the
Affiliated Funds are subject to certain restrictions in their dealings with each
other. For example, Smith Barney or SBI may act as broker to an Affiliated Fund
in a transaction involving an exchange-traded security only when that fund
maintains procedures that govern, among other things, the execution price of the
transaction and the commissions paid; it may not, however, conduct principal
transactions with an Affiliated Fund. Further, an Affiliated Fund may acquire
securities during the existence of an underwriting where Smith Barney or SBI is
a principal underwriter only in certain limited situations.
SBI, Smith Barney and R-H are members of the Securities Investor Protection
Corporation ("SIPC"), which, in the event of liquidation of a broker-dealer,
provides protection for customers' securities accounts held by the firm of up to
$500,000 for each eligible customer, subject to a limitation of $100,000 for
claims for cash balances. In
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<PAGE> 14
addition, SSBH has purchased additional coverage of up to $150 million for
eligible customers, approximately $50 million of which is from a subsidiary of
Travelers Group.
President Clinton's recent budget proposal (the "Budget Proposal") contains a
number of tax provisions that could adversely impact Salomon Smith Barney,
including provisions relating to tax-exempt interest obligations and variable
annuities. The Budget Proposal, which is in its early stages of consideration,
has not yet been introduced as part of any legislation in Congress but has
engendered considerable opposition from the public and members of Congress.
CAPITAL REQUIREMENTS
As registered broker-dealers, SBI, Smith Barney and R-H are subject to the SEC's
net capital rule, Rule 15c3-1 (the "Net Capital Rule"), promulgated under the
Exchange Act. These companies compute net capital under the alternative method
of the Net Capital Rule, which requires the maintenance of minimum net capital,
as defined. A member of the NYSE may be required to reduce its business if its
net capital is less than 4% of aggregate debit balances (as defined) and may
also be prohibited from expanding its business or paying cash dividends if
resulting net capital would be less than 5% of aggregate debit balances.
Furthermore, the Net Capital Rule does not permit withdrawal of equity or
subordinated capital if the resulting net capital would be less than 5% of such
debit balances.
The Net Capital Rule also limits the ability of broker-dealers to transfer large
amounts of capital to parent companies and other affiliates. Under the Net
Capital Rule, equity capital cannot be withdrawn from a broker-dealer without
the prior approval of the SEC in certain circumstances, including when net
capital after the withdrawal would be less than (i) 120% of the minimum net
capital required by the Net Capital Rule, or (ii) 25% of the broker-dealer's
securities position "haircuts," i.e., deductions from capital of certain
specified percentages of the market value of securities to reflect the
possibility of a market decline prior to disposition. In addition, the Net
Capital Rule requires broker-dealers to notify the SEC and the appropriate
self-regulatory organization two business days before a withdrawal of excess net
capital if the withdrawal would exceed the greater of $500,000 or 30% of the
broker-dealer's excess net capital, and two business days after a withdrawal
that exceeds the greater of $500,000 or 20% of excess net capital. Finally, the
Net Capital Rule authorizes the SEC to order a freeze on the transfer of capital
if a broker-dealer plans a withdrawal of more than 30% of its excess net capital
and the SEC believes that such a withdrawal would be detrimental to the
financial integrity of the firm or would jeopardize the broker-dealer's ability
to pay its customers.
Compliance with the Net Capital Rule could limit those operations of the Company
that require the intensive use of capital, such as underwriting and trading
activities and the financing of customer account balances, and also could
restrict SSBH's ability to withdraw capital from its broker-dealer subsidiaries,
which in turn could limit SSBH's ability to pay dividends and make payments on
its debt. See Note 10 of Notes to Consolidated Financial
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<PAGE> 15
Statements. At December 31, 1997, SBI and Smith Barney had net capital, computed
in accordance with the Net Capital Rule, of $1.047 billion and $1.086 billion,
respectively, which exceeded the minimum net capital requirement by $974 million
and $884 million, respectively. The net capital of R-H was $66 million above its
minimum requirement.
SBAL, SBIL and SBAG are also subject to regulation in the countries in which
they do business. Such regulations include requirements to maintain specified
levels of net capital or its equivalent. At December 31, 1997, SBAL's regulatory
capital was $307 million above the minimum required by Japan's Ministry of
Finance. SBIL's regulatory capital was $699 million above the minimum required
by the Securities and Futures Authority, and SBAG's regulatory capital was $32
million above the minimum required by Germany's Banking Supervisory Authority.
In addition, in order to maintain its triple-A rating, Swapco, an indirect
wholly owned subsidiary of SSBH, must maintain minimum levels of capital in
accordance with agreements with its rating agencies. At December 31, 1997,
Swapco was in compliance with all such agreements. Swapco's capital requirements
are dynamic, varying with the size and concentration of its counterparty
receivables.
OTHER INFORMATION
GENERAL BUSINESS FACTORS
In the judgment of the Company, no material part of the business of the Company
and its subsidiaries is dependent upon a single customer or group of customers,
the loss of any one of which would have a materially adverse effect on the
Company, and no one customer or group of affiliated customers accounts for as
much as 10% of the Company's consolidated revenues.
At December 31, 1997, the Company had approximately 34,400 full-time and 1,850
part-time employees.
SOURCE OF FUNDS
For a discussion of the Company's sources of funds and maturities of the
long-term debt of the Company and its subsidiaries, see Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources," and Notes 6 and 7 of Notes to Consolidated
Financial Statements.
TAXATION
For a discussion of tax matters affecting the Company and its operations, see
Note 12 of Notes to Consolidated Financial Statements.
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<PAGE> 16
ITEM 2. PROPERTIES.
The Company's principal executive offices are located in New York City. In
addition, the Company owns two office buildings in New York City, which total
approximately 627,000 square feet. The Company also owns an office building in
Rutherford, New Jersey, totaling approximately 249,000 square feet and an office
building in Tampa, Florida, totaling approximately 135,000 square feet. In
addition, the Company owns an office building in London, England, that contains
approximately 212,760 net square feet. The building is subject to a mortgage
that becomes due in 2007, but which may be prepaid without premium at any time
with notice. Most of the Company's other offices are located in leased
premises, the leases for which expire at various times.
The Company leases two buildings located at 388 and 390 Greenwich Street, New
York and totaling approximately 2,300,000 square feet, through 1999. The Company
expects to extend the lease term to 2003. The Company has a purchase option with
respect to these properties. The Company also leases approximately 1,018,000
square feet of office space at Seven World Trade Center in New York City,
through 2010.
The Company believes that these facilities are adequate for the purposes for
which they are used and are well maintained. For further information concerning
leases, see Note 8 of Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
This section describes the major pending legal proceedings, other than ordinary
routine litigation incidental to the business, to which the Company or its
subsidiaries is a party or to which any of their property is subject. As a
result of the Merger, certain other pending matters previously reported by the
Company or Smith Barney Holdings Inc. are no longer required to be disclosed
herein.
In September 1992, Harris Trust and Savings Bank (as trustee for Ameritech
Pension Trust ("APT")), Ameritech Corporation, and an officer of Ameritech filed
suit against SBI and Salomon Brothers Realty Corporation ("SBRC") in the U.S.
District Court for the Northern District of Illinois (Harris Trust Savings Bank,
not individually but solely as trustee for the Ameritech Pension Trust,
Ameritech Corporation and John A. Edwardson v. Salomon Brothers Inc and Salomon
Brothers Realty Corp.). The second amended complaint alleges that three
purchases by APT from defendants of participation interests in net cash flow or
resale proceeds of three portfolios of motels owned by Motels of America, Inc.
("MOA"), as well as a fourth purchase by APT of a similar participation interest
with respect to a portfolio of motels owned by Best Inns, Inc. ("Best"),
violated the Employee Retirement Income Security Act ("ERISA"), and that the
purchase of the participation interests for the third MOA portfolio and for the
Best portfolio violated the Racketeer Influenced and Corrupt Organization Act
("RICO") and state law. SBI had acquired the participation interests in
transactions in which it purchased as principal mortgage notes issued by MOA and
Best to finance purchases of motel portfolios; 95% of three such interests and
100% of one such interest were sold to APT for purchase prices aggregating
approximately $20.9 million. Plaintiffs' second amended complaint seeks (i) a
judgment on the ERISA claims for the purchase prices of the four
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<PAGE> 17
participation interests (approximately $20.9 million), for rescission and for
disgorgement of profits, as well as other relief, and (ii) a judgment on the
claims brought under RICO and state law in the amount of $12.3 million, with
damages trebled to $37 million on the RICO claims and punitive damages in excess
of $37 million on certain of the state law claims as well as other relief. SBI
and SBRC answered the second amended complaint in part, moved to dismiss in part
and asserted counterclaims against plaintiff Ameritech Corp. In August 1993 the
Court (i) dismissed the RICO claims as well as plaintiffs' claims for breach of
contract and unjust enrichment; (ii) denied SBI's motion to dismiss one of the
ERISA claims (which alleges that SBI participated in a fiduciary's breach); and
(iii) denied Ameritech's motion to dismiss SBI's counterclaims.
In June 1996, the Court (i) granted in part defendants' motion for summary
judgment on the ERISA claims, dismissing Counts I and III of the second amended
complaint and any claims contained in Count II that are premised on an alleged
breach of fiduciary duty; (ii) otherwise denied defendants' motion for summary
judgment as it related to the remaining portions of the claims in Count II;
(iii) denied plaintiffs' motion for partial summary judgment with respect to
Count II; and (iv) granted plaintiffs' motion for summary judgment dismissing
defendants' counterclaims against Ameritech for contribution. In September 1997,
the Court granted defendants' alternative motion for summary judgment on
plaintiffs' remaining state law claims, dismissing Counts VIII-X of the second
amended complaint. In January 1998, the Court certified for interlocutory appeal
on that portion of its June 1996 order denying defendants' motion for summary
judgment on Count III. Also in January 1998, defendants filed, in the U.S. Court
of Appeals for the Seventh Circuit, a petition for permission to appeal, and
that petition remains pending.
Both the Department of Labor and the Internal Revenue Service have advised SBI
that they were or are reviewing the transactions in which APT acquired such
participation interests. With respect to the Internal Revenue Service review,
SSBH, SBI and SBRC have consented to extensions of time for the assessment of
excise taxes that may be claimed to be due with respect to the transactions for
the years 1987, 1988 and 1989. In August 1996, the IRS sent SSBH, SBI and SBRC
what appeared to be draft "30-day letters" with respect to the transactions and
SSBH, SBI and SBRC were given an opportunity to comment on whether the IRS
should issue 30-day letters, which would actually commence the assessment
process. In October 1996, SSBH, SBI and SBRC submitted a memorandum setting
forth reasons why the IRS should not issue 30-day letters with respect to the
transactions.
In the fall of 1994, various federal and state lawsuits brought as purported
class actions against SBI, Smith Barney, R-H, and 34 other broker-dealers were
consolidated for pre-trial purposes as In re Nasdaq Market-Makers Antitrust
Litigation in the U.S. District Court for the Southern District of New York. In
the consolidated action, plaintiffs allege that broker-dealers making markets in
securities traded on NASDAQ violated antitrust laws by conspiring to maintain a
minimum spread between the bid and asked price for certain securities, and seek
unspecified monetary damages, subject to trebling under the antitrust laws,
injunctive relief, attorneys' fees and court costs. In late 1996, the Court
certified a class. In
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December 1997, SBI, Smith Barney, R-H, and all but one of the other 34
broker-dealer defendants executed a settlement agreement with the plaintiffs
that has been preliminarily approved by the Court subject to final approval
following a hearing scheduled for September 1998. If approved, the settlement
will not have a material effect on the Company's results of operations,
financial condition or liquidity.
In July 1996, the Antitrust Division of the Department of Justice filed a
complaint containing similar allegations to the above-described action against
24 market makers in certain NASDAQ stocks. When the complaint was filed, and
with no admission of liability, SBI, Smith Barney and the other defendants
entered into a settlement pursuant to which the defendants agreed not to engage
in certain practices relating to the quoting and trading of NASDAQ securities
and to implement additional compliance procedures. There are no fines, penalties
or other payments of money in connection with this settlement, which the Court
approved in April 1997. In May 1997, plaintiffs in the above-described related
civil action (who were permitted to intervene for limited purposes) appealed the
Court's approval of the settlement. The appeal was argued before the U.S. Court
of Appeals, Second Circuit in March 1998.
In December 1996, a complaint seeking unspecified monetary damages was filed by
Orange County, California against numerous brokerage firms, including Smith
Barney, in the U.S. Bankruptcy Court for the Central District of California.
Plaintiff alleges, among other things, that defendants recommended and sold to
plaintiff unsuitable securities. The case (County of Orange et al v. Bear
Stearns & Co. Inc. et al.) has been stayed by agreement of the parties.
ENVIRONMENTAL MATTERS
Because of now discontinued industrial operations previously conducted by
subsidiaries of Salomon, SSBH is subject to uncertain remedial liability under
the federal Comprehensive Environmental Response, Compensation, and Liability
Act of 1980, as amended ("CERCLA" or "Superfund"), and comparable environmental
laws. Under CERCLA, in certain circumstances, a potentially responsible party
("PRP") may be held jointly and severally liable, without regard to fault, for
the costs of investigation and cleanup of contamination. In most cases, such
remediation expenditures are incurred over a number of years.
In 1988, a subsidiary of Salomon, The S.W. Shattuck Chemical Company, Inc.
("Shattuck"), along with over 350 industrial, municipal and other entities, was
named by the federal Environmental Protection Agency ("EPA") as a PRP at Section
6 of the Lowry Landfill in Arapaho County, Colorado ("Lowry"), a federal
Superfund site owned by the City and County of Denver ("Denver"). Based on
current EPA estimates, that remediation at Lowry will cost approximately $94
million. Under the terms of settlements among Salomon, Shattuck and certain
PRPs, Salomon's share is not expected to exceed $13 million, of which
approximately 60% has been paid into a trust fund.
In August 1992, EPA issued an administrative order for remedial studies and
action to be performed by Shattuck under CERCLA at a Superfund site (Denver
Radium Site,
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Operable Unit VIII), which includes property owned by, and a metal processing
plant previously operated by, Shattuck in Denver, Colorado. Shattuck has since
performed significant remediation activities at the site and has maintained
financial assurance of $26.6 million to guarantee performance of the
remediation, both in accordance with the order.
In July 1996, Denver enacted an ordinance imposing a substantial "fee" on any
radioactive waste or radium-contaminated material disposed of in the City of
Denver. Under this ordinance, Denver assessed Shattuck $9.35 million for certain
disposal already carried out. This "fee," and any additional "fees," if upheld,
would greatly increase remediation costs for the Denver Radium Site. Shattuck
has sued to enjoin enforcement of the "fee." The United States has also sued,
seeking to enjoin imposition of the "fee" on constitutional grounds. Denver has
counterclaimed and has moved to add SSBH as a defendant. These cases, which have
been consolidated, are now pending before the U.S. District Court in Colorado.
In another matter, in May 1993, the National Zinc site in Bartlesville,
Oklahoma, defined by EPA to include a smelter facility that had been owned by a
former subsidiary of Salomon, and an eight square mile area surrounding the
smelter, was proposed for listing as a Superfund site. Salomon and one other
PRP, Cyprus Amax Minerals Company ("Cyprus"), removed contamination from the
site pursuant to an order from EPA in 1994.
In 1994, Salomon, Cyprus and the City of Bartlesville entered into a consent
agreement with the Oklahoma regulatory authorities to conduct further
investigation of the site. In August 1995, Cyprus and the City of Bartlesville
(but not Salomon) entered into a consent agreement with state regulatory
authorities to perform remediation of Operable Unit 1 at the site, related to
protection of human health. These remediation activities are nearing completion.
The remedy selected to protect ecologically sensitive areas, known as Operable
Unit 2, is estimated to cost approximately $2.8 million. In February 1997,
Cyprus (but not Salomon) entered into a consent agreement to perform this
remediation, but these remediation activities have not commenced.
In March 1998, SSBH and Cyprus received letters from EPA demanding reimbursement
of past response costs of $12.3 million allegedly incurred by EPA at the
National Zinc site. SSBH intends to contest vigorously this claim asserted by
EPA to the extent it exceeds amounts which SSBH may be obligated to pay to EPA
under the 1994 EPA order and the 1994 consent agreement with Oklahoma
regulatory authorities.
In February 1994, Horseheads Industries, Inc. d/b/a/ Zinc Corporation of America
("ZCA"), the current owner of the facility, filed suit in the U.S. District
Court for the Northern District of Oklahoma against former owners or operators
of the smelters, including Salomon, St. Joe Minerals Company ("St. Joe"), Fluor
Corporation ("Fluor") and Cyprus seeking recovery of response costs under
CERCLA. In August 1994, a settlement agreement was entered into among ZCA,
Fluor/St. Joe and Salomon (collectively, the "Settling Parties"), allocating
both past and future response costs and establishing a committee to study future
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corrective action at the smelter under the Resource Conservation and Recovery
Act ("RCRA"). Cyprus did not join in the settlement. In April 1996, the Court
allocated past and future response costs at the National Zinc site 70% to the
Settling Parties and 30% to Cyprus, except for response costs relating to
certain residue piles stored at the facility, which the Court allocated 100% to
the Settling Parties. Salomon subsequently entered into an agreement with Cyprus
that satisfies certain of the liabilities and obligations of the parties as set
forth in the Court's decision. In November 1997, ZCA's modified RCRA permit
became effective, approving a corrective action at the facility. SSBH's share of
the cost of the corrective action is not expected to exceed $15 million.
Philipp Brothers, Inc. ("Philipp Brothers"), a subsidiary of Salomon, together
with 23 other parties, is the subject of a motion brought by the United States
in August 1997 seeking to join them as additional defendants in an action under
CERCLA to recover response costs and natural resource damages allegedly caused
by activities in the "Coeur D'Alene Basin," an area in northern Idaho
encompassing the Bunker Hill Superfund site in Kellogg, Idaho. At the same
time, the Coeur D'Alene Tribe moved the Court to join 13 additional parties,
including Philipp Brothers, as defendants in an action brought by the Tribe to
recover natural resource damages under CERCLA. Philipp Brothers believes that it
conducted no activities with respect to the Bunker Hill Superfund site which
would give rise to such liability.
The Company and various subsidiaries have also been named as defendants in
various matters incident to and typical of the businesses in which they are
engaged. These include numerous civil actions, arbitration proceedings and other
matters in which the Company's broker-dealer subsidiaries have been named,
arising in the normal course of business out of activities as a broker and
dealer in securities, as an underwriter of securities, as an investment banker
or otherwise. In the opinion of the Company's management, none of these actions
is expected to have a material adverse effect on the consolidated financial
condition of the Company and its subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Pursuant to General Instruction I of Form 10-K, the
information required by Item 4 is omitted.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
All of the outstanding common stock of the Company is owned by
Travelers Group.
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ITEM 6. SELECTED FINANCIAL DATA.
Pursuant to General Instruction I of Form 10-K, the
information required by Item 6 is omitted.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE MERGER
On November 28, 1997, a newly formed wholly owned subsidiary of Travelers Group
Inc. was merged into Salomon Inc ("Salomon"). Pursuant to the merger agreement,
Salomon common stockholders received 1.695 shares of Travelers Group Inc. common
stock for each share of Salomon common stock; each share of preferred stock of
Salomon was exchanged for a share of Travelers Group Inc. preferred stock having
substantially identical terms, except that the Travelers Group Inc. preferred
stock has certain voting rights; and Salomon became a wholly owned subsidiary of
Travelers Group Inc. Following this merger, Salomon and Smith Barney Holdings
Inc. ("Smith Barney") were merged (the "Merger") to form Salomon Smith Barney
Holdings Inc. (collectively, with its subsidiaries the "Company"). The
transaction is a tax-free exchange. The consolidated financial statements give
retroactive effect to the Merger in a transaction accounted for in a manner
similar to a pooling of interests. The pooling of interests method of accounting
requires the restatement of all periods presented as if Salomon and Smith Barney
had always been combined. Certain reclassifications have been made to conform
the accounting policies of Salomon and Smith Barney.
