<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2000
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 1-7367
PAINE WEBBER GROUP INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-2760086
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 713-2000
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 [_]
On August 4, 2000 the Registrant had outstanding 147,784,526 shares of common
stock of $1 par value.
<PAGE> 2
PAINE WEBBER GROUP INC.
FORM 10-Q
JUNE 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
--------------------- ----
<S> <C> <C> <C>
Item 1. Financial Statements.
Condensed Consolidated Statements of Income
(unaudited) for the Three and Six Months Ended
June 30, 2000 and 1999. 2
Condensed Consolidated Statements of Financial
Condition (unaudited) at June 30, 2000
and December 31, 1999. 3
Condensed Consolidated Statements of Cash Flows
(unaudited) for the Six Months Ended
June 30, 2000 and 1999. 4
Notes to Condensed Consolidated Financial Statements
(unaudited). 5-13
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations. 14-20
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings. 21
Item 6. Exhibits and Reports on Form 8-K. 21
Signature. 22
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PAINE WEBBER GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands of dollars except share and per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- ---------------------------------
2000 1999 2000 1999
--------------- --------------- --------------- ---------------
REVENUES
<S> <C> <C> <C> <C>
Commissions $ 560,510 $ 488,878 $ 1,236,682 $ 967,751
Principal transactions 181,428 279,846 490,717 594,054
Asset management 300,705 224,487 578,993 430,538
Investment banking 155,647 160,133 277,827 286,086
Interest 1,074,208 770,271 2,055,755 1,527,431
Other 43,928 47,363 81,573 88,428
---------- ---------- ---------- -----------
Total revenues 2,316,426 1,970,978 4,721,547 3,894,288
Interest expense 905,254 623,071 1,713,270 1,231,490
---------- ---------- ---------- -----------
Net revenues 1,411,172 1,347,907 3,008,277 2,662,798
---------- ---------- ---------- -----------
NON-INTEREST EXPENSES
Compensation and benefits 839,603 780,078 1,789,389 1,548,792
Office and equipment 99,695 89,330 196,287 170,782
Communications 46,807 42,645 90,930 84,848
Business development 41,776 28,534 80,677 52,401
Brokerage, clearing & exchange fees 20,300 23,487 47,603 47,877
Professional services 50,455 32,397 99,881 62,849
Other 100,466 81,769 201,221 160,563
---------- ---------- ---------- -----------
Total non-interest expenses 1,199,102 1,078,240 2,505,988 2,128,112
---------- ---------- ---------- -----------
INCOME BEFORE TAXES AND MINORITY INTEREST 212,070 269,667 502,289 534,686
Provision for income taxes 76,503 98,102 182,312 194,461
---------- ---------- ---------- -----------
INCOME BEFORE MINORITY INTEREST 135,567 171,565 319,977 340,225
Minority interest 8,061 8,061 16,122 16,122
---------- ---------- ---------- -----------
NET INCOME $ 127,506 $ 163,504 $ 303,855 $ 324,103
========== ========== =========== ===========
Net income applicable to common shares $ 127,506 $ 157,555 $ 303,855 $ 312,205
========== ========== =========== ===========
Earnings per common share:
Basic $ 0.87 $ 1.08 $ 2.09 $ 2.14
Diluted $ 0.82 $ 1.02 $ 1.98 $ 2.02
Weighted-average common shares:
Basic 146,067,820 145,742,741 145,324,940 145,631,920
Diluted 154,576,404 154,960,397 153,233,875 154,305,795
Dividends declared per common share $ 0.12 $ 0.11 $ 0.24 $ 0.22
</TABLE>
Results for the quarter and six months ended June 30, 2000 include J.C. Bradford
merger-related costs of $30 million, $18.8 million after taxes.
See notes to condensed consolidated financial statements.