As a result of the Merger, the Company booked a pre-tax restructuring charge of
$838 million ($496 million after tax) in 1997. Approximately $663 million of
this charge is related to excess or unused office space and other
facilities-related write-offs and approximately $161 million is related to
severance.
RESULTS OF OPERATIONS
The Company's income from continuing operations for 1997, which includes the
restructuring charge, was $1,145 million compared to $1,865 million and $1,108
million for the years ended December 31, 1996 and 1995, respectively. The
Company's income from continuing operations excludes the results of Basis
Petroleum, Inc. ("Basis Petroleum" or "Basis"). The Company's 1996 results also
reflect losses from discontinued operations, including a $290 after-tax loss in
1996 related to the sale of Basis Petroleum. As discussed in the Discontinued
Operations section that follows, Basis Petroleum is reflected as a discontinued
operation in this report.
Revenues, net of interest in 1997 were $10.9 billion, a 3% improvement over
$10.7 billion in 1996, primarily reflecting increases in commissions and asset
management and administration
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<PAGE> 22
fees offset by a decline in principal transaction revenues from equities, fixed
income and commodities trading. Revenues, net of interest in 1996 reflect
improvements over 1995 in most businesses, including fixed income trading,
investment banking, asset management and retail sales, and were partially offset
by a decrease in revenues from equities trading.
Commission revenues increased 14% in 1997 to $2.97 billion, from $2.61 billion
in 1996 and $2.38 billion in 1995. The 1997 and 1996 increases reflect growth in
sales of listed and over-the-counter ("OTC") securities, as well as increased
insurance and annuity sales. The 1997 results also reflect higher commissions
from mutual funds activity.
Investment banking revenues were $2.12 billion in 1997 compared to $2.00 billion
in 1996 and $1.32 billion in 1995. The 6% increase in 1997 reflects revenue
growth in unit trust, public finance, high yield and high grade debt
underwritings, and mergers and acquisitions. This was offset somewhat by a
decline in equity underwritings. For 1997, the Company was ranked #1 in the
industry in municipal and mortgage debt underwritings, and #2 in both domestic
and global debt and equity underwriting, according to Securities Data Corp. The
52% increase in 1996 was attributable to significant improvements in equity and
debt underwriting, combined with a higher level of advisory fees.
Principal transaction revenues from fixed income were $1.88 billion in 1997
compared to $2.05 billion in 1996 and $900 million in 1995. The 8% decrease in
1997 was the result of a decrease in long-term trading strategies, partially
offset by an increase in customer sales and trading. The 128% increase in 1996
reflects strong performances in customer sales and trading, favorable market
conditions, and excellent results from long-term trading strategies.
Principal transaction revenues from equities were $397 million in 1997 compared
to $576 million in 1996 and $995 million in 1995. The 31% decrease in 1997
reflects the volatility in the global equity markets and a loss on a risk
arbitrage position in British Telecommunications PLC and MCI Communications
Corporation, partially offset by improved results in long-term equity
strategies. The 42% decrease in 1996 primarily reflects losses associated with
long-term equity strategies.
Principal transaction revenues from commodities were $218 million in 1997
compared with $393 million in 1996 and $238 million in 1995.
Asset management and administration fees were $1.72 billion in 1997 compared to
$1.39 billion in 1996 and $1.09 billion in 1995. The 23% increase in 1997
reflects broad growth in all recurring fee-based products, led by a 36% increase
in revenues from managed accounts, a 28% increase in externally managed
Consulting Group and other accounts revenues, and an 11% increase in money
market and mutual fund revenues. Internally managed assets reached $164.1
billion, and total assets under fee-based management were $223.8 billion at the
end of 1997, representing increases of 22% and 25%, respectively, compared with
the prior year. The 28% increase in asset management and administration fees in
1996 is due to growth in
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<PAGE> 23
assets under management, as well as bringing in-house all of the administrative
functions for Smith Barney proprietary mutual funds and money funds in the third
quarter of 1995.
Total assets under fee-based management at December 31, were as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------
Dollars in billions
At December 31, 1997 1996 1995
---------------------------------------------------------------------------
<S> <C> <C> <C>
Money market funds $ 46.5 $ 41.6 $ 35.8
Mutual funds 51.9 40.4 36.1
Managed accounts 54.1 44.5 35.2
---------------------------------------------------------------------------
Salomon Smith Barney Asset Management 152.5 126.5 107.1
Financial Consultant managed accounts 11.6 7.9 5.6
---------------------------------------------------------------------------
Total internally managed accounts 164.1 134.4 112.7
Consulting Group externally managed assets 59.7 44.1 35.3
---------------------------------------------------------------------------
Total assets under fee-based management $ 223.8 $ 178.5 $ 148.0
---------------------------------------------------------------------------
</TABLE>
Net interest and dividends were $1.51 billion in 1997 compared to $1.49 billion
in 1996 and $1.64 billion in 1995. The 10% decrease in 1996 is primarily due to
a decrease in average net inventory balances, partially offset by increased
margin lending to clients.
Gain on sale of subsidiaries and affiliates in 1996 includes a pre-tax gain of
$48 million related to the sale of the Company's indirect wholly owned
subsidiary The Mortgage Corporation Limited, which originated and serviced
residential mortgages in the United Kingdom.
Total expenses, excluding interest and the Merger-related restructuring charge,
were $8.29 billion in 1997 compared to $7.65 billion in 1996 and $6.87 billion
in 1995. The 8% increase in 1997 and 11% increase in 1996 primarily reflects an
increase in production-related compensation and benefits expense, reflecting
increased revenues as well as higher floor brokerage and other production
related costs. Compensation and benefits expenses as a percentage of revenues,
net of interest expense was 55% in 1997, compared with 52% in 1996 and 56% in
1995. The ratio of non-compensation expenses (before the restructuring charge)
to revenues, net of interest expense was 21% in 1997, 20% in 1996 and 23% in
1995. The Company continues to maintain its focus on controlling fixed expenses.
OUTLOOK
The Company's business is significantly affected by the levels of activity in
the securities markets, which in turn are influenced by the level and trend of
interest rates, the general state of the global economy and the national and
worldwide political environments, among other factors.
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<PAGE> 24
As Salomon's operations are integrated with the existing operations of Smith
Barney, management expects to achieve, by the end of a two-year period,
annualized after-tax cost savings in excess of $200 million from the reduction
of overhead expenses, changes in corporate infrastructure and the elimination of
certain redundant expenses. There can be no assurance that these projected cost
savings will be achieved.
DISCONTINUED OPERATIONS
In March 1997, Salomon's Board of Directors approved a non-binding letter of
intent to sell all of the outstanding stock of Basis Petroleum, the Company's
oil refining and marketing business, to Valero Energy Corporation and a plan of
disposition for Basis. Consequently, the Company recorded an after-tax loss of
$290 million in the fourth quarter of 1996. For a description of the terms of
the sale see Note 4 to the consolidated financial statements.
In 1996, Basis and Howell Corporation contributed their respective crude oil
gathering, marketing and transportation activities to form Genesis Energy, L.P.
("Genesis"). The Company's investment in Genesis was not transferred to Valero.
Basis Petroleum had after-tax operating losses of $75 million and $56 million in
1996 and 1995, respectively. Basis' 1996 results included an after-tax gain of
$37 million ($60 million pretax) related to a Genesis public offering and an
after-tax gain of $14 million ($23 million pretax) related to the reduction of
its minimum physical inventories needed to support its refining operations. In
addition, 1996 results include an after-tax charge of $13 million ($22 million
pretax) related to the shutdown of Basis' chemical processing facility in
Houston.
21
<PAGE> 25
CAPITAL AND LIQUIDITY MANAGEMENT
Capital is an expensive resource. To maximize the return on equity, it is
essential that the Company deploy its capital in an efficient manner. Liquidity
management is integral to capital management and is especially critical for a
financial institution such as the Company. Access to funding must be assured
under all market conditions. The confidence of creditors and counterparties in
the Company's ability to perform pursuant to its contractual obligations is
important to the Company's continued success.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets were $277 billion at December 31, 1997, up from $246
billion at year-end 1996. Due to the nature of the Company's trading activities,
including its matched book activities, it is not uncommon for the Company's
asset levels to fluctuate from period to period. A "matched book" transaction
involves a security purchased under an agreement to resell (i.e., reverse
repurchase transaction) and simultaneously sold under an agreement to repurchase
(i.e., repurchase transaction). The Company's balance sheet is highly liquid,
with the vast majority of its assets consisting of marketable securities and
collateralized short-term financing agreements arising from securities
transactions. The highly liquid nature of these assets provides the Company with
flexibility in financing and managing its business. The Company monitors and
evaluates the adequacy of its capital and borrowing base on a daily basis in
order to allow for flexibility in its funding, to maintain liquidity, and to
ensure that its capital base supports the regulatory capital requirements of its
subsidiaries.
The Company funds its operations through the use of collateralized and
uncollateralized short-term borrowings, long-term borrowings, trust preferred
securities, and its equity. Collateralized short-term financing, including
repurchase agreements and collateralized loans, is the Company's principal
funding source. Such borrowings totaled $120.3 billion at December 31, 1997.
Uncollateralized short-term borrowings provide the Company with a source of
short-term liquidity and are also utilized as an alternative to collateralized
financing when they represent a cheaper funding source. Sources of short-term
uncollateralized borrowings include commercial paper, uncollateralized bank
borrowings and letters of credit, deposit liabilities, promissory notes and
corporate loans. Short-term uncollateralized borrowing totaled $10.7 billion at
December 31, 1997.
The Company and Phibro Inc. have committed uncollateralized revolving lines of
credit totaling $2.0 billion and $550 million, respectively. In addition,
Salomon Brothers Inc has a $2.1 billion committed secured standby bank credit
facility for financing securities positions, which enables it to borrow on a
secured basis using a variety of financial instruments as collateral. Salomon
Brothers International Limited has a similar committed securities repurchase
facility in the amount of $1.0 billion. At December 31, 1997 there were no
outstanding borrowings under these facilities. The Company also has substantial
borrowing arrangements consisting of facilities that the Company has been
advised are available, but
22
<PAGE> 26
where no contractual lending obligation exists. These arrangements are reviewed
on an ongoing basis to ensure flexibility in meeting the Company's short-term
requirements. Uncollateralized term debt is a significant component of the
Company's long-term capital. Term debt totaled $19.1 billion at
December 31, 1997, compared with $15.7 billion at December 31, 1996. The
Company utilizes interest rate swaps to convert the majority of its fixed rate
term debt used to fund inventory-related working capital requirements into
variable rate obligations. Term debt issuances denominated in currencies other
than the U.S. dollar that are not used to finance assets in the same currency
are effectively converted to U.S. dollar obligations through the use of
cross-currency swaps and forward currency contracts. The average remaining
maturity of the Company's term debt was 3.7 years at December 31, 1997 and
3.6 years at December 31, 1996. See Note 7 to the consolidated financial
statements for additional information regarding term debt and an analysis
of the impact of interest rate swaps on term debt.
As a result of the Merger, the components of equity have changed. On the date of
the Merger, Salomon's preferred stock, including the redeemable preferred, was
exchanged for substantially identical preferred stock of Travelers Group. The
equivalent amount of equity was then added to the Company's additional paid-in
capital. In addition, Salomon's treasury stock was retired. These transactions
had no impact on the total long-term capitalization of the Company.
In July 1996, the Company issued $345 million of trust preferred securities,
which pay interest at an annual rate of 9.50%. In January 1998, the Company
issued $400 million of trust preferred securities, which pay interest at an
annual rate of 7.20%. For a detailed description of these securities see Note 9
to the consolidated financial statements.
The Company's borrowing relationships are with a broad range of banks, financial
institutions and other firms from which it draws funds. The volume of the
Company's borrowings generally fluctuates in response to changes in the level of
the Company's financial instruments, commodities and contractual commitments,
customer balances, the amount of reverse repurchase transactions outstanding and
securities borrowed transactions. As the Company's activities increase,
borrowings generally increase to fund the additional activities. Availability of
financing to the Company can vary depending upon market conditions, credit
ratings, and the overall availability of credit to the securities industry. The
Company seeks to expand and diversify its funding mix as well as its creditor
sources. Concentration levels for these sources, particularly for short-term
lenders, are closely monitored both in terms of single investor limits and daily
maturities.
The Company monitors liquidity by tracking asset levels, collateral and funding
availability to maintain flexibility to meet its financial commitments. As a
policy, the Company attempts to maintain sufficient capital and funding sources
in order to have the capacity to finance itself on a fully collateralized basis
in the event that the Company's access to uncollateralized financing is
impaired. The Company's liquidity management process includes a contingency
funding plan designed to ensure adequate liquidity even if access to
uncollateralized funding sources is severely
23
<PAGE> 27
restricted or unavailable. This plan is reviewed periodically to keep the
funding options current and in line with market conditions. The management of
this plan includes an analysis used to determine the Company's ability to
withstand varying levels of stress, which could impact its liquidation horizons
and required margins. In addition, the Company monitors its leverage and capital
ratios on a daily basis. The ratio of total assets less securities purchased
under agreements to resell to equity (including trust preferred securities) at
December 31, 1997 and 1996 was 22.7x and 20.7x, respectively.
OTHER
HIGH YIELD PORTFOLIO
The Company's activities include trading securities that are less than
investment grade, characterized as "high yield." High yield securities include
corporate debt, convertible debt, preferred and convertible preferred equity
securities rated lower than "triple B-" by internationally recognized rating
agencies, unrated securities with market yields comparable to entities rated
below "triple B-," as well as sovereign debt issued by certain countries in
currencies other than their local currencies and which are not collateralized by
U.S. government securities. For example, high yield securities exclude the
collateralized portion of the Company's holdings of "Brady Bonds," but include
such securities to the extent they are not collateralized. The Company's trading
portfolio of high yield securities owned is carried at market or fair value and
totaled $6.8 billion at December 31, 1997; the largest high yield exposure to
one counterparty was $785 million.
24
<PAGE> 28
DERIVATIVE INSTRUMENTS
Derivatives are an integral element of the world's financial and commodity
markets. Globalization of economic activity has brought more market participants
in contact with foreign exchange and interest rate risk at a time when market
volatility has increased. The Company has developed many techniques using
derivatives to enhance the efficiency of capital and trading risk management.
DERIVATIVE INSTRUMENTS - OVERVIEW
Derivative instruments are contractual commitments or payment exchange
agreements between counterparties that "derive" their value from some underlying
asset, index, interest rate or exchange rate. The markets for these instruments
have grown tremendously over the past decade. A vast increase in the types of
derivative users and their motivations in using these products has resulted in
an expansion of geographic coverage, transaction volume and liquidity, and the
number of underlying products and instruments.
Derivatives have been used quite successfully by multinational corporations to
hedge foreign currency exposure, by financial institutions to manage gaps in
maturities between assets and liabilities, by investment companies to reduce
transaction costs and take positions in foreign markets without assuming
currency risk, and by non-financial companies to fix the prices of inputs into
the manufacturing process or prices of the products they sell. Derivatives are
also used by investors when, considering such factors as taxes, regulations,
capital, and liquidity, they provide the most efficient means of taking a
desired market position. These are just a few of the business objectives for
which derivatives are used. The list of objectives is large and continues to
grow.
Derivatives are accounted for and settled differently than cash instruments and
their use requires special management oversight. Such oversight should ensure
that management understands the transactions to which it commits the firms and
that the transactions are executed in accordance with sensible corporate risk
policies and procedures.
Derivatives activities, like the Company's other ongoing business activities,
give rise to market, credit, and operational risks. Market risk represents the
risk of loss from adverse market price movements. While market risk relating to
derivatives is clearly an important consideration for intermediaries such as the
Company, such risk represents only a component of overall market risk, which
arises from activities in non-derivative instruments as well. Consequently, the
scope of the Company's market risk management procedures extends beyond
derivatives to include all financial instruments and commodities. Credit risk is
the loss that the Company would incur if counterparties failed to perform
pursuant to their contractual obligations. While credit risk is not a principal
consideration with respect to exchange-traded instruments, it is a major factor
with respect to non-exchange-traded OTC instruments. Whenever possible, the
Company uses industry master netting agreements to reduce aggregate
25
<PAGE> 29
credit exposure. Swap and foreign exchange agreements are documented utilizing
counterparty master netting agreements supplemented by trade confirmations. Over
the past several years, the Company has enhanced the funding and risk management
of its derivatives activities through the increased use of bilateral security
agreements. The Company, in particular, has been an industry leader in promoting
the use of this risk reduction technique. Based on notional amounts, at both
December 31, 1997 and 1996 approximately 80% of the Company's swap portfolio was
subject to the bilateral exchange of collateral. This initiative, combined with
the success of Salomon Swapco Inc, the Company's triple-A rated derivatives
subsidiary, has greatly strengthened the liquidity profile of the Company's
derivative trading activities. See "Risk Management" for discussions of the
Company's management of market, credit, and operational risks.
NATURE AND TERMS OF DERIVATIVE INSTRUMENTS
The Company and its subsidiaries enter into various bilateral financial
contracts involving future settlement, which are based upon a predetermined
principal or par value (referred to as the "notional" amount). Such instruments
include swaps, swap options, caps and floors, futures contracts, forward
purchase and sale agreements, option contracts and warrants. Transactions are
conducted either through organized exchanges or OTC. For a discussion of the
nature and terms of these instruments see Note 15 to the consolidated financial
statements.
THE COMPANY'S USE OF DERIVATIVE INSTRUMENTS
The Company's use of derivatives can be broadly classified between trading and
non-trading activities. The vast majority of the Company's derivatives use is in
its trading activities, which include market-making activities for customers and
the execution of trading strategies for its own account ("proprietary trading").
The Company's derivative counterparties consist primarily of other major
derivative dealers, financial institutions, insurance companies, pension funds
and investment companies, and other corporations. The scope of permitted
derivatives activities both for trading and non-trading purposes for each of the
Company's businesses is defined by senior management.
TRADING ACTIVITIES
A fundamental activity of the Company is to provide market liquidity to its
customers across a broad range of financial instruments, including derivatives.
The Company also seeks to generate returns by executing proprietary trading
strategies which are generally longer term in nature. By their very nature,
proprietary trading activities represent the assumption of risk. However,
trading positions are constructed in a manner that seeks to define and limit
risk taking only to those risks that the Company intends to assume. The most
significant derivatives-related activity conducted by the Company is in
fixed income derivatives, which includes interest rate swaps, financial futures,
swap options, and caps and floors. Other derivative transactions, such as
currency swaps, forwards and options as well as derivatives linked to equities,
are also regularly executed by the Company. The Company generally earns a spread
from market-making transactions involving derivatives, as it generally does from
its market-making activities for non-derivative transactions. The Company also
utilizes derivatives to manage the market risk inherent in the securities
inventories and derivative
26
<PAGE> 30
portfolios it maintains for market-making purposes as well as its "book" of swap
agreements and related transactions with customers. The Company conducts its
commodities dealer activities in organized futures exchanges as well as in OTC
forward markets. The Company executes transactions involving commodities
options, forwards and swaps, much in the same manner as it does in the financial
markets.
NON-TRADING ACTIVITIES
The Company also makes use of financial derivatives for non-trading, or end
user, purposes. As an end user, these instruments provide the Company with added
flexibility in the management of its capital and funding costs. Interest rate
swaps are utilized to effectively convert the majority of the Company's
fixed-rate term debt and a portion of its short-term borrowings to variable-rate
obligations. Cross-currency swaps and forward currency contracts are utilized to
effectively convert a portion of its non-U.S. dollar denominated term debt to
U.S. dollar denominated obligations and to minimize the variability in equity
otherwise attributable to exchange rate movements.
For additional derivatives-related disclosures contained in the consolidated
financial statements see the following:
- Note 2 - Summary of Significant Accounting Policies
- Note 3 - Principal Transaction Revenues
- Note 7 - Term Debt
- Note 15 - Financial Instruments, Commodities and Contractual
Commitments and Related Risks
- Note 16 - Fair Value Information
27
<PAGE> 31
RISK MANAGEMENT
Effective management of the risks inherent in the Company's businesses is
critical. The following section discusses certain of the risks inherent in the
Company's businesses, procedures in place to manage such risks, and initiatives
underway to continue to enhance the Company's management of risk.
MARKET RISK
Market risk represents the potential loss the Company may incur as a result of
absolute and relative price movements in financial instruments, commodities and
contractual commitments due to price volatility, changes in yield curves,
currency fluctuations and changes in market liquidity. The Company manages
aggregate market risk across both on- and off-balance sheet products and,
therefore, separate discussion of market risk for individual products, including
derivatives, is not meaningful. The distinguishing risks relative to derivatives
are credit risk and funding (liquidity) risk, which is roughly equivalent to the
risk of margin calls. Each type of risk can be increased or decreased by market
movements. See "Risk Management - Credit Risk - Credit Exposure from Derivatives
Activities."
Within the Company's trading businesses, sound management of market risk has
always been a critical consideration. The sections that follow discuss
organizational elements of market risk management, as well as specific risk
management tools and techniques. The Company has sought to institutionalize
these elements across all its businesses. Efforts to further strengthen the
Company's management of market risk are ongoing and the enhancement of risk
management systems and reporting, including the development and utilization of
quantitative tools, is of major importance. Nevertheless, the basis for strong
risk management is the expertise and judgment of the Company's trading
professionals and senior management, and open lines of communication.
THE COMPANY'S RISK MANAGEMENT CONTROL FRAMEWORK
The Company's risk management control framework is based upon the ongoing
participation of senior management, business unit managers and the coordinated
efforts of various support units throughout the firm.
The Company's risk management capabilities meet or exceed the risk management
requirements of the major regulatory and reporting bodies. These requirements
include the establishment of appropriate market and credit risk controls,
policies and procedures; appropriate senior management risk oversight with
thorough risk analysis and reporting; and independent risk management with
capabilities to evaluate and monitor risk limits.
28
<PAGE> 32
VALUATION AND CONTROL OF TRADING INVENTORY
With regard to the Company's trading inventory (financial instruments,
commodities and contractual commitments), the Chairmen and Chief Executive
Officers determine the appropriate risk profile of the Company with assistance
from the Risk Management Committee. This committee is comprised of the Chief
Executive Officers, senior business managers, the Chief Financial Officer, the
Chief Risk Officer and the Global Risk Manager and reviews and recommends
appropriate levels of risk, reviews risk capital allocations, balance sheet and
regulatory capital usage by business units and recommends overall risk policies
and controls. Lastly, an independent Global Risk Management Group provides
technical and quantitative analysis of the market risk associated with trading
inventory to the Chairmen and Chief Executive Officers and members of the Risk
Management Committee on a frequent basis.
Trading inventory is necessary for an active market maker, but can be a major
source of liquidity risk. Monitoring the Company's trading inventory levels and
composition and oversight for pricing is the responsibility of the Global Risk
Management Group and various support units, which monitor trading inventory on a
position by position level, and employ specific risk models to track inventory
exposure in credit markets, emerging markets and the mortgage market. The
Company also provides for liquidity risk by imposing markdowns as the age of the
inventory increases. Inventory event risk, both for issuer credit and emerging
markets, is analyzed with the involvement of senior traders, economists and
credit department personnel. Market scenarios for the major emerging markets are
maintained and updated to reflect the event risk for the emerging market
inventory. In addition, the Company, as a dealer of securities in the global
capital markets, has risk to issuers of fixed income securities for the timely
payment of principal and interest. Principal risk is reviewed by the Global Risk
Management Group, which identifies and reports major risks undertaken by the
trading businesses. The Credit Department (the "Department") combines principal
risk positions with credit risks resulting from market and delivery risk to
review aggregate exposures by counterparty, industry and country.
RISK LIMITS
The Company's trading businesses have implemented business unit limits on
exposure to risk factors. These limits, which are intended to enforce the
discipline of communicating and gaining approval for higher risk positions, are
periodically reviewed by the Global Risk Management Group. Business units may
not exceed risk limits without the approval of the appropriate member of the
Risk Management Committee.
THEORETICAL REVENUE RECONCILIATION
The trading units of the Company, the Global Risk Management Group and various
support units perform periodic revenue reconciliations, comparing actual
revenues with the revenue outcome that would have been expected based on risk
factor exposures. A discrepancy
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<PAGE> 33
between the expected revenue impact for a given market event and the actual
revenues may indicate an unexplained dimension of market risk. Comparing the two
thus provides a fundamental check that risk management is capturing all the
material market risk factors and that the sources of trading risk and trading
revenue are consistent with the realized revenue.
TOOLS FOR RISK MANAGEMENT AND REPORTING
The Company's market risk measurement begins with the identification of relevant
market risk factors. These core risk factors vary from market to market, and
region to region. Risk factors are used in three types of analysis: stress
analysis, scenario analysis and value-at-risk analysis.
STRESS ANALYSIS The Company performs stress analysis by repricing inventory
positions for specified upward and downward moves in risk factors, and computing
the revenue implications of these repricings. Stress analysis is a useful tool
for identifying exposures that appear to be relatively small in the current
environment but grow more than proportionately with changes in risk factors.
Such risk is typical of a number of derivative instruments, including options
sold, many mortgage derivatives and a number of structured products. Stress
analysis provides for the measurement of the potential impact of extremely large
moves in risk factors, which, though infrequent, can be expected to occur from
time to time.
SCENARIO ANALYSIS Scenario analysis is a tool that generates forward-looking
"what-if" simulations for specified changes in market factors. For example, a
scenario analysis could simulate the impact of a dramatic tightening of interest
rates by the Federal Reserve Board. The revenue implications of the specified
scenario are quantified not only for the Company as a whole, but on a business
unit basis and on a geographic basis. The risk management system keeps track of
many scenarios developed by both members of the Group and the Company's
economists and strategists.
VALUE AT RISK Value at risk ("VAR") is a statistical tool for measuring the
variability of trading revenue. The VAR reported reflects a potential range of
revenue loss, over a one day period, at the "95% confidence level." This level
implies that on 95 trading days out of 100, the mark-to-market of the portfolio
will likely result in either (1) an increase in revenue, or (2) a decrease from
average revenue that is less than the VAR estimate; and that on 5 trading days
out of 100, a decrease from average revenue that will likely exceed the VAR
estimate.
Value at risk is calculated by performing simulation analysis of the
volatilities and correlations of key underlying market risk factors (e.g.,
interest rates, interest rate spreads, equity prices, foreign exchange rates,
commodity prices, option volatilities) to estimate the range of possible changes
in the market value of the Company's market risk sensitive financial
instruments.
Measuring market risk using statistical risk management models has recently
become the main focus of risk management efforts by many companies whose
earnings are exposed to changes in the fair value of financial instruments.
Management believes that statistical models alone do not provide a reliable
method of monitoring and controlling risk. While VAR models are
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<PAGE> 34
relatively sophisticated, they are of limited value for internal risk management
in that they do not give any indication of which individual exposures are
problematic or which of the many risk simulations are particularly worrisome.
Therefore, such models do not substitute for the experience or judgment of
senior management and the Global Risk Management Group, who have extensive
knowledge of the markets and revise strategies as they deem necessary. These
models are used by the Company only as a supplement to other risk management
tools.
The Company engages in long-term trading activities. The horizon of these
activities can vary and is often in excess of a fiscal quarter. Therefore, daily
VAR is of limited use in measuring the true risk over longer horizons. For
long-term strategies that have convergence or mean-reverting characteristics,
the daily VAR will overestimate the risk that these strategies will have over a
longer horizon. The Company believes that this feature of the horizon makes
comparisons of VAR across different firms problematic.
The following table shows the results of the Company's VAR analysis, which
includes substantially all of the Company's financial assets and liabilities,
including all financial instruments and commodities owned and sold, contractual
commitments, repurchase and resale agreements, and related funding at December
31, 1997. The VAR relating to non-trading financial instruments has been
excluded from this analysis.
<TABLE>
<CAPTION>
Dollars in millions December 31, 1997
- -------------------------------------------------------------
<S> <C>
Interest rate $41
Equities $ 8
Commodities $ 8
Currency $ 9
Total $44
- -------------------------------------------------------------
</TABLE>
The quantification of market risk using VAR analysis requires a number of key
assumptions. In calculating the above market risk amounts, the Company used a
95% confidence level and a one day interval. The standard deviations and
correlation assumptions are based on historical data and reflect a horizon of
one year or more and no more than five years. Over 100 risk factors are used in
the simulations. VAR reflects the risk profile of the Company at December 31,
1997 and is not a predictor of future results.
The following describes the components of market risk:
INTEREST RATE RISK
Interest rate risk arises from the possibility that changes in interest rates
will affect the value of financial instruments. In connection with the Company's
dealer and arbitrage activities, including market-making in OTC derivative
contracts, the Company is exposed to interest rate risk, arising from changes in
the level or volatility of interest rates, mortgage prepayment speeds or the
shape and slope of the yield curve. The Company's corporate bond activities
expose it to the risk of loss related to changes in credit spreads. When
appropriate, the
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<PAGE> 35
Company attempts to hedge its exposure to interest rate risk by entering into
transactions such as interest rate swaps, options, U.S. and non-U.S. government
securities and futures and forwards contracts designed to mitigate such
exposure.
EQUITY PRICE RISK
The Company is exposed to equity price risk as a consequence of making markets
in equity securities and equity derivatives. Equity price risk results from
changes in the level or volatility of equity prices, which affect the value of
equity securities, or instruments that derive their value from a particular
stock, a basket of stock or a stock index. The Company attempts to reduce the
risk of loss inherent in its inventory in equity securities by entering into
hedging transactions, including equity options and futures, designed to mitigate
the Company's market risk profile.
COMMODITY PRICE RISK
Commodity price risk results from the possibility that the price of the
underlying commodity may rise or fall. Cash flows from commodity contracts are
based on the difference between an agreed-upon fixed price and a price that
varies with changes in a specified commodity price or index. Commodity contracts
principally relate to energy, precious metals, and base metals.
CURRENCY RISK
Currency risk arises from the possibility that changes in foreign exchange rates
will impact the value of financial instruments. When the Company buys or sells a
foreign currency or financial instrument denominated in a currency other than
U.S. dollars, exposure exists from a net open currency position. Until the
position is covered by selling or buying an equivalent amount of the same
currency or by entering into a financing arrangement denominated in the same
currency, the Company is exposed to a risk that the exchange rate may move
against it.
CREDIT RISK
Credit risk represents the loss the Company could incur if an issuer or
counterparty is unable or unwilling to perform on its commitments, including the
timely payment of principal and interest or settlement of swap and foreign
exchange transactions, repurchase agreements, securities purchases and sales,
and other contractual obligations. The Company's credit risk management process
considers the many factors that influence the probability of a potential loss,
including, but not limited to, the issuer's or counterparty's financial profile,
its business prospects and reputation, the specific terms and duration of the
transactions, the exposure of the transactions to market risk, macroeconomic
developments and sovereign risk.
ORIGIN OF CREDIT RISK
In the normal course of its operations, the Company and its subsidiaries enter
into various transactions that give rise to credit risk. Credit risk is
generally attributable to one or more of the following risks: market, delivery
and default of principal. Market and delivery risks create credit risk with
respect to transactions with counterparties. Default of principal risk is the
risk of nonpayment of the principal and interest of a security.
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<PAGE> 36
The components of market risk such as absolute and relative price movements,
price volatility, changes in yield curves, currency fluctuations, and changes in
market liquidity, result in credit risk when a counterparty's obligation to the
Company exceeds the obligation of the Company to the counterparty. Delivery risk
arises from the requirement, in certain circumstances, to release cash or
securities before receiving payment. For both market and delivery risk, the
Department sets credit limits or requires specific approvals that anticipate the
potential exposure of transactions.
CREDIT RISK MANAGEMENT AT SALOMON SMITH BARNEY HOLDINGS INC.
The Chief Credit Officer, who is independent of any revenue-generating function,
manages the Department, whose professionals assess, approve, monitor, and
coordinate the extension of credit on a global basis. In considering such risk,
the Department evaluates the risk/return trade-offs as well as current and
potential credit exposures to a counterparty or to groups of counterparties that
are related because of industry, geographic, or economic characteristics. The
Department also has established various credit policies and control procedures
used singularly or in combination, depending upon the circumstances.
CREDIT RISK MANAGEMENT OF COMMODITIES-RELATED TRANSACTIONS
Phibro's credit department determines the credit limits for counterparties in
its commodities-related activities. Exposure reports, which contain detailed
information about cash flows with customers, goods in transit and forward
mark-to-market positions, are reviewed daily.
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<PAGE> 37
CREDIT EXPOSURE FROM DERIVATIVES ACTIVITIES
The following table summarizes the Company's credit exposure, net of cash and
securities collateral for swap agreements, swap options, caps and floors and
foreign exchange contracts and options at December 31, 1997. These numbers do
not present potential credit exposure that may result from factors that
influence market risk or from the passage of time. Severe changes in market
factors may cause credit exposure to increase suddenly and dramatically. Swap
agreements, swap options, caps and floors include transactions with both short-
and long-term periods of commitment.
<TABLE>
<CAPTION>
Transactions with
over 3 years to
Dollars in billions All transactions maturity 1997 average
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Swaps, swap options, caps and floors:
Risk classes 1 and 2 $ 1.5 $ 1.1 $ 1.1
Risk class 3 1.5 .8 1.2
Risk classes 4 and 5 1.0 .5 .8
Risk classes 6, 7 and 8 .1 .1 .1
- -------------------------------------------------------------------------------------------------------------
$ 4.1 $ 2.5 $ 3.2
=============================================================================================================
Foreign exchange contracts and options:
Risk classes 1 and 2 $ .7 -- $ .7
Risk class 3 .7 -- .6
Risk classes 4 and 5 .2 -- .2
Risk classes 6, 7 and 8 -- -- --
- -------------------------------------------------------------------------------------------------------------
$1.6 -- $1.5
=============================================================================================================
</TABLE>
To monitor credit risk, the Company utilizes a series of eight internal
designations of counterparty credit quality. These designations are analogous to
external credit ratings whereby risk classes one through three are high quality
investment grades. Risk classes four and five include counterparties ranging
from the lowest investment grade to the highest non-investment grade. Risk
classes six, seven and eight represent higher risk counterparties.
With respect to sovereign risk related to derivatives, credit exposure at
December 31, 1997 was primarily to counterparties in the U.S. ($2.9 billion),
Germany ($.6 billion), Great Britain ($.5 billion), Italy ($.4 billion), Japan
($.3 billion) and France ($.3 billion).
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OPERATIONAL RISK
As a major intermediary in financial and commodities markets, the Company is
directly exposed to market risk and credit risk, which arise in the normal
course of its business activities. Slightly less direct, but of critical
importance, are risks pertaining to operational and back office support. This is
particularly the case in a rapidly changing and increasingly global environment
with increasing transaction volumes and an expansion in the number and
complexity of products in the marketplace. Such risks include:
- Operational/Settlement Risk - the risk of financial and
opportunity loss and legal liability attributable to
operational problems, such as inaccurate pricing of
transactions, untimely trade execution, clearance and/or
settlement, or the inability to process large volumes of
transactions. The Company is subject to increased risks with
respect to its trading activities in emerging market
securities, where clearance, settlement, and custodial risks
are often greater than in more established markets.
- Technological Risk - the risk of loss attributable to
technological limitations or hardware failure that constrain
the Company's ability to gather, process, and communicate
information efficiently and securely, without interruption,
with customers, among units within the Company, and in the
markets where the Company participates. The Company has
analyzed the impact of year 2000 on its systems and processes
and is in the process of enhancing and testing its systems to
process dates starting with the year 2000. Beginning in early
1999, the Company plans to participate in industry-wide
testing coordinated by the Securities Industry Association. In
addition, the Company is addressing the technological
implications that will result from regulatory and market
changes, such as Europe's Economic and Monetary Union. The
Company anticipates incurring approximately $150 million to
$200 million in additional expenses through the year 2000 to
make these enhancements.
- Legal/Documentation Risk - the risk of loss attributable to
deficiencies in the documentation of transactions (such as
trade confirmations) and customer relationships (such as
master netting agreements) or errors that result in
noncompliance with applicable legal and regulatory
requirements.
- Financial Control Risk - the risk of loss attributable to
limitations in financial systems and controls. Strong
financial systems and controls ensure that assets are
safeguarded, that transactions are executed in accordance with
management's authorization, and that financial information
utilized by management and communicated to external parties,
including the Company's stockholder, creditors, and
regulators, is free of material errors.
As the above risks are largely interrelated, so are the Company's actions to
mitigate and manage them. The Company's Chief Administrative Officer is
responsible for, among other things, oversight of global operations and
technology. An essential element in mitigating the risks noted above is the
optimization of information technology and the ability to manage and implement
change. To be an effective competitor in an information-driven business of a
global nature requires the development of global systems and databases that
ensure increased and more timely access to reliable data.
35
<PAGE> 39
ENVIRONMENTAL RISK
The Company is subject to environmental risk from two primary sources:
discontinued commodities processing and oil refining operations, and existing
energy-related transportation activities.
The Company is subject to uncertain remedial liability as a result of
commodities-related industrial operations, which were discontinued in or prior
to 1984. Such liability arises under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended ("CERCLA" or "Superfund"),
which provides that potentially responsible parties ("PRPs"), including waste
generators and past and present site owners and operators, may be held jointly
and severally liable for the entire cost of site clean-up. The Company may also
be subject to liability under state or other U.S. environmental laws.
The process of remediating hazardous waste sites under CERCLA is normally
lengthy and involves a series of events including initial site identification,
environmental site studies and evaluations, issuance of the "Preliminary
Identification of Remedial Alternatives," completion of the "Remedial
Investigation and Feasibility Study," selection of an appropriate site remedy
and its related cost estimate known as the "Record of Decision," performance of
site remediation and post-remediation site monitoring. Factors that influence
the cost and time of completion include the remediation method selected; the
number of financially solvent PRPs responsible for payment; whether PRPs were
owners, operators or generators; determination of cost allocation among PRPs,
and the ongoing development of more efficient and effective remediation
technologies. The process may take ten years or more from site identification to
completion and may be further complicated by protracted legal proceedings
involving numerous PRPs.
The ultimate share of remediation costs that will be borne by the Company and
its subsidiaries cannot be predicted with accuracy. Although certain exposures
may be covered by insurance contracts or indemnification agreements from other
parties, the Company has incurred and will continue to incur costs related to
remediation at certain sites already identified. Further, it is possible that
the Company will be named as a PRP at additional sites. Management believes,
based upon currently known facts and established reserves, that the ultimate
disposition of these matters will not have a material adverse effect on the
Company's financial condition.
Phibro has potential environmental exposure in connection with activities in
which cargoes of products are transported and stored. Phibro mitigates this
exposure through insurance coverage and consideration of ports of delivery and
storage terminals.
36
<PAGE> 40
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" above.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Consolidated Financial Statements and Schedules
on page F-1 hereof. There is also incorporated by reference herein in response
to this Item the Company's Consolidated Financial Statements and the notes
thereto and the material under the caption "Quarterly Financial Data
(Unaudited)" set forth in the Consolidated Financial Statements, and the
Independent Auditors' Report filed as Exhibit 99.01 herewith.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Pursuant to General Instruction I of Form 10-K, the
information required by Item 10 is omitted.
ITEM 11. EXECUTIVE COMPENSATION.
Pursuant to General Instruction I of Form 10-K, the
information required by Item 11 is omitted.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Pursuant to General Instruction I of Form 10-K, the
information required by Item 12 is omitted.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Pursuant to General Instruction I of Form 10-K, the
information required by Item 13 is omitted.