2
<PAGE> 4
PAINE WEBBER GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(In thousands of dollars except share and per share amounts)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---------------- ------------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 429,002 $ 176,401
Cash and securities segregated and on deposit for
federal and other regulations 719,651 823,059
Financial instruments owned 23,577,357 21,144,830
Securities received as collateral 907,299 1,079,976
Securities purchased under agreements to resell 15,313,111 15,923,948
Securities borrowed 10,517,232 10,526,638
Receivables, net of allowance for doubtful accounts of
$21,301 and $30,039 at June 30, 2000 and
December 31, 1999, respectively 12,215,893 10,287,937
Office equipment and leasehold improvements, net of accumulated
depreciation and amortization of $591,129 and $527,718 at
June 30, 2000 and December 31, 1999, respectively 747,931 579,819
Other assets 1,975,026 1,069,768
------------ -----------
$ 66,402,502 $61,612,376
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term borrowings $ 2,255,603 $ 1,884,250
Financial instruments sold, not yet purchased 4,275,325 7,099,208
Securities sold under agreements to repurchase 27,918,155 25,740,196
Securities loaned 7,249,077 5,661,200
Obligation to return securities received as collateral 907,299 1,079,976
Payables 11,882,125 8,448,217
Other liabilities and accrued expenses 3,121,054 3,164,496
Long-term borrowings 5,209,136 5,223,826
------------ -----------
62,817,774 58,301,369
------------ -----------
Commitments and contingencies
Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary
Trusts holding solely Company Guaranteed Related Subordinated Debt 393,750 393,750
Stockholders' Equity:
Common stock, $1 par value, 400,000,000 shares authorized,
issued 195,719,680 shares and 193,145,152 shares at
June 30, 2000 and December 31, 1999, respectively 195,720 193,145
Additional paid-in capital 1,755,825 1,672,085
Retained earnings 2,439,962 2,171,080
Treasury stock, at cost; 48,971,281 shares and 47,557,064 shares at
June 30, 2000 and December 31, 1999, respectively (1,191,934) (1,113,736)
Accumulated other comprehensive income (8,595) (5,317)
------------- ------------
3,190,978 2,917,257
------------ -------------
$ 66,402,502 $61,612,376
============ =============
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 5
PAINE WEBBER GROUP INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands of dollars)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------------------------------
2000 1999
--------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 303,855 $ 324,103
Adjustments to reconcile net income to cash provided by
(used for) operating activities:
Noncash items included in net income:
Depreciation and amortization 63,815 49,206
Deferred income taxes 14,268 (10,317)
Amortization of deferred charges 53,729 51,736
Stock-based compensation (3,126) 11,480
(Increase) decrease in operating assets:
Cash and securities on deposit 103,685 (54,585)
Financial instruments owned (2,156,799) (2,200,354)
Securities purchased under agreements to resell 610,837 (306,902)
Securities borrowed 234,592 (197,510)
Receivables (1,031,176) (1,032,062)
Other assets (306,671) (243,111)
Increase (decrease) in operating liabilities:
Financial instruments sold, not yet purchased (2,823,883) 2,863,254
Securities sold under agreements to repurchase 2,177,959 1,697,395
Securities loaned 1,319,954 14,021
Payables 2,603,232 (1,204,663)
Other (312,241) 73,936
------------ --------------
Cash provided by (used for) operating activities 852,030 (164,373)
------------ --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for:
Net assets acquired in business acquisition (621,667) -
Office equipment and leasehold improvements (196,740) (110,289)
------------ ------------
Cash used for investing activities (818,407) (110,289)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) short-term borrowings 337,151 (233,289)
Proceeds from:
Long-term borrowings 346,762 875,985
Employee stock transactions 88,365 56,593
Payments for:
Long-term borrowings (403,560) (190,180)
Repurchases of common stock (114,767) (121,080)
Dividends (34,973) (43,706)
------------ --------------
Cash provided by financing activities 218,978 344,323
----------- ------------
Increase in cash and cash equivalents 252,601 69,661
Cash and cash equivalents, beginning of period 176,401 228,359
----------- ------------
Cash and cash equivalents, end of period $ 429,002 $ 298,020
========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS OF DOLLARS EXCEPT SHARE AND PER SHARE AMOUNTS)
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated financial statements include the accounts of Paine
Webber Group Inc. ("PWG") and its wholly owned subsidiaries, including its
principal subsidiary PaineWebber Incorporated ("PWI") (collectively, the
"Company"). All material intercompany balances and transactions have been
eliminated. Certain reclassifications have been made to prior year amounts to
conform to current year presentations. The December 31, 1999 Condensed
Consolidated Statement of Financial Condition was derived from the audited
consolidated financial statements of the Company. The financial information as
of and for the periods ended June 30, 2000 and 1999 is unaudited. All normal
recurring adjustments which, in the opinion of management, are necessary for a
fair presentation have been made.