37
<PAGE> 41
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as a part of the report:
(1) Financial Statements. See Index to
Consolidated Financial Statements and
Schedules on page F-1 hereof.
(2) Financial Statement Schedules. See Index to
Consolidated Financial Statements and
Schedules on page F-1 hereof.
(3) Exhibits:
See Exhibit Index.
(b) Reports on Form 8-K:
On October 21, 1997, the Company filed a Current
Report on Form 8-K, dated October 21, 1997, filing as
an exhibit under Item 7 thereof a press release
announcing the results of its operations for the
three and nine months ended September 30, 1997 and
certain additional information.
On October 28, 1997, the Company filed a Current
Report on Form 8-K, dated October 28, 1997 (which was
amended by a Form 8-K/A filed December 1, 1997),
reporting under Item 5 thereof certain information
with respect to its pending transaction with
Travelers Group and filing under Item 7 thereof
certain exhibits.
On October 28, 1997, the Company filed a Current
Report on Form 8-K/A (which amended the Form 8-K
filed on September 29, 1997 and which was further
amended by the Form 8-K/A filed on December 1, 1997),
reporting under Item 5 thereof certain information
with respect to its transaction with Travelers Group
and filing under Item 7 thereof certain exhibits.
On November 21, 1997, the Company filed a Current
Report on Form 8-K, dated September 24, 1997 (which
was amended by a Form 8-K/A filed December 1, 1997),
reporting under Item 5 thereof certain information
with respect to the results of operations of
Travelers Group and Smith Barney Holdings Inc. for
the three and nine months ended September 30, 1997
and filing under Item 7 thereof certain exhibits.
On November 28, 1997, the Company filed a Current
Report on Form 8-K, dated November 28, 1997,
reporting under Item 1 thereof the change of control
of the Company, reporting under Item 4 thereof
certain information
38
<PAGE> 42
with respect to changes in the Company's independent
auditors, reporting under Item 5 thereof certain
additional information and filing under Item 7
thereof certain exhibits.
On December 5, 1997, the Company filed a Current
Report on Form 8-K, dated December 4, 1997, reporting
under Item 4 thereof certain information with respect
to changes in the Company's independent auditors and
filing a related exhibit under Item 7 thereof.
On December 9, 1997, the Company filed a Current
Report on Form 8-K, dated December 9, 1997, filing
under Item 7 thereof certain exhibits.
No other reports on Form 8-K were filed during the
fourth quarter of 1997; however, on January 9, 1998,
the Company filed a Current Report on Form 8-K, dated
January 7, 1998, filing certain exhibits under Item 7
thereof relating to the offer and sale of the
Company's 6 1/4% Notes due January 15, 2005; on
January 26, 1998, the Company filed a Current Report
on Form 8-K, dated January 26, 1998, reporting under
Item 5 thereof the results of its operations for the
three and twelve months ended December 31, 1997 and
certain additional financial information; on February
2, 1998, the Company filed a Current Report on Form
8-K, dated January 29, 1998, filing certain exhibits
under Item 7 thereof relating to the offer and sale
of the Company's 6 1/8% Notes due January 15, 2003;
and on March 3, 1998, the Company filed a Current
Report on Form 8-K, dated February 26, 1998, filing
certain exhibits under Item 7 thereof relating to the
offer and sale of the Company's Equity Linked Notes
based upon the Dow Jones Industrial Average(SM) Due
September 6, 2005.
39
<PAGE> 43
EXHIBIT INDEX
-------------
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
<S> <C>
3.01 Amended and Restated Certificate of Incorporation of Salomon Smith
Barney Holdings Inc. (the "Company"), effective December 1, 1997,
incorporated by reference to Exhibit 4(a) to Amendment No. 2 to the
Company's Registration Statement on Form S-3 (No. 333-38931).
3.02 By-Laws of the Company, incorporated by reference to Exhibit 4(b) to
Amendment No. 2 to the Company's Registration Statement on Form S-3
(No. 333-38931).
10.01 Amended and Restated Lease dated as of December 30, 1994 between
State Street Bank and Trust Company of Connecticut, National
Association, as Trustee (Lessor), and Smith Barney Inc., Mutual
Management Corp., Smith Barney Mutual Funds Management Inc. and The
Travelers Inc., as tenants in common (Lessee), incorporated by
reference to Exhibit 10.03 to the Annual Report on Form 10-K of
Smith Barney Holdings Inc. for the fiscal year ended December
31, 1994 (File No. 1-12484).
10.02 Lease dated November 23, 1988 between 7 World Trade Company and
Salomon Inc, incorporated by reference to Exhibit 10(a) to the
Company's Annual Report on Form 10-K, as amended, for the fiscal
year ended December 31, 1991 (File No. 1-4346).
12.01+ Computation of ratio of earnings to fixed charges.
21.01 Pursuant to General Instruction I of Form 10-K, the list of
subsidiaries of the Company is omitted.
23.01+ Consent of Coopers & Lybrand L.L.P.
23.02+ Consent of Arthur Andersen LLP.
24.01+ Powers of Attorney of certain directors of the Company.
27.01+ Financial Data Schedule.
27.02+ Restated Financial Data Schedule -- 1996 and 1995
99.01+ Independent Auditors' Report.
</TABLE>
- --------------------
+ Filed herewith.
40
<PAGE> 44
The total amount of securities authorized pursuant to any instrument
defining rights of holders of long-term debt of the Company does not
exceed 10% of the total assets of the Company and its consolidated
subsidiaries. The Company will furnish copies of any such instrument
to the SEC upon request.
Copies of any of the exhibits referred to above will be furnished at
a cost of $.25 per page to security holders who make written request
therefor to Salomon Smith Barney Holdings Inc., 388 Greenwich
Street, New York, New York 10013, Attention: Corporate Secretary.
41
<PAGE> 45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the
23rd day of March, 1998.
SALOMON SMITH BARNEY HOLDINGS INC.
(Registrant)
By: /s/ James Dimon
...................................
James Dimon, Co-Chairman of the
Board and Co-Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons on behalf of the
registrant and in the capacities indicated on the 23rd day of March, 1998.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ James Dimon
...................................... Co-Chairman of the Board, Co-Chief Executive Officer (Co-Principal Executive
James Dimon Officer) and Director
/s/ Deryck C. Maughan
...................................... Co-Chairman of the Board, Co-Chief Executive Officer (Co-Principal Executive
Deryck C. Maughan Officer) and Director
/s/ Charles W. Scharf
...................................... Chief Financial Officer (Principal Financial Officer)
Charles W. Scharf
/s/ Michael J. Day
...................................... Controller (Principal Accounting Officer)
Michael J. Day
*
...................................... Director
Steven D. Black
</TABLE>
42
<PAGE> 46
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
*
...................................... Director
James S. Boshart, III
*
...................................... Director
Thomas G. Maheras
*
...................................... Director
Jay P. Mandelbaum
*
...................................... Director
Eduardo G. Mestre
*
...................................... Director
Shigeru Myojin
*
...................................... Director
Paul Underwood
*By: /s/ Robert H. Mundheim
......................................
Robert H. Mundheim
Attorney-in-fact
</TABLE>
43
<PAGE> 47
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGE
REPORT OF INDEPENDENT ACCOUNTANTS F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Income for the years ended
December 31, 1997, 1996 and 1995 F-3
Consolidated Statements of Financial Condition as of
December 31, 1997 and 1996 F-4
Consolidated Statements of Changes in Stockholder's Equity
for the years ended December 31, 1997, 1996 and 1995 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements F-8
QUARTERLY FINANCIAL DATA (UNAUDITED) F-40
F-1
<PAGE> 48
[LETTERHEAD OF COOPERS & LYBRAND L.L.P.]
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholder of Salomon Smith Barney Holdings Inc. and
subsidiaries:
We have audited the accompanying consolidated statements of financial condition
of Salomon Smith Barney Holdings Inc. and subsidiaries as of December 31, 1997
and 1996, and the related consolidated statements of income, cash flows and
changes in stockholder's equity for the years ended December 31, 1997, 1996 and
1995. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits. The consolidated
financial statements give retroactive effect to the merger of Salomon Inc and
Smith Barney Holdings Inc. on November 28, 1997, which has been accounted for in
a manner similar to a pooling of interests as described in Note 1 to the
consolidated financial statements. We did not audit the consolidated statement
of financial condition of Salomon Inc and subsidiaries as of December 31, 1996,
or the related statements of income, cash flows and changes in stockholders'
equity for the years ended December 31, 1996 and 1995, which statements reflect
total assets of $194,881 million as of December 31, 1996, and total revenues,
net of interest expense of $4,367 million and $3,199 million for the years ended
December 31, 1996 and 1995, respectively, and net income of $617 million, and
$457 million for the years ended December 31, 1996 and 1995, respectively. Those
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Salomon Inc
and subsidiaries for such periods, is based solely on the report of such other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
accompanying consolidated financial statements present fairly, in all material
respects, the consolidated financial position of Salomon Smith Barney Holdings
Inc. and subsidiaries as of December 31, 1997 and 1996, and the consolidated
results of their operations and their cash flows for the years ended December
31, 1997, 1996 and 1995, in conformity with generally accepted accounting
principles.
/s/ Coopers & Lybrand L.L.P.
New York, New York
January 26, 1998.
F-2
<PAGE> 49
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Commissions $ 2,967 $ 2,612 $ 2,376
Investment banking 2,118 2,001 1,318
Principal transactions 2,504 3,027 2,140
Asset management and administration fees 1,715 1,390 1,087
Other 130 150 124
- --------------------------------------------------------------------------------------------------------------------
Total noninterest revenues 9,434 9,180 7,045
- --------------------------------------------------------------------------------------------------------------------
Interest and dividends 12,043 9,663 10,442
Interest expense 10,530 8,175 8,797
- --------------------------------------------------------------------------------------------------------------------
Net interest and dividends 1,513 1,488 1,645
- --------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 10,947 10,668 8,690
- --------------------------------------------------------------------------------------------------------------------
Noninterest expenses:
Compensation and benefits 6,037 5,558 4,900
Communications 495 486 489
Occupancy and equipment 432 435 442
Floor brokerage and other production 389 302 281
Advertising and market development 276 218 180
Professional services 210 190 199
Other operating and administrative expenses 450 456 379
Restructuring charge 838 7 --
- --------------------------------------------------------------------------------------------------------------------
Total noninterest expenses 9,127 7,652 6,870
- --------------------------------------------------------------------------------------------------------------------
Gain on sale of subsidiaries and affiliates -- 48 --
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 1,820 3,064 1,820
Provision for income taxes 675 1,199 712
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations 1,145 1,865 1,108
- --------------------------------------------------------------------------------------------------------------------
Discontinued operations:
Loss, net of benefit for income taxes of $48 and $35 -- (75) (56)
Loss on sale of Basis Petroleum, net of tax benefit of $215 -- (290) --
- --------------------------------------------------------------------------------------------------------------------
Net income $ 1,145 $ 1,500 $ 1,052
====================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 50
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
DECEMBER 31, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ 1,808 $ 1,607
Cash segregated and on deposit for Federal and other regulations
or deposited with clearing organizations 2,034 1,446
Collateralized short-term financing agreements:
Securities purchased under agreements to resell $75,802 $72,881
Deposits paid for securities borrowed 33,932 25,104
----------- -----------
109,734 97,985
Financial instruments and commodities owned and contractual commitments:
U.S. government and government agency securities 52,109 51,980
Non-U.S. government and government agency securities 46,502 35,189
Corporate debt securities 13,614 14,668
Contractual commitments 10,120 7,218
Equity securities 6,420 7,396
Mortgage loans and collateralized mortgage securities 3,103 4,345
Other financial instruments 6,590 4,782
Commodities 1,274 995
----------- -----------
139,732 126,573
Receivables:
Customers 12,415 9,488
Brokers, dealers and clearing organizations 3,212 2,103
Other 2,387 1,755
----------- -----------
18,014 13,346
Property, equipment and leasehold improvements, net of
accumulated depreciation and amortization of $884 and
$798, respectively 986 959
Net realizable value of discontinued operations -- 490
Other assets 4,312 3,708
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $276,620 $246,114
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 51
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
DECEMBER 31, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Liabilities and Stockholder's Equity:
Commercial paper and other short-term borrowings $ 11,464 $ 10,020
Collateralized short-term financing agreements:
Securities sold under agreements to repurchase $113,593 $97,269
Deposits received for securities loaned 5,978 5,525
----------- -----------
119,571 102,794
Financial instruments and commodities sold, not yet purchased, and
contractual commitments:
U.S. government and government agency securities 33,970 41,864
Non-U.S. government and government agency securities 45,166 31,699
Contractual commitments 11,688 9,984
Equity securities 3,462 6,142
Corporate debt securities and other 1,880 2,452
----------- -----------
96,166 92,141
Payables and accrued liabilities:
Customers 9,791 8,160
Brokers, dealers and clearing organizations 2,972 1,859
Other 8,719 7,012
----------- -----------
21,482 17,031
Term debt 19,074 15,748
----------- -----------
Total liabilities 267,757 237,734
Redeemable preferred stock, Series A -- 420
Guaranteed preferred beneficial interests in Company
subordinated debt securities 345 345
Stockholder's equity:
Preferred stock, Series D and E -- 450
Common stock (par value $.01 per share 1,000 shares
authorized; 1,000 shares issued and outstanding) -- --
Additional paid-in capital 1,574 2,399
Retained earnings 6,943 6,433
Cumulative translation adjustments 1 10
Treasury stock -- (1,677)
----------- -----------
Total stockholder's equity 8,518 7,615
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $276,620 $246,114
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 52
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
ADDITIONAL CUMULATIVE TOTAL
PREFERRED COMMON PAID-IN RETAINED TRANSLATION TREASURY STOCKHOLDER'S
DOLLARS IN MILLIONS STOCK STOCK CAPITAL EARNINGS ADJUSTMENTS STOCK EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ 312 -- $2,251 $5,190 $ 9 $(1,654) $6,108
Net income 1,052 1,052
Common dividends (506) (506)
Preferred dividends* (69) (69)
Other capital transactions 4 19 23
Net change in cumulative translation
adjustments 9 9
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 312 -- 2,255 5,667 18 (1,635) 6,617
Net income 1,500 1,500
Common dividends (666) (666)
Preferred dividends* (68) (68)
Issuance of preferred stock 250 250
Retirement of preferred stock (112) (112)
Other capital transactions 144 (42) 102
Net change in cumulative translation
adjustments (8) (8)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 450 -- 2,399 6,433 10 (1,677) 7,615
Net income 1,145 1,145
Common dividends (581) (581)
Preferred dividends* (54) (54)
Merger-related capital transactions (450) (1,035) 1,764 279
Other capital transactions 210 (87) 123
Net change in cumulative translation
adjustments (9) (9)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $ -- -- $1,574 $6,943 $ 1 $ -- $8,518
====================================================================================================================================
</TABLE>
* Net of after-tax impact of related interest rate swaps that effectively
convert fixed rate dividend obligations to variable rate obligations.
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 53
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
DOLLARS IN MILLIONS
YEAR ENDED DECEMBER 31, 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income adjusted for noncash items and non-operating activities -
Net income $ 1,145 $ 1,500 $ 1,052
Loss on disposal of Basis Petroleum -- 290 --
Deferred income tax benefit (675) (207) (345)
Depreciation and amortization 290 353 309
Gain on Genesis transaction and limited service motels -- (59) --
Gain on the sale of subsidiaries and affiliates -- (31) --
- ---------------------------------------------------------------------------------------------------------------------------------
Cash items included in net income 760 1,846 1,016
- ---------------------------------------------------------------------------------------------------------------------------------
(Increase) decrease in operating assets -
Cash segregated and on deposit for Federal and other regulations or
deposited with clearing organizations (588) (99) (174)
Collateralized short-term financing agreements (11,749) (12,959) 1,455
Financial instruments and commodities owned and contractual commitments (13,159) (5,443) (19,843)
Receivables (4,818) (1,539) 5,358
Other assets 223 (128) (31)
- ---------------------------------------------------------------------------------------------------------------------------------
Increase in operating assets (30,091) (20,168) (13,235)
- ---------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in operating liabilities -
Collateralized short-term financing agreements 16,777 (10,123) 19,392
Financial instruments and commodities sold, not yet purchased, and contractual
commitments 4,025 29,847 (4,265)
Payables and accrued liabilities 4,330 (1,166) (1,972)
- ---------------------------------------------------------------------------------------------------------------------------------
Increase in operating liabilities 25,132 18,558 13,155
- ---------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) operating activities (4,199) 236 936
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase (decrease) in commercial paper and other short-term borrowings 1,444 (1,178) 201
Proceeds from issuance of term debt 8,059 5,398 3,622
Term debt maturities and repurchases (4,397) (4,318) (5,380)
Collateralized mortgage obligations (185) (403) (704)
Dividends paid (604) (820) (436)
Issuance of trust preferred securities -- 345 --
Issuance of preferred stock -- 250 --
Redemption of preferred stock -- (112) (140)
Other capital transactions (95) (45) 13
- ---------------------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) financing activities 4,222 (883) (2,824)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Genesis transaction and limited service motels -- 123 --
Sale of subsidiaries and affiliates 365 82 --
Assets securing collateralized mortgage obligations 175 480 721
Property, equipment and leasehold improvements (220) (225) (454)
Other (142) (159) (84)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash provided by investing activities 178 301 183
- ---------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 201 (346) (1,705)
Cash and cash equivalents at beginning of year 1,607 1,962 3,667
Cash of discontinued operations -- (9) --
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 1,808 $ 1,607 $ 1,962
=================================================================================================================================
</TABLE>
Interest paid did not differ materially from the amount of interest expense
recorded for financial statement purposes in 1997, 1996 and 1995.
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE> 54
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE MERGER
On November 28, 1997, a newly formed wholly owned subsidiary of Travelers Group
Inc. was merged into Salomon Inc ("Salomon"). Pursuant to the merger agreement,
Salomon common stockholders received 1.695 shares of Travelers Group Inc. common
stock for each share of Salomon common stock; each share of preferred stock of
Salomon was exchanged for a share of Travelers Group Inc. preferred having
substantially identical terms, except that the Travelers Group Inc. preferred
stock has certain voting rights; and Salomon became a wholly owned subsidiary of
Travelers Group Inc. Following this merger, Salomon and Smith Barney Holdings
Inc. ("Smith Barney") were merged (the "Merger") to form Salomon Smith Barney
Holdings Inc. (collectively, with its subsidiaries the "Company"). The
transaction is a tax free exchange.
The consolidated financial statements give retroactive effect to the Merger as a
combination of entities under common control in a transaction accounted for in a
manner similar to a pooling of interests. The pooling of interests method of
accounting requires the restatement of all periods presented as if Salomon and
Smith Barney had always been combined. Certain reclassifications have been made
to conform the accounting policies of Salomon and Smith Barney.
The separate results of operations for Salomon and Smith Barney during the
periods preceding the Merger that are included in the Company's Consolidated
Statements of Income were as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
Nine months ended Year ended Year ended
Dollars in millions September 30, 1997 December 31, 1996 December 31, 1995
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues, net of interest
Salomon $3,302 $ 4,402 $3,282
Smith Barney 5,148 6,266 5,408
-----------------------------------------------------------------------------------------------
Total revenues, net of interest $8,450 $10,668 $8,690
===============================================================================================
Net income
Salomon $ 599 $ 617 $ 457
Smith Barney 770 883 595
-----------------------------------------------------------------------------------------------
Total net income $1,369 $ 1,500 $1,052
===============================================================================================
</TABLE>
As a result of the Merger, the Company booked a pre-tax restructuring charge of
$838 million ($496 million after tax) in 1997. Approximately $663 million of
this charge is related to excess or unused office space and other
facilities-related write-offs. Approximately $161 million of the charge is
severance, which relates to approximately 1,900 employees, primarily in the
United States, of which approximately 1,400 are support functions and
approximately 500 are production-related. At December 31, 1997, the reserve
balance associated with the restructuring charge was $825 million.
F-8
<PAGE> 55
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States, which require the use of
management's best judgment and estimates. Estimates, including the fair value of
financial instruments, commodities and contractual commitments, may vary from
actual results.
The Company provides investment banking, asset management, brokerage, securities
trading, advisory and other financial services to customers, and engages in
proprietary trading activities for its own account.
Material intercompany transactions have been eliminated in consolidation.
Long-term investments in operating joint ventures and affiliated (20% to 50%
owned) companies are carried on the equity method of accounting and are included
in "Other assets." The Company's equity in the earnings of joint ventures and
affiliates is reported in "Other" revenues.
Assets and liabilities denominated in non-U.S. dollar currencies are translated
into U.S. dollar equivalents using year-end spot foreign exchange rates.
Revenues and expenses are translated monthly at amounts that approximate
weighted average exchange rates, with resulting gains and losses included in
income. The effects of translating the statements of financial condition of
non-U.S. subsidiaries with functional currencies other than the U.S. dollar are
recorded, net of related hedge gains and losses and income taxes, as "Cumulative
translation adjustments," a separate component of "Stockholder's equity." Hedges
of such exposure include designated issues of non-U.S. dollar term debt and, to
a lesser extent, forward currency contracts.
As discussed in Note 4 of the consolidated financial statements, Basis
Petroleum, Inc. ("Basis Petroleum") is classified as a discontinued operation in
the Company's consolidated financial statements.
CASH AND CASH EQUIVALENTS The Company defines "Cash and cash equivalents" as
highly liquid investments with original maturities of three months or less at
the time of purchase, other than investments held for sale in the ordinary
course of business.
COLLATERALIZED SHORT-TERM FINANCING AGREEMENTS Securities purchased under
agreements to resell ("reverse repurchase agreements") and securities sold under
agreements to repurchase ("repurchase agreements") are collateralized
principally by government and government agency securities and generally have
terms ranging from overnight to up to five years and are carried at their
contractual amounts, including accrued interest as specified in the respective
agreements. In the determination of income, certain financing transactions are
marked to fair value, which has no material effect on the Company's results of
operations.
F-9
<PAGE> 56
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
It is the Company's policy to take possession of the underlying collateral,
monitor its market value relative to the amounts due under the agreements, and,
when necessary, require prompt transfer of additional collateral or reduction in
the loan balance in order to maintain contractual margin protection. In the
event of counterparty default, the financing agreement provides the Company with
the right to liquidate the collateral held. Reverse repurchase and repurchase
agreements are reported net by counterparty, when applicable, pursuant to the
provisions of Financial Accounting Standards Board ("FASB") Interpretation 41,
Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase
Agreements ("FIN 41"). Excluding the impact of FIN 41, reverse repurchase
agreements totaled $114.3 billion at December 31, 1997. At December 31, 1997,
the market value of securities collateralizing reverse repurchase agreements was
$116.6 billion.
Deposits paid for securities borrowed ("securities borrowed") and deposits
received for securities loaned ("securities loaned") are recorded at the amount
of cash advanced or received and are collateralized principally by government
and government agency securities, corporate debt and equity securities. The
Company monitors the market value of securities borrowed and securities loaned
daily, and additional collateral is obtained as necessary. Excluding the impact
of FIN 41, securities borrowed totaled $40.5 billion at December 31, 1997. At
December 31, 1997, the market value of securities collateralizing securities
borrowed was $40.1 billion.
FINANCIAL INSTRUMENTS, COMMODITIES AND CONTRACTUAL COMMITMENTS Financial
instruments, commodities and contractual commitments (also referred to as
"derivative instruments"), including derivatives used for trading purposes, are
recorded at either market value or, when market prices are not readily
available, fair value, which is determined under an alternative approach, such
as matrix or model pricing. Fair value includes related accrued interest or
dividends. The determination of market or fair value considers various factors,
including: closing exchange or over-the-counter market price quotations; time
value and volatility factors underlying options, warrants and contractual
commitments; price activity for equivalent or synthetic instruments in markets
located in different time zones; counterparty credit quality; and the potential
impact on market prices or fair value of liquidating the Company's positions in
an orderly manner over a reasonable period of time under current market
conditions.
The majority of the Company's financial instruments, commodities and contractual
commitments are recorded on a trade date basis. Recording the remaining
instruments on a trade date basis would not materially affect the consolidated
financial statements. Commissions, underwriting, and principal transaction
revenues and related expenses are recognized in income on a trade date basis.
Customer security transactions are recorded on a settlement date basis.
DERIVATIVE INSTRUMENTS
Derivatives Used for Trading Purposes
Derivatives used for trading purposes include interest rate, currency and
commodity swap agreements, swap options, caps and floors, options, warrants and
financial and commodity futures and forward contracts. The market values
(unrealized gains and losses) associated with contractual commitments are
reported net by counterparty, provided a legally enforceable master netting
agreement exists, and are netted across products and against cash collateral
when such provisions are stated
F-10
<PAGE> 57
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in the master netting agreement. Contractual commitments in a net receivable
position, as well as options owned and warrants held, are reported as assets in
"Contractual commitments." Similarly, contractual commitments in a net payable
position, as well as options written and warrants issued, are reported as
liabilities in "Contractual commitments." This category also includes the
Company's long-term obligations that have principal repayments directly linked
to equity securities of unaffiliated issuers for which the Company holds in
inventory a note exchangeable for the same equity securities. Cash collateral
received in connection with interest rate swaps totaled $340 million and $250
million at December 31, 1997 and 1996, respectively, and cash collateral paid
totaled $2,507 million and $1,637 million, respectively. Revenues generated from
derivative instruments used for trading purposes are reported as "Principal
transactions" and include realized gains and losses as well as unrealized gains
and losses resulting from changes in the market or fair value of such
instruments.
Margin on futures contracts is included in "Receivables - Brokers, dealers and
clearing organizations" and "Payables and accrued liabilities - Brokers, dealers
and clearing organizations."
Derivatives Used for Non-Trading Purposes
Non-trading derivative instruments that are designated as hedges must be
effective at reducing the risk associated with the exposure being hedged and
must be designated as a hedge at the inception of the derivative contract.
Accordingly, changes in the market or fair value of the derivative instrument
must be highly correlated with changes in the market or fair value of the
underlying hedged item. The Company monitors the effectiveness of its hedges by
periodically comparing the change in value of the derivative instrument with the
change in value of the underlying hedged item. Derivatives used as hedges
include interest rate swaps, cross currency swaps and forward currency
contracts.
Interest rate and cross currency swaps are utilized to effectively convert a
portion of the Company's short-term borrowings and the majority of its fixed
rate term debt to variable rate instruments. These swaps are recorded
"off-balance sheet," with accrued inflows and outflows reflected as adjustments
to interest expense. Upon early termination of an underlying hedged instrument,
the derivative is accounted for at market or fair value and the impact is
recognized currently in income. Changes in market or fair value of such
instruments, or realized gains or losses resulting from the termination of such
instruments, are also recognized currently in income.
The Company utilizes forward currency contracts to hedge a portion of the
currency exchange rate exposure relating to non-U.S. dollar term debt issued by
the Company. The impact of translating the forward currency contracts and the
related debt to prevailing exchange rates is recognized currently in income. The
Company also utilizes forward currency contracts to hedge certain investments in
subsidiaries with functional currencies other than the U.S. dollar. The impact
of marking open contracts to prevailing exchange rates and the impact of
realized gains or losses on maturing contracts, both net of the related tax
effects, are included in "Cumulative translation adjustments" in "Stockholder's
equity" as is the impact of translating the investments being hedged. Upon the
disposition of an investment in a subsidiary with a functional currency other
than the U.S. dollar, accumulated gains or losses previously included in
"Cumulative translation adjustments" are recognized currently in income.
F-11
<PAGE> 58
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Derivative instruments that do not meet the criteria to be designated as a hedge
are considered trading derivatives and are recorded at market or fair value.
See Note 7 of the consolidated financial statements for a further discussion of
the use of interest rate swaps and forward currency contracts for non-trading
purposes.
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS Property, equipment and leasehold
improvements are carried at cost less accumulated depreciation and amortization.
Depreciation and amortization are recorded substantially on a straight-line
basis over the lesser of the estimated useful lives of the related assets or
noncancelable lease terms, as appropriate. Maintenance and repairs are charged
to occupancy expense as incurred.
The cost of purchased software is capitalized and amortized over a three-year
period. Costs incurred in connection with the internal development of software,
solely for the Company's use, as well as the customization of purchased
software, are expensed in the period incurred.
INTANGIBLE ASSETS The excess of purchase price over fair value of net assets
acquired, which amounted to $391 million at December 31, 1997, is being
amortized over 40 years. The Company amortizes other intangible assets, which
are included in "Other assets," on a straight-line basis over their estimated
useful lives ranging from 7 to 20 years.
NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 1997, the Company adopted
SFAS 125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities ("SFAS 125"). This statement establishes
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities. These standards are based on a
approach that focuses on control. Under this approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets when
control has been surrendered and derecognizes liabilities when extinguished.
SFAS 125 provides standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. In December 1996 the
FASB issued SFAS 127, Deferral of the Effective Date of Certain Provisions of
FASB Statement No. 125, which delays until January 1, 1998 the effective date
for certain provisions. Earlier or retroactive application is not permitted. The
adoption of the provisions of this Statement effective January 1, 1997 did not
have a material impact on results of operations, financial condition or
liquidity. The adoption of the provisions of SFAS 127 effective January 1, 1998
will not have any impact on results of operations or liquidity; however, total
assets and total liabilities may increase significantly by like amounts.
In June 1997, the FASB issued SFAS 130, Reporting Comprehensive Income and SFAS
131, Disclosures about Segments of an Enterprise and Related Information. The
Company is currently assessing these statements, which are effective for fiscal
years beginning after December 15, 1997 and establish standards for the
reporting and display of comprehensive income and disclosure related to
segments.
F-12
<PAGE> 59
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. PRINCIPAL TRANSACTION REVENUES
The following table presents principal transaction revenues by business activity
from continuing operations for the years ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
Dollars in millions
For the Year Ended December 31, 1997 1996 1995
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fixed income $1,882 $2,049 $ 900
Equities 397 576 995
Commodities 218 393 238
Other 7 9 7
------------------------------------------------------------------------------------------------------
Total principal transaction revenues $2,504 $3,027 $2,140
======================================================================================================
</TABLE>
FIXED INCOME Fixed income revenues include realized and unrealized gains and
losses arising from the trading of government and government agency securities,
investment and non-investment grade corporate debt, municipal securities, and
preferred stock, mortgage securities (primarily U.S. government agencies,
including interest only and principal only strips), and emerging market fixed
income securities and derivatives. Revenues also include realized and unrealized
gains and losses generated from a variety of fixed income securities utilized in
arbitrage strategies for the Company's own account, and realized and unrealized
gains and losses arising from the spot and forward trading of currencies and
exchange-traded and over-the-counter ("OTC") currency options. Realized and
unrealized gains and losses resulting from changes in the market or fair value
of options on fixed income securities, interest rate swaps, currency swaps, swap
options, caps and floors, financial futures, options and forward contracts on
fixed income securities are reflected as fixed income revenue.
EQUITIES Revenues from equities consist of realized and unrealized gains and
losses arising from proprietary and customer trading of U.S. and non-U.S. equity
securities, including common and convertible preferred stock, convertible
corporate debt, equity-linked notes and exchange-traded and OTC equity options
and warrants. Revenues also include realized and unrealized gains and losses on
equity securities and related derivatives utilized in arbitrage strategies for
the Company's own account.
F-13
<PAGE> 60
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMODITIES The Company, primarily through its wholly owned subsidiary Phibro
Inc. and its wholly owned subsidiaries (collectively, "Phibro"), conducts a
commodities trading and dealer business. Commodities traded include crude oil,
refined oil products, natural gas, electricity, metals and various soft
commodities. In December 1997, Phibro began implementing a downsizing plan that
will significantly reduce the scope of some of its activities. In 1996, Phibro
discontinued trading coal, coke and fertilizers. Commodity revenues consist of
realized and unrealized gains and losses from trading these commodities and
related derivative instruments.
NOTE 4. DISCONTINUED OPERATIONS
In March 1997, Salomon's Board of Directors approved a non-binding letter of
intent to sell all of the outstanding stock of Basis Petroleum to Valero Energy
Corporation ("Valero") and a plan of disposition for Basis Petroleum. This
transaction resulted in a pretax loss in 1996 of approximately $505 million
($290 million after tax). The sale was completed on May 1, 1997. Proceeds from
the sale included cash of $365 million, Valero common stock with a market value
of $120 million and participation payments based on a fixed notional throughput
and the difference, if any, between an average market crackspread, as defined,
and a base crackspread, as defined, over each of the next ten years. The total
of the participation payments is capped at $200 million, with a maximum of $35
million per year. In addition, as a result of Valero's merger agreement with
PG&E Corporation, Valero's common stock was exchanged for stock of PG&E
Corporation and a new stock of the "spin-off" company ("New Valero"),
representing Valero's refining assets. In the third quarter of 1997, the Company
liquidated its interest in the PG&E and New Valero common stock. In July 1997,
the Company paid Valero $3 million in connection with the final determination of
working capital. The estimated loss includes severance costs and anticipated
operating losses to be incurred prior to the completion of the sale, and
reflects other estimates of value at time of closing. The Company's investment
in Genesis Energy, L.P., a publicly traded crude oil gathering, marketing and
transportation partnership, was not transferred to Valero.
The following tables present Basis Petroleum's results of operations and the
loss on the disposal of Basis Petroleum, which are included in "Discontinued
operations" on the consolidated statements of income, as well as details of
Basis Petroleum's net assets at December 31, 1996, which are included in "Net
realizable value of discontinued operations" on the consolidated statements of
financial condition.
F-14
<PAGE> 61
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
Dollars in millions
Year ended December 31, 1997 1996 1995
--------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Discontinued operations:
Revenues, net of interest - $ (85) $ (48)
Expenses - 38 43
--------------------------------------------------------------------------------------------------------
Loss before income taxes - (123) (91)
Benefit for income taxes - (48) (35)
--------------------------------------------------------------------------------------------------------
Loss from operations - (75) (56)
Loss on sale, net of tax benefit of $215 - (290) -
--------------------------------------------------------------------------------------------------------
Loss from discontinued operations, net of taxes - $ (365) $ (56)
--------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
Dollars in millions December 31, 1996
-------------------------------------------------------------------------------------------------
<S> <C>
ASSETS
Commodities-related products and instruments $ 379
Receivables 438
Property, plant and equipment, net of accumulated
depreciation of $202 823
Other assets 34
-------------------------------------------------------------------------------------------------
Total assets $1,674
-------------------------------------------------------------------------------------------------
LIABILITIES
Customer payables $ 512
Other payables 150
Commodities-related contractual commitments 17
-------------------------------------------------------------------------------------------------
Total liabilities 679
-------------------------------------------------------------------------------------------------
Net assets 995
Pretax loss on sale (505)
-------------------------------------------------------------------------------------------------
Net realizable value of discontinued operations $ 490
-------------------------------------------------------------------------------------------------
</TABLE>
F-15
<PAGE> 62
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5. GEOGRAPHIC DATA
The accompanying table summarizes the Company's operations by geographic area.
Amounts are determined principally by the respective legal jurisdictions of the
Company's subsidiaries. Because of the global nature of the financial and
commodities markets in which the Company competes and the integration of the
Company's worldwide business activities, the Company believes that amounts
determined in this manner are not particularly useful in understanding its
business.
<TABLE>
<CAPTION>
Revenues Income (Loss) from
before Interest Continuing Operations
Dollars in millions Expense Before Income Taxes Total Assets*
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Year Ended December 31, 1997
North America $16,601 $1,376 $162,684
Europe 4,506 351 82,497
Asia and other 370 93 31,439
----------------------------------------------------------------------------------------------------------------
Consolidated $21,477 $1,820 $276,620
----------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1996
North America $15,298 $2,943 $152,423
Europe 3,365 77 76,875
Asia and other 180 44 16,816
----------------------------------------------------------------------------------------------------------------
Consolidated $18,843 $3,064 $246,114
----------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1995
North America $12,844 $1,256 $141,956
Europe 4,370 607 75,292
Asia and other 273 (43) 12,139
----------------------------------------------------------------------------------------------------------------
Consolidated $17,487 $1,820 $229,387
----------------------------------------------------------------------------------------------------------------
</TABLE>
* The net realizable value of Basis Petroleum is included in North America
in 1996. The total assets of Basis Petroleum of $1,747 million are
included in North America in 1995.
F-16
<PAGE> 63
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS
Information regarding the Company's short-term borrowings used to finance
operations, including the securities settlement process is presented below.
Average balances were computed based on month-end outstanding balances.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
Dollars in millions
Year Ended December 31, 1997 1996
-------------------------------------------------------------------------------------------------------
<S> <C> <C>
Bank borrowings:
Balance at year-end $2,415 $4,388
Weighted average interest rate 5.9% 5.8%
Annual averages --
Amount outstanding $3,766 $2,950
Weighted average interest rate 5.3% 4.7%
Maximum amount outstanding at any month-end $5,436 $4,388
-------------------------------------------------------------------------------------------------------
Commercial paper:
Balance at year-end $7,110 $4,133
Weighted average interest rate 5.8% 5.7%
Annual averages --
Amount outstanding $5,189 $3,636
Weighted average interest rate 5.6% 5.4%
Maximum amount outstanding at any month-end $7,110 $4,238
-------------------------------------------------------------------------------------------------------
Other short-term borrowings:
Balance at year-end $1,939 $1,499
=======================================================================================================
</TABLE>
Outstanding bank borrowings include both U.S. dollar and non-U.S. dollar
denominated loans. The non-U.S. dollar loans are denominated in multiple
currencies including Japanese yen, German mark and U.K. sterling. All of the
Company's commercial paper outstanding at December 31, 1997 and 1996 was U.S.
dollar denominated. Also included in short-term borrowings are deposit
liabilities and other short-term obligations.
The Company has a $750 million 364-day revolving credit agreement that extends
through May 1998. The Company may borrow under its revolving credit facility at
various interest rate options (LIBOR, CD or base rate) and compensates the banks
for the facility through commitment fees. Salomon Brothers Inc ("SBI"), an
indirect wholly owned subsidiary, has a committed secured standby bank credit
facility for financing securities positions. The facility, which has a capacity
of $2.1 billion, contains certain restrictive covenants that require, among
other things, that SBI maintain minimum levels of excess net capital and net
worth, as defined. SBI's excess net capital exceeded the minimum required under
the facility by $574 million and SBI's net worth exceeded the minimum amount
required by $1.0 billion at December 31, 1997. In 1996, Salomon Brothers
International Limited ("SBIL"), an indirect wholly owned subsidiary, entered
into a $1.0 billion committed securities repurchase facility. The facility is
subject to restrictive covenants including a requirement that SBIL maintain
minimum levels of tangible net worth and excess financial resources, as defined.
At December 31, 1997, SBIL exceeded these requirements by $4.0 billion and $699
million, respectively.
F-17
<PAGE> 64
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 1997, Phibro Inc. entered into an unsecured committed revolving line of
credit. This facility, which has a capacity of $550 million, requires Phibro
Inc. to maintain minimum levels of capital and net working capital, as defined.
Phibro Inc. exceeded these minimums by $54 million and $98 million,
respectively, at December 31, 1997.
At December 31, 1997, there were no outstanding borrowings under any of these
facilities. In addition, the Company also has substantial borrowing arrangements
consisting of facilities that the Company has been advised are available, but
where no contractual lending obligation exists.
NOTE 7. TERM DEBT
Term debt, net of unamortized discount and including unamortized premium, if
applicable, consists of issues with original maturities in excess of one year.
Certain issues are redeemable, in whole or in part, at par or at premiums prior
to maturity.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
Fixed Rate
Obligations Fixed Rate Total Fixed Variable
Swapped to Obligations Rate Rate Total Total
Dollars in millions Variable Not Swapped Obligations Obligations Dec. 31, 1997 Dec. 31, 1996
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (Parent Company) $ 9,557 $3,592 $13,149 $2,498 $15,647 $11,693
Subsidiaries - - - - - 19
- -------------------------------------------------------------------------------------------------------------------------------
U.S. dollar denominated 9,557 3,592 13,149 2,498 15,647 11,712
- -------------------------------------------------------------------------------------------------------------------------------
Non-U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (Parent Company) 485 176 661 1,473 2,134 2,155
Subsidiaries 1,149 16 1,165 128 1,293 1,881
- -------------------------------------------------------------------------------------------------------------------------------
Non-U.S. dollar denominated 1,634 192 1,826 1,601 3,427 4,036
- -------------------------------------------------------------------------------------------------------------------------------
Term debt $11,191 $3,784 $14,975 $4,099 $19,074 $15,748
===============================================================================================================================
</TABLE>
F-18
<PAGE> 65
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The maturity structure of the Company's term debt, based on contractual
maturities or the earliest date on which the debt is repayable at the option of
the holder, was as follows at December 31, 1997:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
Salomon Smith Barney
Holdings Inc.
Dollars in millions (Parent Company) Subsidiaries Total
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1998 $ 3,740 $ 148 $ 3,888
1999 2,859 19 2,878
2000 2,714 275 2,989
2001 1,658 214 1,872
2002 2,428 52 2,480
Thereafter 4,382 585 4,967
----------------------------------------------------------------------------------------------------
Total $ 17,781 $ 1,293 $ 19,074
----------------------------------------------------------------------------------------------------
</TABLE>
The Company issues U.S. dollar and non-U.S. dollar denominated fixed and
variable rate term debt. Fixed rate debt matures at various dates through 2023.
The contractual interest rates on fixed rate debt ranged from 1.25% (U.S. dollar
denominated) to 11.82% (U.S. dollar denominated) at December 31, 1997 and 1.25%
(Japanese yen denominated) to 10.13% (U.S. dollar denominated) at December 31,
1996. The weighted average contractual rate on total fixed rate term debt (both
U.S. dollar denominated and non-U.S. dollar denominated) was 6.76% at December
31, 1997 and 6.74% at December 31, 1996. The Company utilizes interest rate swap
agreements to convert most of its fixed rate term debt to variable rate
obligations. The maturity structure of the swaps generally corresponds with the
maturity structure of the debt being hedged.
The Company's non-U.S. dollar fixed rate term debt was issued across a broad
range of currencies (including Japanese yen, German mark, U.K. sterling, Italian
lira, French franc, and Portuguese escudos) and, consequently, the term debt
bears a wide range of interest rates.
At December 31, 1997, the Company had outstanding approximately $3.4 billion of
non-U.S. dollar denominated term debt, of which $.9 billion was Japanese yen
denominated, $1.2 billion was German mark denominated and $.8 billion was U.K.
sterling denominated (converted at the December 31, 1997 spot rates). Of the
$3.4 billion, approximately $.8 billion of Salomon Smith Barney Holdings Inc.
(Parent Company) non-U.S. dollar denominated debt has been designated as a hedge
of investments in subsidiaries with functional currencies other than the U.S.
dollar. Another $1.2 billion of Parent Company debt has been effectively
converted to U.S. dollar denominated obligations using cross-currency swaps. The
remaining $1.4 billion is used for general corporate purposes.
F-19
<PAGE> 66
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the Company's fixed rate term debt that is
swapped to variable rate obligations using interest rate swaps at December 31,
1997 and 1996. The variable rates presented are indicative of the Company's
actual costs related to such obligations.
<TABLE>
<CAPTION>
1997 1996
---------------------------------------------- ----------------------------------------------
Contractual Contractual
Weighted Weighted
Average Average
Fixed Rate Fixed Rate
on Swapped Weighted Average on Swapped Weighted Average
Principal Fixed Rate Variable Rate on Principal Fixed Rate Variable Rate on
(Dollars in millions) Balance Term Debt Swapped Term Debt Balance Term Debt Swapped Term Debt
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. dollar denominated $ 9,557 6.8% 6.5% $6,670 7.0% 6.7%
German mark denominated 1,069 7.4 3.8 1,252 7.4 4.7
Japanese yen denominated 77 4.6 0.8 420 4.3 0.8
Japanese yen swapped to
U.S. dollar denominated 187 3.9 6.7 317 3.6 6.9
French franc swapped to
U.S. dollar denominated 168 5.4 6.7 - - -
Swiss franc swapped to
U.S. dollar denominated - - - 65 5.1 6.1
Italian lira swapped to
U.S. dollar denominated 62 3.9 6.5 40 9.9 6.8
U.K. sterling denominated 4 7.6 7.5 4 7.6 7.5
Portuguese escudos swapped
to U.S. dollar
denominated 67 5.3 6.5 3 9.5 7.1
- ------------------------------------------------------------------------------------------------------------------------------
Total swapped
fixed rate term debt $ 11,191 6.8% 6.2% $8,771 6.8% 6.1%
==============================================================================================================================
</TABLE>
Variable rate term debt matures at various dates through 2007. The interest
rates are determined periodically by reference to money market rates, or in
certain instances, are calculated based on stock or bond market indices as
specified in the agreements governing the respective issues. The interest rates
on variable rate term debt ranged from 0.82% (Japanese yen denominated) to
11.63% (U.S. dollar denominated) at December 31, 1997 and .41% (Japanese yen
denominated) to 9.36% (U.S. dollar denominated) at December 31, 1996. The
weighted average contractual rate on total variable rate term debt (both U.S.
dollar denominated and non-U.S. dollar denominated) was 5.83% at December 31,
1997 and 4.89% at December 31, 1996.
Term debt includes subordinated debt, which totaled $28 million at December 31,
1997 and $32 million at December 31, 1996. At December 31, 1997 and 1996,
subordinated debt included approximately $6 million of convertible restricted
notes, convertible at the rate of $8.19 per share into 668,888 shares and
685,516 shares of Travelers Group Inc. common stock at December 31, 1997 and
1996, respectively. At December 31, 1997, the Company had outstanding $61
million of term debt for which the principal repayment is linked to certain
equity securities of unaffiliated issuers.
The Company has a $1.25 billion revolving credit agreement with a bank syndicate
that extends through May 2000, under which it may borrow at various interest
rate options (LIBOR, CD or base rate) and compensates the banks for the facility
through commitment fees. At December 31, 1997, there were no outstanding
borrowings under this facility.
F-20
<PAGE> 67
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company is limited by covenants in its revolving credit facilities as to the
amount of dividends that may be paid to Travelers Group Inc. The amount of
dividends varies based upon, among other things, levels of net income of the
Company.
NOTE 8. LEASE COMMITMENTS
The Company has noncancelable leases covering office space and equipment
expiring on various dates through 2010. Presented below is a schedule of minimum
future rentals on noncancelable operating leases, net of subleases, as of
December 31, 1997. Various leases contain provisions for lease renewals and
escalation of rent based on increases in certain costs incurred by the lessors.
<TABLE>
<CAPTION>
------------------------------------------------------------------
Dollars in millions
------------------------------------------------------------------
<S> <C>
1998 $ 215
1999 203
2000 137
2001 121
2002 105
Thereafter 505
------------------------------------------------------------------
Minimum future rentals $1,286
------------------------------------------------------------------
</TABLE>
Minimum future rentals include $638 million related to space the Company has
vacated or intends to vacate. The Company has provided reserves for these
premises. Rent expense under operating leases from continuing operations totaled
$258 million, $251 million and $270 million for the years ended December 31,
1997, 1996 and 1995, respectively.
NOTE 9. GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY SUBORDINATED
DEBT SECURITIES
On July 3, 1996, the Company issued $345 million or 13,800,000 trust preferred
units. Each unit includes a 9-1/4% mandatorily redeemable preferred security of
the SI Financing Trust I (the "Trust") and a purchase contract that requires the
holder to purchase, in 2021 (or earlier if the Company elects to accelerate the
contract), one depositary share representing a one-twentieth interest in a share
of Travelers Group Inc.'s 9-1/2% Cumulative Preferred Stock, Series L ("Series L
Preferred"). The Company is obligated under the terms of each purchase contract
to pay contract fees of 0.25% per annum, which is included as dividends in the
consolidated statement of changes in stockholder's equity. The Trust is a wholly
owned subsidiary of the Company and the Company's obligations under the
guarantee, the subordinated debt securities and other contracts, in the
aggregate, constitute a full and unconditional guarantee by the Company of the
Trust's obligations under the preferred securities.
The Trust was established by the Company for the sole purpose of issuing the
9-1/4% preferred securities and common securities and investing the proceeds in
$356 million aggregate principal amount of 9-1/4% subordinated debt securities
issued by Salomon Smith Barney Holdings Inc. due June 30, 2026. The sole asset
of the Trust is the subordinated debt securities. All payments associated with
the 9-1/4% preferred securities are fully and unconditionally guaranteed by
Salomon
F-21
<PAGE> 68
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Smith Barney Holdings Inc. The 9-1/2% per annum on the trust preferred units was
accrued from date of issuance and is payable quarterly, commencing September 30,
1996.
The trust preferred units are redeemable at the option of the Company at any
time on or after June 30, 2001. The Series L Preferred is redeemable at the
option of Travelers Group Inc. at any time on or after June 30, 2001 or the date
of issue, if later. However, if the purchase contracts are accelerated or
exercised by the Company and the holders elect not to settle the purchase
contracts by delivering the Trust preferred security, the right of the Company
to cause the Series L Preferred to be redeemed is postponed for five years.
NOTE 10. CAPITAL REQUIREMENTS
Certain U.S. and non-U.S. subsidiaries are subject to various securities and
commodities regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the countries in which they operate.
Capital requirements related to the Company's principal regulated subsidiaries
are as follows:
<TABLE>
<CAPTION>
Excess over
Dollars in millions Net Capital minimum
Subsidiary Jurisdiction or equivalent requirement
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Salomon Brothers Inc U.S. Securities and Exchange Commission Uniform $1,047 $ 974
Net Capital Rule (Rule 15c3-1)
Smith Barney Inc. U.S. Securities and Exchange Commission Uniform $1,086 $ 884
Net Capital Rule (Rule 15c3-1)
Salomon Brothers International Limited United Kingdom's Securities and Futures Authority $4,796 $ 699
Salomon Brothers Asia Limited Japan's Ministry of Finance $ 718 $ 307
Salomon Brothers AG Germany's Banking Supervisory Authority $ 219 $ 32
The Robinson-Humphrey Company, LLC U.S. Securities and Exchange Commission Uniform $ 67 $ 66
Net Capital Rule (Rule 15c3-1)
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Advances, dividend payments and other equity withdrawals from regulated
subsidiaries are restricted by the regulations of the U.S. Securities and
Exchange Commission, the New York Stock Exchange and other regulatory agencies
and by certain covenants contained in the Company's revolving credit facilities.
See Notes 6 and 7 to the consolidated financial statements. These restrictions
may limit the amounts that these subsidiaries pay as dividends or advances to
the Company.
In addition, in order to maintain its triple-A rating, Salomon Swapco Inc
("Swapco"), an indirect wholly owned subsidiary of the Company, must maintain
minimum levels of capital in accordance with agreements with its rating
agencies. At December 31, 1997, Swapco was in compliance with all such
agreements. Swapco's capital requirements are dynamic, varying with the size and
concentration of its counterparty receivables.
F-22
<PAGE> 69
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. EMPLOYEE BENEFIT PLANS
The Company's current employee benefit plans are substantially unchanged from
the respective plans that were in effect for Salomon and Smith Barney prior to
the Merger. Accordingly, the following information summarizes both the Salomon
and Smith Barney predecessor plans.
The Company is currently in the process of reviewing the benefit plans of both
predecessor institutions.
SALOMON PREDECESSOR PLANS
RETIREMENT PLANS
Substantially all full-time U.S. employees of Salomon participate in defined
contribution plans. These plans resulted in expenses from continuing operations
of $33 million, $34 million and $26 million in 1997, 1996 and 1995,
respectively.
Non-U.S. employees generally participate in defined benefit plans that are
insured or otherwise funded. These plans resulted in expenses from continuing
operations of $27 million, $25 million and $25 million in 1997, 1996 and 1995,
respectively.
HEALTH CARE AND LIFE INSURANCE
Salomon provides certain health care and life insurance benefits for its active
employees, qualifying retired U.S. employees and certain non-U.S. employees who
reach the retirement criteria specified by the various plans. Salomon
self-insures such benefit programs. At December 31, 1997, there were
approximately 7,300 active and 700 retired employees eligible for such benefits.
Expenses recorded for health care and life insurance benefits from continuing
operations were $36 million, $33 million and $39 million in 1997, 1996 and 1995,
respectively.
Salomon provides for the cost of postretirement benefits other than pensions
over the service periods of eligible employees. The present value of the
liability related to these benefits and postemployment benefits, included in
"Payables and accrued liabilities-Other," was $88 million and $84 million at
December 31, 1997 and 1996, respectively.
EMPLOYEE INCENTIVE PLANS
In the following presentation, all per share amounts and option prices have been
adjusted by the 1.695 exchange ratio to reflect the conversion of the plans to
Travelers Group Inc. common stock.
F-23
<PAGE> 70
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SALOMON STOCK INCENTIVE PLAN ("SIP") The SIP provides for the issuance of up to
5.9 million shares of Travelers Group Inc. common stock in the form of options,
restricted stock and stock bonuses, as well as an additional grant of up to 2.5
million shares of Travelers Group Inc. common stock in the form of stand-alone
stock appreciation rights, phantom stock and cash bonuses to key employees,
including officers. In December 1996, 2.7 million options were awarded under the
SIP with an exercise price set at the market value on the date of grant
($26.48). The awards expire five years after the grant date and vest 100% three
years after the grant date. At the grant date, the fair value per option issued
was $7.76, as estimated using the Black-Scholes option pricing model assuming a
risk-free interest rate of 5.88%, a constant annual dividend rate of $0.38 per
share, and expected volatility of 25%. Fair value also assumes an expected term
of 5 years and has not been reduced to reflect either the non-exercisable status
of the options prior to the vesting date or the non-transferability of the
options. SFAS 123, Accounting for Stock-Based Compensation ("SFAS 123"), allows
the fair value of stock-based compensation to be included in expense over the
period earned; alternatively, if the fair value of stock-based compensation
awards is not included in expense, SFAS 123 requires disclosure of net income,
on a pro forma basis, as if expense treatment had been applied. As permitted by
SFAS 123, the Company continues to account for such compensation under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25"), pursuant to which no compensation cost has been recognized
in connection with the issuance of stock options. Had the Company applied SFAS
123 in accounting for stock options, net income would have been reduced by $4
million and less than $1 million in 1997 and 1996, respectively.
THE NON-QUALIFIED STOCK OPTION PLAN OF 1984, AS AMENDED (THE "1984 PLAN") The
1984 Plan, which terminated on June 30, 1994, provided for the granting of
options to purchase common stock to certain key employees. Stock appreciation
rights accompanied some of the options granted. Exercise of such rights
extinguishes the related options. Options issued under the 1984 Plan expired in
1997.
Changes in options outstanding under the SIP and 1984 Plan are summarized as
follows:
<TABLE>
<CAPTION>
Grant Date Fair Value of
Number of Shares Option Price per Share Options Issued
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Shares under option at:
December 31, 1997* 2,508,600 $26.48
December 31, 1996 3,562,670 $10.70 - $26.48
December 31, 1995 1,209,332 $10.70 - $23.82
Options issued:
1996 2,712,000 $26.48 $7.76
Options exercised:
1997 849,144 $10.70 - $11.76
1996 347,814 $10.70 - $23.82
1995 1,042,798 $10.70 - $23.82
Options canceled or expired:
1997 204,926 $10.70 - $26.48
1996 10,848 $10.70 - $23.82
1995 185,941 $10.70 - $27.14
=====================================================================================================================
</TABLE>
* Consists solely of options issued under the SIP.
F-24
<PAGE> 71
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE EQUITY PARTNERSHIP PLAN (THE "EPP") The EPP, which began in 1990, was
amended for 1996 and future awards. Under the original EPP, qualifying employees
("participants") received a portion of their compensation in the form of common
stock, the payment of which is deferred for five years. The stock is purchased
by the EPP's trustee in the open market as well as from participants upon
distribution in order to satisfy their income tax withholding liabilities. The
portion of each participant's compensation paid in stock is fixed in relation to
total compensation, and for 1995 and prior years reached a maximum of 50% of
total compensation. Participants received the shares for 1995 and prior years
with an incentive of 17.65%, whereby the Company makes an additional
contribution to participants' accounts of 17.65% of their compensation deferred
into the EPP.
The amendments for 1996 and future awards included: an increase in the award
incentive from 17.65% to 25%, a reduction in the deferral period from five years
to three years, and the introduction of additional forfeiture provisions on both
the award and the incentive. The award is forfeited if the participant's
employment is terminated for cause (no change from prior EPP). The award is
subject to forfeiture provisions if the participant leaves the Company to join a
competitor within three years after the award date. If a participant leaves the
Company other than by virtue of death, disability, retirement or as the result
of a downsizing during the three years following the award, the entire 25% award
incentive will be forfeited. The EPP, as amended, also includes revisions to the
participation schedule which reduce the portion of participants' compensation
subject to the EPP (participation reaches a maximum of $1.5 million) and
increase the minimum level of annual compensation required for participation to
$360,000.
Total purchases of shares by the EPP totaled $192 million (4.8 million shares)
in 1997, $153 million (6.1 million shares) in 1996 and $76 million (3.6 million
shares) in 1995. Stock awarded under the EPP totaled $191 million (5.4 million
shares), $147 million (6.1 million shares) and $98 million (4.6 million shares)
in 1997, 1996 and 1995, respectively. These amounts are included as a component
of compensation expense. The net asset related to the EPP, which represents the
cost of the unawarded shares held by the EPP less Salomon's liability related to
the EPP, payable in common stock, is included in "Other assets."
In December 1997, restrictions on transferability were lifted on 3 million
shares (net of withholding tax requirements) awarded by the EPP in 1992.
Employees of certain subsidiaries of Salomon do not participate in the EPP or
are unable to participate in the EPP but instead receive stock appreciation
rights subject to the same terms as shares awarded under the EPP.
F-25
<PAGE> 72
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SMITH BARNEY PREDECESSOR PLANS
RETIREMENT PLANS
Smith Barney participates in a noncontributory defined benefit pension plan with
Travelers Group Inc. that covers substantially all of its U.S. employees.
Separate plans are maintained to cover non-U.S. employees. These plans resulted
in expenses of $26 million, $21 million and $45 million in 1997, 1996 and 1995,
respectively.
Smith Barney, through Travelers Group Inc., has a defined contribution employee
savings plan covering substantially all U.S. employees. The costs relating to
this plan were $1 million, $15 million and $20 million in 1997, 1996 and 1995,
respectively.
HEALTH CARE AND LIFE INSURANCE
Smith Barney provides certain health care and life insurance benefits for its
active employees, qualifying retired U.S. employees and certain non-U.S.
employees who reach the retirement criteria specified by the various plans. At
December 31, 1997, there were approximately 27,200 active and 600 retired
employees eligible for such benefits.
Expenses recorded for health care and life insurance benefits from continuing
operations were $85 million, $77 million, and $86 million in 1997, 1996 and
1995, respectively.
Smith Barney provides for the cost of postemployment and postretirement benefits
other than pensions over the service periods of eligible employees, primarily
related to disability and severance-related costs. During 1997, 1996 and 1995,
expenses for these benefits totaled $13 million, $13 million and $10 million,
respectively.
EMPLOYEE INCENTIVE PLANS
Smith Barney participates in a stock option plan sponsored by Travelers Group
Inc. that provides for the granting of stock options in Travelers Group Inc.
common stock to officers and key employees. The Company applies APB 25 and
related interpretations in accounting for stock options. Since stock options are
issued at fair market value on the date of award, no compensation cost has been
recognized for these awards. As permitted by SFAS 123, the Company continues to
account for such compensation under APB 25, pursuant to which no compensation
cost has been recognized in connection with the issuance of stock options. Had
the Company applied SFAS 123 in accounting for stock options, net income would
have been reduced by $36 million and $14 million in 1997 and 1996, respectively.
Smith Barney has various incentive plans under which stock of Travelers Group
Inc. is purchased for subsequent distribution to employees, subject to vesting
requirements. These plans resulted in expenses of $253 million, $171 million and
$143 million for the years ended December 31, 1997, 1996 and 1995, respectively.
F-26
<PAGE> 73
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. INCOME TAXES
The components of income taxes from continuing operations reflected on the
consolidated statements of income are:
<TABLE>
<CAPTION>
Dollars in millions
Year Ended December 31, 1997 1996 1995
----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current tax provision/(benefit):
U.S. federal $ 817 $1,097 $ 533
State and local 250 322 183
Non-U.S. 283 (13) 341
----------------------------------------------------------------------------------------------
Total current tax provision 1,350 1,406 1,057
----------------------------------------------------------------------------------------------
Deferred tax provision/(benefit):
U.S. federal (424) (205) (148)
State and local (142) (68) (65)
Non-U.S. (109) 66 (132)
----------------------------------------------------------------------------------------------
Total deferred tax benefit (675) (207) (345)
----------------------------------------------------------------------------------------------
Provision for income taxes $ 675 $1,199 $ 712
==============================================================================================
</TABLE>
Under SFAS 109, Accounting for Income Taxes, temporary differences between
recorded amounts and the tax bases of assets and liabilities are accounted for
at current income tax rates.
At December 31, 1997 and December 31, 1996, respectively, the Company's
consolidated statements of financial condition included net deferred tax assets
from continuing operations of $844 million and $217 million, comprised of the
following:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
Dollars in millions
Year Ended December 31, 1997 1996
----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Employee benefits and deferred compensation $1,087 $ 847
Lease obligations and fixed assets 214 -
Other deferred tax assets 292 244
----------------------------------------------------------------------------------------------------------
Total deferred tax assets 1,593 1,091
----------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Intangible assets (323) (329)
Mark-to-market adjustments (140) (287)
Cumulative translation adjustments (91) (114)
U.S. taxes provided on the undistributed earnings of non-U.S.
subsidiaries (119) (84)
Lease obligations and fixed assets - (23)
Other deferred tax liabilities (76) (37)
----------------------------------------------------------------------------------------------------------
Total deferred tax liabilities (749) (874)
----------------------------------------------------------------------------------------------------------
Net deferred tax asset $ 844 $ 217
==========================================================================================================
</TABLE>
The Company had no deferred tax valuation allowance at December 31, 1997 or
December 31, 1996.
Tax benefits (liabilities) allocated directly to stockholder's equity for the
years ended December 31, 1997, 1996 and 1995 were $64 million, $(4) million and
$2 million, respectively.
F-27
<PAGE> 74
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company paid taxes, net of refunds, of $918 million, $1,696 million and $710
million in 1997, 1996 and 1995, respectively. Of these respective amounts, Smith
Barney paid taxes of $727 million, $596 million and $350 million, the majority
of which was paid to Travelers Group Inc. under an income tax allocation
agreement. Salomon paid income taxes of $191 million in 1997, $1,100 million in
1996 and $360 million in 1995. These amounts include estimated tax payments
during the current tax year as well as cash settlements relating to prior tax
years. Salomon Inc and its wholly owned domestic subsidiaries filed their own
consolidated U.S. federal income tax return prior to the Merger.
The Company provides income taxes on the undistributed earnings of foreign
subsidiaries except to the extent that such earnings are indefinitely invested
outside the United States. At December 31, 1997, $1.3 billion of the Company's
accumulated undistributed earnings was indefinitely invested. At the existing
U.S. federal income tax rate, additional taxes of $376 million would have to be
provided if such earnings were remitted to the United States.
The following table reconciles the U.S. federal statutory income tax rate to the
Company's effective tax rate from continuing operations:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
Dollars in millions
Year Ended December 31, 1997 1996 1995
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory U.S. federal income tax rate for corporations 35% 35% 35%
Impact of:
State and local (net of U.S. federal tax) and foreign taxes 4 6 5
Tax advantaged income (3) (1) (2)
Other, net 1 (1) 1
---------------------------------------------------------------------------------------------------------------
Effective tax rate 37% 39% 39%
---------------------------------------------------------------------------------------------------------------
</TABLE>
F-28
<PAGE> 75
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. PLEDGED ASSETS, COMMITMENTS AND CONTINGENCIES
At December 31, 1997, the approximate market values of securities sold under
agreements to repurchase, excluding the impact of FIN 41, or pledged by the
Company were:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
Dollars in millions
--------------------------------------------------------------------------------------------------------
<S> <C>
For securities sold under agreements to repurchase $158,209
As collateral for securities borrowed of approximately equivalent value 59,139
As collateral on bank loans 1,066
To clearing organizations or segregated under securities laws and regulations 1,935
For securities loaned 14,269
As collateral for letters of credit 1,043
Other 431
--------------------------------------------------------------------------------------------------------
Repurchase agreements and securities pledged $236,092
--------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1997, the Company had $2.7 billion of outstanding letters of
credit from banks to satisfy various collateral and margin requirements.
OTHER CONTINGENCIES
The Company has provided a residual value guarantee of $586 million in
connection with the lease of the buildings occupied by the Company's executive
offices and New York operations.
On July 31, 1993, Smith Barney, along with certain of its affiliates and
Travelers Group Inc., acquired the domestic retail brokerage and asset
management businesses (the "Shearson Acquisition") of Lehman Brothers Holdings
Inc. (then known as Shearson Lehman Brothers Holdings Inc.) and its
subsidiaries. In conjunction with the Shearson Acquisition, Smith Barney Inc.
has agreed to pay American Express Company additional amounts contingent upon
Smith Barney Inc.'s future performance, consisting of up to $50 million per year
for three years based upon Smith Barney Inc.'s revenues (1996 was the final year
for this portion of the payout) and 10% of its after-tax profits in excess of
$250 million per year over a five-year period. Amounts paid under this agreement
amounted to $75 million and $110 million in 1997 and 1996, respectively. The
contingent consideration is accounted for prospectively, as additional purchase
price, and results in amortization over periods of up to 20 years.
F-29
<PAGE> 76
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14. LEGAL PROCEEDINGS
The Company has been named as a defendant in legal actions relating to its
operations, some of which seek damages of material or indeterminate amounts. In
addition, from time to time the Company is a party to examinations and inquiries
by various regulatory and self-regulatory bodies. In connection with its
discontinued commodities processing operations, the Company and certain of its
subsidiaries are subject to claims asserted by the U.S. Environmental Protection
Agency, certain state agencies and private parties in connection with
environmental matters. Management of the Company, after consultation with
outside legal counsel, believes that the ultimate resolution of legal
proceedings and environmental matters (net of applicable reserves) will not have
a material adverse effect on the Company's financial condition; however, such
resolution could have a material adverse impact on operating results in future
periods depending in part on the results for such periods.
NOTE 15. FINANCIAL INSTRUMENTS, COMMODITIES AND CONTRACTUAL COMMITMENTS
AND RELATED RISKS
The Company and its subsidiaries enter into a variety of contractual
commitments, such as swaps, cap and floor agreements, swap options, futures
contracts, forward currency contracts, forward purchase and sale agreements,
option contracts and warrants. These transactions generally require future
settlement, and are either executed on an exchange or traded as OTC instruments.
Contractual commitments have widely varying terms, and durations that range from
a few days to a number of years depending on the instrument.
Interest rate swaps are OTC instruments where two counterparties agree to
exchange periodic interest payment streams calculated on a predetermined
notional principal amount. The most common interest rate swaps generally involve
one party paying a fixed interest rate and the other party paying a variable
rate. Other types of swaps include basis swaps, cross-currency swaps, equity
swaps and commodity swaps. Basis swaps consist of both parties paying variable
interest streams based on different reference rates. Cross-currency swaps
involve the exchange of coupon payments in one currency for coupon payments in
another currency. An equity swap is an agreement to exchange cash flows on a
notional amount based on changes in the values of a referenced index, such as
the Standard & Poor's 500 Index. Commodity swaps involve the exchange of a fixed
price of a commodity for a floating price, which is usually the prevailing spot
price, throughout the swap term. The most common commodity swaps are
petroleum-based; other types are based on metals or soft commodities.
Caps are contractual commitments that require the writer to pay the purchaser an
excess amount, if the reference rate exceeds a contractual rate at specified
times during the contract. Likewise, a floor is a contractual commitment that
requires the writer to pay an excess amount, if any, of a contractual rate over
a reference rate at specified times over the life of the contract. Swap options
are OTC contracts that entitle the holder to either enter into an interest rate
swap at a future date or to cancel an existing swap at a future date.
F-30
<PAGE> 77
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Futures contracts are exchange-traded contractual commitments to either receive
(purchase) or deliver (sell) a standard amount or value of a commodity or
financial instrument at a specified future date and price (or, with respect to
futures contracts on indices, the net cash amount). Maintaining a futures
contract will typically require the Company to deposit with the futures exchange
(or other financial intermediary), as security for its obligations, an amount of
cash or other specified asset ("initial margin") that typically ranges from 1%
to 10% of the face amount of the contract (but may be higher in some
circumstances). Additional cash or assets ("variation margin") may be required
to be deposited daily as the mark-to-market value of the futures contract
fluctuates. Futures contracts may be settled by physical delivery of the
underlying asset or cash settlement (for index futures) on the settlement date,
or by entering into an offsetting futures contract with the futures exchange
prior to the settlement date. Forward contracts are OTC contractual commitments
to purchase or sell a specified amount of foreign currency, financial
instruments, or commodities at a future date at a predetermined price. The
notional amount for forward settling securities transactions represents the
amount of cash that will be paid or received by the counterparties when the
transaction settles. Upon settlement, the security is reflected on the statement
of financial condition as either long or short inventory.
Option contracts are contractual agreements that give the purchaser the right,
but not the obligation, to purchase or sell a currency, financial instrument or
commodity at a predetermined price. In return for this right, the purchaser pays
a premium to the seller (or writer) of the option. Option contracts also exist
for various indices and are similar to options on a security or other
instruments except that, rather than settling by physical delivery of the
underlying instrument, they are settled in cash. Options on futures contracts
give the purchaser the right, in return for the premium paid, to assume a
position in a futures contract. Warrants have characteristics similar to those
of options whereby the buyer has the right, but not the obligation, to purchase
a certain instrument at a specific future date and price. The seller (or writer)
of the option/warrant is subject to the risk of an unfavorable change in the
underlying financial instrument, commodity, or currency. The purchaser is
subject to market risk to the extent of the premium paid and credit risk. The
Company is obligated to post margin for options on futures. Option contracts may
be either exchange-traded or OTC. Exchange-traded options issued by certain
regulated intermediaries, such as the Options Clearing Corporation, are the
obligations of the issuing intermediary. In contrast to such options, which
generally have standardized terms and performance mechanics, all of the terms of
an OTC option, including the method of settlement, term, exercise price,
premium, guarantees and security, are determined by negotiation of the parties,
and there is no intermediary between the parties to assume the risks of
performance. The Company issues warrants that entitle holders to cash
settlements on exercise based upon movements in market prices of specific
financial instruments and commodities, foreign exchange rates and equity
indices.
The Company sells various financial instruments that have not been purchased
("short sales"). In order to sell them short, the Company borrows these
securities, or receives the securities as collateral in conjunction with
short-term financing agreements and, at a later date, must deliver (i.e.
replace) like or substantially the same financial instruments or commodities to
the parties from which they were originally borrowed. The Company is exposed to
market risk for short sales. If the market value of an instrument sold short
increases, the Company's obligation, reflected as a liability, would increase
and revenues from principal transactions would be reduced.
F-31
<PAGE> 78
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The way in which the Company accounts for and presents contractual commitments
in its financial statements depends on both the type and purpose of the
contractual commitment held or issued. As discussed in Note 2 to the
consolidated financial statements, the Company records all derivatives used for
trading purposes, including those used to hedge trading positions, at market or
fair value. Consequently, changes in the amounts recorded in the Company's
consolidated statements of financial condition resulting from movements in
market or fair value are included in "Principal transactions" in the period in
which they occur. The accounting and reporting treatment of derivatives used for
non-trading purposes varies, depending on the nature of exposure being hedged
(see Note 2 to the consolidated financial statements).
Contractual commitments and short sales risk may expose the Company to both
market risk and credit risk in excess of the amount recorded on the consolidated
statements of financial condition. These off-balance sheet risks are discussed
in more detail below.
MARKET RISK Market risk is the potential loss the Company may incur as a result
of changes in the market or fair value of a particular financial instrument,
commodity or contractual commitment. All financial instruments, commodities and
contractual commitments, including short sales, are subject to market risk. The
Company's exposure to market risk is determined by a number of factors,
including the size, duration, composition and diversification of positions held,
the absolute and relative levels of interest rates and foreign currency exchange
rates, as well as market volatility and illiquidity. For instruments such as
options and warrants, the time period during which the options or warrants may
be exercised and the relationship between the current market price of the
underlying instrument and the option's or warrant's contractual strike or
exercise price also affect the level of market risk. The most significant factor
influencing the overall level of market risk to which the Company is exposed is
its use of hedging techniques to mitigate such risk. The Company manages market
risk by setting risk limits and monitoring the effectiveness of its hedging
policies and strategies.
SFAS 105, Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit
Risk, and SFAS 119, Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments, require the disclosure of the notional amounts
of derivative financial instruments, distinguishing between those used for
trading purposes and those used for purposes other than trading. The
determination of notional amounts does not consider any of the market risk
factors discussed above. Notional amounts are indicative only of the volume of
activity and are not a measure of market risk. Market risk is influenced by the
nature of the items that comprise a particular category of financial instrument.
Market risk is also influenced by the relationship among the various off-balance
sheet categories as well as the relationship between off-balance sheet items and
items recorded in the Company's consolidated statements of financial condition.
For all of these reasons, the interpretation of notional amounts as a measure of
market risk could be materially misleading.
F-32
<PAGE> 79
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of contractual commitments as of December 31, 1997 and 1996 is as
follows:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
-------------------------------- --------------------------------
Current Market or Current Market or
Fair Value Fair Value
Notional -------------------- Notional ----------------------
Dollars in billions Amounts Assets Liabilities Amounts Assets Liabilities
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Exchange-issued products:
Futures contracts (a) $ 940.5 $ - $ - $ 530.9 $ - $ -
Other exchange-issued products:
Equity contracts 10.6 .2 .4 13.1 .1 .2
Fixed income contracts 138.1 - - 61.2 - -
Physical commodities contracts 3.5 - - 5.0 - -
- ----------------------------------------------------------------------------------------------------------------------------------
Total exchange-issued products 1,092.7 .2 .4 610.2 .1 .2
- ----------------------------------------------------------------------------------------------------------------------------------
Over-the-counter ("OTC") swaps, swap options, caps and floors:
Swaps 1,345.9 858.3
Swap options written 38.6 10.8
Swap options purchased 48.8 24.1
Caps and floors 161.4 117.1
- ----------------------------------------------------------------------------------------------------------------------------------
Total OTC swaps, swap options, caps and floors (b) 1,594.7 5.8 6.7 1,010.3 4.2 6.6
- ----------------------------------------------------------------------------------------------------------------------------------
OTC foreign exchange contracts and options:
Forward currency contracts (b) 115.4 1.0 1.0 96.3 .7 .6
Options written 41.3 - .6 37.1 - .3
Options purchased 37.7 .6 - 38.7 .5 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total OTC foreign exchange contracts and options 194.4 1.6 1.6 172.1 1.2 .9
- ----------------------------------------------------------------------------------------------------------------------------------
Other contractual commitments:
Options and warrants on equities and equity indices 54.8 1.8 2.7 45.8 1.1 1.8
Options and forward contracts on fixed income
securities 343.4 .3 .1 202.8 .3 .2
Physical commodities contracts 14.3 .4 .2 22.6 .3 .3
- ----------------------------------------------------------------------------------------------------------------------------------
Total contractual commitments $3,294.3 $ 10.1 $ 11.7 $2,063.8 $ 7.2 $ 10.0
==================================================================================================================================
</TABLE>
(a) Margin on futures contracts is included in receivables/payables to
brokers, dealers and clearing organizations on the consolidated
statements of financial condition.
(b) Includes notional values of swap agreements and forward currency
contracts for non-trading activities (primarily related to the
Company's fixed-rate long-term debt) of $17.6 billion and $ 4.1
billion at December 31, 1997 and $16.0 billion and $2.0 billion at
December 31, 1996, respectively.
The annual average balances of the Company's contractual commitments, based on
month-end balances, are as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------- ----------------------------
Average Average Average Average
Dollars in billions Assets Liabilities Assets Liabilities
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Swaps, swap options, caps and floors $4.4 $ 6.2 $3.6 $5.5
Index and equity contracts and options 1.9 2.9 1.5 1.4
Foreign exchange contracts and options 1.5 1.4 1.0 1.0
Physical commodities contracts .3 .2 .4 .3
Forward contracts on fixed income securities .4 .3 .3 .4
-----------------------------------------------------------------------------------------------------------
Total contractual commitments $8.5 $11.0 $6.8 $8.6
===========================================================================================================
</TABLE>
CREDIT RISK The Company regularly transacts business with, and owns securities
issued by, a broad range of corporations, governments, international
organizations, central banks and other financial institutions. Phibro regularly
transacts business with independent and government-owned oil producers, a wide
variety of end users, trading companies and financial institutions. Credit risk
is measured by the loss the Company would record if its counterparties failed to
perform pursuant to the terms of their contractual obligations and the value of
collateral held, if any, was not adequate to cover such losses. The Company has
established controls to monitor the creditworthiness of counterparties, as well
as the quality of pledged collateral, and uses master netting agreements
whenever possible to mitigate the Company's exposure to counterparty credit
risk. Master netting agreements enable the Company to net certain assets and
liabilities by counterparty. The Company also nets across product lines and
against cash collateral, provided such provisions are established in the master
netting and
F-33
<PAGE> 80
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
cash collateral agreements. The Company may require counterparties to submit
additional collateral when deemed necessary.
The Company enters into collateralized financing agreements in which it extends
short-term credit, primarily to major financial institutions. The Company
controls access to the collateral pledged by the counterparties, which consists
largely of securities issued by the G-7 governments or their agencies that may
be liquidated in the event of counterparty default.
In addition, margin levels are monitored daily and additional collateral must be
deposited as required. If customers cannot meet collateral requirements, the
Company will liquidate sufficient underlying financial instruments to bring the
account in compliance with the required margin level.
CONCENTRATIONS OF CREDIT RISK Concentrations of credit risk from financial
instruments, including contractual commitments, exist when groups of issuers or
counterparties have similar business characteristics or are engaged in like
activities that would cause their ability to meet their contractual commitments
to be adversely affected, in a similar manner, by changes in the economy or
other market conditions. The Company monitors credit risk on both an individual
and group counterparty basis. The Company's largest single concentration of
credit risk is with securities issued by the U.S. government and its agencies,
which totaled $52.1 billion at December 31, 1997 and $52.0 billion at December
31, 1996. With the addition of U.S. government and U.S. government agency
securities pledged as collateral by counterparties in connection with
collateralized financing activity, the Company's total holdings of U.S.
government securities were $132.8 billion or 41% of the Company's total assets
at December 31, 1997 and $110.7 billion or 42% of the Company's total assets at
December 31, 1996. Similarly, concentrations with non-U.S. governments totaled
$103.5 billion at December 31, 1997 and $75.1 billion at December 31, 1996.
These consist predominantly of securities issued by the governments of major
industrial nations. Remaining concentrations arise principally from contractual
commitments with counterparties in financial or commodities transactions
involving future settlement and fixed income securities owned. Excluding
governments, no concentration with a single counterparty exceeded 1% of total
assets at December 31, 1997 or 1996. North America and Europe represent the
largest geographic concentrations. Among industries, other major derivatives
dealers represent the largest group of counterparties. The Company has two years
remaining on a three-year credit support agreement with Genesis Energy, L.P.,
pursuant to which it provides Genesis with working capital support of up to $400
million in 1998 and $300 million until December 31, 1999.
NOTE 16. FAIR VALUE INFORMATION
SFAS 107, Disclosures about Fair Value of Financial Instruments, requires the
disclosure of the fair value of all financial instruments. The following
information is presented to help users gain an understanding of the relationship
between the amounts reported in the Company's financial statements and the
related market or fair values. Specific accounting policies are discussed in
Note 2 to the consolidated financial statements.
F-34
<PAGE> 81
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 1997, $272 billion or 98% of the Company's total assets and $253
billion or 94% of the Company's total liabilities were carried at market value
or fair value or at amounts that approximate such values. At December 31, 1996,
$242 billion or 98% of the Company's total assets and $226 billion or 95% of the
Company's total liabilities were carried at either market or fair values or at
amounts that approximate such values. Financial instruments recorded at market
or fair value include cash and cash equivalents, financial instruments,
commodities and contractual commitments used for trading purposes.
Financial instruments recorded at contractual amounts that approximate market or
fair value include collateralized short-term financing agreements, receivables,
commercial paper and other short-term borrowings, payables and accrued
liabilities, and variable rate term debt. The market values of such items are
not materially sensitive to shifts in market interest rates because of the
limited term to maturity of many of these instruments and/or their variable
interest rates.
The following table reflects financial instruments which are recorded at
contractual or historical amounts that do not necessarily approximate market or
fair value.
Such instruments include U.S. dollar denominated collateralized mortgage
obligations ("CMOs") and the assets securing U.S. dollar denominated CMOs, the
Company's fixed rate term debt, as well as the fair value of derivative
instruments that are used for non-trading, or end user, purposes.
<TABLE>
<CAPTION>
Dollars in billions
- --------------------------------------------------------------------------------------------------------------------------
December 31, 1997 1996
--------------------------------- ---------------------------------
Assets Liabilities Assets Liabilities
--------------- --------------- --------------- ---------------
Carrying Fair Carrying Fair Carrying Fair Carrying Fair
Value Value Value Value Value Value Value Value
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Financial instruments recorded at contractual
amounts or historical amounts that do not
necessarily approximate market or fair value:
Assets securing U.S. dollar denominated CMOs
(fixed rate) $.2 $.3 $.4 $.5
U.S. dollar denominated CMOs (fixed rate) $ .2 $ .2 $ .4 $ .4
Fixed rate term debt 15.0 15.3 11.7 12.0
==========================================================================================================================
Derivatives used for non-trading purposes $-- $.5 $ -- $ .2 $-- $.5 $ -- $ .2
==========================================================================================================================
</TABLE>
The fair value of fixed rate term debt has been estimated by using a discounted
cash flow analysis. The Company's U.S. dollar denominated fixed rate CMOs and
assets securing U.S. dollar denominated fixed rate CMOs are carried at their
contractual amounts. At December 31, 1997 and 1996, prevailing interest rates
and prepayments resulted in the fair value of the liabilities associated with
such CMOs exceeding their carrying amount. The fair value of assets securing the
dollar denominated CMOs also exceeded their carrying value at December 31, 1997
and 1996. CMOs and the assets that secure them should not be viewed
independently. Taken together, the fair value of the Company's dollar
denominated CMOs and the assets securing them is the present value of the
difference between future cash inflows from the CMO collateral and cash outflows
to service the CMOs. This difference was nominal at December 31, 1997 and 1996.
F-35
<PAGE> 82
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17. RELATED PARTY TRANSACTIONS
The Company has entered into various related party transactions with Travelers
Group Inc. Other than the transactions disclosed in the consolidated financial
statements and elsewhere in the notes, the amounts are immaterial for the years
ended and at December 31, 1997, 1996 and 1995.
NOTE 18. OTHER EVENTS
In 1996, the Company sold its indirect wholly owned subsidiary, The Mortgage
Corporation Limited ("TMC"), resulting in an after-tax gain of $31 million ($48
million pre-tax). TMC originated and serviced residential mortgages in the
United Kingdom.
NOTE 19. PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
The following are condensed financial statements of Salomon Smith Barney
Holdings Inc.
(Parent Company Only):
PARENT COMPANY ONLY CONDENSED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Dollars in millions
Year Ended December 31, 1997 1996 1995
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues, net of interest expense $ 213 $ 126 $ 299
Loss on sale of Basis Petroleum - (505) -
Restructuring charge 180 - -
Noninterest expenses 154 117 243
------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (121) (496) 56
Provision/ (benefit) for income taxes (57) (225) 20
Equity in earnings of subsidiaries 1,209 1,771 1,016
------------------------------------------------------------------------------------------------------
Net income $1,145 $1,500 $1,052
======================================================================================================
</TABLE>
F-36
<PAGE> 83
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PARENT COMPANY ONLY CONDENSED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
Dollars in millions
- ---------------------------------------------------------------------------------------------------------------------------------
December 31, 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $ - $ 3
Financial instruments and contractual commitments 258 111
Receivables 280 172
Receivables from subsidiaries: (1)
Salomon Brothers Holding Company Inc $20,602 $14,332
Smith Barney Inc. 7,349 2,236
Other subsidiaries 1,320 1,703
------- -------
29,271 18,271
Investments in subsidiaries:
Salomon Brothers Holding Company Inc 4,027 4,018
Smith Barney Inc. 2,853 2,484
Other subsidiaries 361 358
------- -------
7,241 6,860
Property, equipment and leasehold improvements, net 238 252
Other assets 1,054 635
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 38,342 $ 26,304
=================================================================================================================================
Liabilities and stockholder's equity:
Commercial paper and other short-term borrowings $ 8,723 $ 2,120
Financial instruments sold, not yet purchased and
contractual commitments 644 543
Other liabilities 2,320 1,402
Term debt 17,781 13,848
Subordinated debt payable to SI Financing Trust I 356 356
-------- --------
Total liabilities 29,824 18,269
Redeemable preferred stock, Series A - 420
Stockholder's equity 8,518 7,615
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholder's equity $ 38,342 $ 26,304
=================================================================================================================================
</TABLE>
(1) Includes $3.1 billion and $4.0 billion of subordinated note receivables at
December 31, 1997 and December 31, 1996, respectively.
F-37
<PAGE> 84
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PARENT COMPANY ONLY CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Dollars in millions
Year ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from financing activities:
Issuance of term debt $ 7,984 $ 4,659 $ 3,504
Term debt maturities and repurchases (3,955) (4,180) (5,306)
Net (increase) decrease in commercial paper and other short-term
borrowings 6,603 229 (570)
Redemption of preferred stock -- (112) (140)
Issuance of preferred stock -- 250 --
Other capital transactions (95) (45) 13
Dividends paid (604) (820) (436)
- --------------------------------------------------------------------------------------------------------------
Cash provided by (used in) financing activities 9,933 (19) (2,935)
- --------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
(Increase) decrease in receivables from subsidiaries (11,356) (3,290) 2,260
Dividends received from subsidiaries 834 2,359 564
Capital infusions and other capital transactions with subsidiaries (69) (174) (135)
Purchases of property, equipment and leasehold improvements (9) (3) (4)
Proceeds from sale of Basis Petroleum 365 -- --
- --------------------------------------------------------------------------------------------------------------
Cash provided by (used in) investing activities (10,235) (1,108) 2,685
- --------------------------------------------------------------------------------------------------------------
Cash provided by operating activities 299 1,116 257
- --------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (3) (11) 7
Cash and cash equivalents at beginning of year 3 14 7
- --------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 0 $ 3 $ 14
==============================================================================================================
</TABLE>
BASIS OF PRESENTATION
The accompanying condensed financial statements, which include the accounts of
Salomon Smith Barney Holdings Inc. ("SSBH"), a wholly owned subsidiary of
Travelers Group Inc., should be read in conjunction with the consolidated
financial statements of SSBH and its subsidiaries. On January 1, 1996, the
commodities dealer businesses conducted by the Phibro Division of SSBH (Parent
Company Only) was transferred to the Company's wholly owned subsidiary, Phibro
Inc. Therefore, 1996 and 1997 results for Phibro, including activities
previously conducted by the Phibro Division, are included in equity in earnings
of subsidiaries and affiliates in the Parent Company Only condensed statement of
income.
Investments in subsidiaries are accounted for under the equity method. For
information regarding the Company's term debt see Note 7 of the consolidated
financial statements.
F-38
<PAGE> 85
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RELATED PARTY TRANSACTIONS
SSBH engages in various transactions with its subsidiaries that are
characteristic of a consolidated group under common control. As a public debt
issuer, SSBH has access to long-term sources of funds that are loaned from SSBH
to certain of its subsidiaries. Such intercompany advances are payable on demand
and bear interest at varying rates.
F-39
<PAGE> 86
SALOMON SMITH BARNEY HOLDINGS INC.
QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly results for the year ended December 31, 1997 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Quarter Ended
Dollars in millions March 31 June 30 September 30 December 31
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Noninterest revenues $ 2,379 $ 2,294 $ 2,659 $ 2,102
Net interest and dividends 322 430 366 395
- --------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 2,701 2,724 3,025 2,497
Expenses, excluding interest 2,023 1,985 2,197 2,922
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
income taxes 678 739 828 (425)
Provision/(benefit) for income taxes 267 288 321 (201)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 411 $ 451 $ 507 $ (224)
================================================================================================================================
</TABLE>
Quarterly results for the year ended December 31, 1996 were as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Quarter Ended
Dollars in millions March 31 June 30 September 30 December 31
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Noninterest revenues $ 2,457 $ 2,443 $ 1,986 $ 2,294
Net interest and dividends 400 402 340 346
- --------------------------------------------------------------------------------------------------------------------------------
Revenues, net of interest expense 2,857 2,845 2,326 2,640
- --------------------------------------------------------------------------------------------------------------------------------
Expenses, excluding interest 1,976 1,973 1,802 1,901
Gain on sale of subsidiaries and affiliates - - 48 -
- --------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes 881 872 572 739
Provision for income taxes 348 345 225 281
- --------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations $ 533 $ 527 $ 347 $ 458
================================================================================================================================
Net income $ 499 $ 520 $ 319 $ 162
================================================================================================================================
</TABLE>
F-40
<PAGE> 87
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
<S> <C>
3.01 Amended and Restated Certificate of Incorporation of Salomon Smith
Barney Holdings Inc. (the "Company"), effective December 1, 1997,
incorporated by reference to Exhibit 4(a) to Amendment No. 2 to the
Company's Registration Statement on Form S-3 (No. 333-38931).
3.02 By-Laws of the Company, incorporated by reference to Exhibit 4(b) to
Amendment No. 2 to the Company's Registration Statement on Form S-3
(No. 333-38931).
10.01 Amended and Restated Lease dated as of December 30, 1994 between
State Street Bank and Trust Company of Connecticut, National
Association, as Trustee (Lessor), and Smith Barney Inc., Mutual
Management Corp., Smith Barney Mutual Funds Management Inc. and The
Travelers Inc., as tenants in common (Lessee), incorporated by
reference to Exhibit 10.03 to the Annual Report on Form 10-K of
Smith Barney Holdings Inc. for the fiscal year ended December
31,1994.
10.02 Lease dated November 23, 1988 between 7 World Trade Company and
Salomon Inc, incorporated by reference to Exhibit 10(a) to the
Company's Annual Report on Form 10-K, as amended, for the fiscal
year ended December 31, 1991.
12.01+ Computation of ratio of earnings to fixed charges.
21.01 Pursuant to General Instruction I of Form 10-K, the list of
subsidiaries of the Company is omitted.
23.01+ Consent of Coopers & Lybrand L.L.P.
23.02+ Consent of Arthur Andersen LLP.
24.01+ Powers of Attorney of certain directors of the Company.
27.01+ Financial Data Schedule.
27.02+ Restated Financial Data Schedule -- 1996 and 1995
99.01+ Independent Auditors' Report.
</TABLE>
- --------------------
+ Filed herewith.
<PAGE> 1
EXHIBIT 12.01
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
Computation of Ratio of Earnings to Fixed Charges
(Unaudited)
<TABLE>
<CAPTION>
Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
Dollars in millions 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Earnings from continuing operations:
Income (loss) from continuing operations before income taxes
and cumulative effect of change in accounting principles $ 1,820 $ 3,064 $ 1,820 $ (173) $2,047
Add fixed charges (see below) 10,626 8,265 8,890 7,204 6,477
Other adjustments 0 1 0 0 22
------- ------- ------- ------- ------
Earnings as defined $12,446 $11,330 $10,710 $ 7,031 $8,546
======= ======= ======= ======= ======
Fixed charges from continuing operations:
Interest expense $10,530 $ 8,175 $ 8,797 $ 7,112 $6,391
Other adjustments 96 90 93 92 86
------- ------- ------- ------- ------
Fixed charges from continuing operations as defined $10,626 $ 8,265 $ 8,890 $ 7,204 $6,477
======= ======= ======= ======= ======
Ratio of earnings to fixed charges 1.17 1.37 1.20* 0.98 1.32
======= ======= ======= ======= ======
</TABLE>
NOTE:
The ratio of earnings to fixed charges from continuing operations is calculated
by dividing fixed charges into the sum of income (loss) from continuing
operations before income taxes and cumulative effect of change in accounting
principles and fixed charges. Fixed charges consist of interest expense,
including capitalized interest and a portion of rental expense representative of
the interest factor.
* For the year ended December 31, 1994, earnings as defined were inadequate to
cover fixed charges. The amount by which fixed charges exceeded earnings as
defined for the year was $173 million.
<PAGE> 1
EXHIBIT 23.01
[LETTERHEAD OF COOPERS & LYBRAND L.L.P.]
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of Salomon Smith Barney Holdings Inc.:
We consent to the incorporation by reference in the Registration
Statements on Form S-3 of Salomon Smith Barney Holdings Inc.:
Nos 33-40600, 33-41932, 33-48199, 33-49136, 33-57922, 33-51269, 33-54929,
33-56481, 333-01807, 333-02897, 333-11881, 333-38931, and 333-45529
of our report dated January 26, 1998 relating to our audit of the consolidated
statements of financial condition of Salomon Smith Barney Holdings Inc. and
Subsidiaries as of December 31, 1997 and 1996 and the related consolidated
statements of income, cash flows, and changes in stockholder's equity for each
of the three years in the period ended December 31, 1997, which report is
included in the Form 10-K of Salomon Smith Barney Holdings Inc. for the year
ended December 31, 1997.
/s/ Coopers & Lybrand L.L.P.
----------------------------
New York, New York
March 23, 1998
<PAGE> 1
EXHIBIT 23.02
[ARTHUR ANDERSEN LLP LETTERHEAD]
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in the following Registration Statements on Form S-3 of Salomon Smith
Barney Holdings Inc.:
- Nos. 33-40600, 33-41932, 33-48199, 33-49136, 33-57922,
33-51269, 33-54929, 33-56481, 333-01807, 333-02897,
333-11881, 333-38931, and 333-45529
of our report dated March 13, 1997, relating to the consolidated statement of
financial condition of Salomon Inc and subsidiaries as of December 31, 1996 and
1995, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996, which report is incorporated by reference or included
in the annual report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the year ended December 31, 1997.
/s/ ARTHUR ANDERSEN LLP
New York, New York
March 23, 1998
<PAGE> 1
EXHIBIT 24.01
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ Steven D. Black
______________________________
<PAGE> 2
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ James S. Boshart, III
______________________________
<PAGE> 3
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ Thomas G. Maheras
______________________________
<PAGE> 4
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ Jay P. Mandelbaum
______________________________
<PAGE> 5
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ Eduardo G. Mestre
______________________________
<PAGE> 6
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ Shigeru Myojin
______________________________
<PAGE> 7
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that I, the undersigned, a director of
Salomon Smith Barney Holdings Inc., a Delaware corporation, do hereby constitute
and appoint Robert Druskin, Robert H. Mundheim and Charles W. Scharf, and each
of them severally, to be my true and lawful attorneys-in-fact and agents, each
acting alone with full power of substitution and re-substitution, to sign my
name to an Annual Report on Form 10-K of Salomon Smith Barney Holdings Inc. for
the fiscal year ended December 31, 1997, and all amendments thereto, and to
file, or cause to be filed, the same with all exhibits thereto (including this
power of attorney), and other documents in connection therewith with the
Securities and Exchange Commission, provided that such Annual Report on Form
10-K in final form, and any amendment or amendments thereto and such other
documents, be approved by said attorneys-in-fact, or by any one of them; and I
do hereby grant unto said attorneys-in-fact and agents full power and authority
to do and perform each and every act and thing requisite and necessary to be
done in or about the premises, as fully and to all intents and purposes as I
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, I have subscribed these presents as of March 23,
1998.
/s/ Paul Underwood
______________________________
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S
CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,808
<RECEIVABLES> 18,014
<SECURITIES-RESALE> 75,802
<SECURITIES-BORROWED> 33,932
<INSTRUMENTS-OWNED> 139,732
<PP&E> 986
<TOTAL-ASSETS> 276,620
<SHORT-TERM> 11,464
<PAYABLES> 21,482
<REPOS-SOLD> 113,593
<SECURITIES-LOANED> 5,978
<INSTRUMENTS-SOLD> 96,166
<LONG-TERM> 19,074
0
0
<COMMON> 0
<OTHER-SE> 8,518
<TOTAL-LIABILITY-AND-EQUITY> 276,620
<TRADING-REVENUE> 2,504
<INTEREST-DIVIDENDS> 12,043
<COMMISSIONS> 2,967
<INVESTMENT-BANKING-REVENUES> 2,118
<FEE-REVENUE> 1,715
<INTEREST-EXPENSE> 10,530
<COMPENSATION> 6,037
<INCOME-PRETAX> 1,820
<INCOME-PRE-EXTRAORDINARY> 1,145
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,145
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
THIS SCHEDULE CONTAINS RESTATED SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-END> DEC-31-1996 DEC-31-1995
<CASH> 1,607 1,962
<RECEIVABLES> 13,346 11,880
<SECURITIES-RESALE> 72,881 60,509
<SECURITIES-BORROWED> 25,104 24,517
<INSTRUMENTS-OWNED> 126,573 121,812
<PP&E> 959 1,791
<TOTAL-ASSETS> 246,114 229,387
<SHORT-TERM> 10,020 11,249
<PAYABLES> 17,031 20,796
<REPOS-SOLD> 97,269 108,980
<SECURITIES-LOANED> 5,525 3,937
<INSTRUMENTS-SOLD> 92,141 62,318
<LONG-TERM> 15,748 14,930
420 560
450 312
<COMMON> 0 0
<OTHER-SE> 7,165 6,305
<TOTAL-LIABILITY-AND-EQUITY> 246,114 229,387
<TRADING-REVENUE> 3,027 2,140
<INTEREST-DIVIDENDS> 9,663 10,442
<COMMISSIONS> 2,612 2,376
<INVESTMENT-BANKING-REVENUES> 2,001 1,318
<FEE-REVENUE> 1,390 1,087
<INTEREST-EXPENSE> 8,175 8,797
<COMPENSATION> 5,558 4,900
<INCOME-PRETAX> 3,064 1,820
<INCOME-PRE-EXTRAORDINARY> 1,500 1,052
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,500 1,052
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
<PAGE> 1
Exhibit 99.01
[ARTHUR ANDERSEN LLP LETTERHEAD]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF SALOMON INC:
We have audited the accompanying consolidated statement of financial condition
of Salomon Inc (a Delaware corporation) and subsidiaries as of December 31,
1996 and 1995, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Salomon Inc and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
NEW YORK, NEW YORK
MARCH 13, 1997