Certain financial information that is normally in annual financial statements
but is not required for interim reporting purposes has been condensed or
omitted. The condensed consolidated financial statements are prepared in
conformity with accounting principles generally accepted in the United States
which require management to make estimates and assumptions that affect the
amounts reported in the condensed consolidated financial statements and
accompanying notes. Actual results could differ from those estimates. These
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 and the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2000. The results
of operations reported for interim periods are not necessarily indicative of the
results of operations for the entire year.
Statement of Cash Flows
Total interest payments, which relate principally to agreements to repurchase,
short-term borrowings, securities loaned and long-term borrowings, were
$1,763,452 and $1,211,332 for the six months ended June 30, 2000 and 1999,
respectively. Income taxes paid were $202,888 and $118,274 for the six months
ended June 30, 2000 and 1999, respectively.
Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes revised accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity measure all derivative instruments at fair value and
recognize such instruments as either assets or liabilities in the consolidated
statements of financial condition. The accounting for changes in the fair value
of a derivative instrument will depend on the intended use of the derivative as
either a fair value hedge, a cash flow hedge or a foreign currency hedge. The
effect of the changes in fair value of the derivatives and, in certain cases,
the hedged items are to be reflected in either the consolidated statements of
income or as a component of other comprehensive income, based upon the resulting
designation. As issued, SFAS No. 133 was effective for fiscal years beginning
after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133." SFAS No. 137 defers the effective date of SFAS No. 133
for one year to fiscal years beginning after June 15, 2000. In June 2000, the
FASB issued Statement No. 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities--an Amendment to FASB Statement No. 133". The
Company has not yet determined the impact of these statements on the Company's
Consolidated Financial Statements, taken as a whole.
NOTE 2: SUBSEQUENT EVENT
On July 12, 2000, PWG entered into an agreement and plan of merger with UBS AG
("UBS") and a subsidiary of UBS, pursuant to which PWG will merge with and into
that subsidiary. Under the terms of the agreement, PWG's shareholders will have
the right to elect to receive either $73.50 in cash or 0.4954 of an ordinary
share of UBS AG stock for each share of PWG's common stock, $1 par value
("common stock") that they own. The percentage of PWG's common stock that will
be converted into the right to receive UBS AG stock is fixed at 50 percent.
Adjustments to elections may therefore be necessary so that, in the aggregate,
50 percent of the shares of PWG's common stock is converted into the right to
receive UBS AG stock, and 50 percent is converted into the right to receive
cash. The transaction, which is expected to be completed in the fourth quarter
of 2000, has been approved by PWG's Board of Directors and is subject to
customary closing conditions, including certain regulatory approvals and the
approval of PWG's shareholders.
5
<PAGE> 7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3: MERGER WITH J.C. BRADFORD
On June 9, 2000, the Company completed its merger with J.C. Bradford & Co.
L.L.C. ("J.C. Bradford"), a leading privately-held brokerage firm in the
Southeastern U.S., for approximately $622,000 in cash. The merger was accounted
for as a purchase and, accordingly, the excess of the purchase cost over the
fair value of the net assets acquired of approximately $185,000, resulted in the
Company recording $560,000 in goodwill, which is being amortized over 25 years
on a straight-line basis. The consolidated financial statements of the Company
include the results of J.C. Bradford from the closing date. As a result of the
merger, the Company recorded after-tax costs of approximately $18,800 ($30,000
pre-tax) relating primarily to elimination of the Company's duplicate
facilities, severance and other costs.
NOTE 4: FINANCIAL INSTRUMENTS OWNED AND SOLD, NOT YET PURCHASED
At June 30, 2000 and December 31, 1999, financial instruments owned and
financial instruments sold, not yet purchased consisted of the following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- --------------
Financial instruments owned:
<S> <C> <C>
U.S. government and agencies $ 6,859,578 $ 5,864,331
Mortgages and mortgage-backed 9,585,261 9,012,415
Corporate debt 1,972,518 1,875,361
Commercial paper and other short-term debt 2,196,741 1,744,036
Equities and other 2,342,821 2,030,986
State and municipals 620,438 617,701
------------- --------------
$ 23,577,357 $ 21,144,830
============= =============
Financial instruments sold, not yet purchased:
U.S. government and agencies $ 2,907,693 $ 5,804,259
Mortgages and mortgage-backed 144,194 123,049
Corporate debt 940,826 785,890
Equities 239,698 348,485
State and municipals 42,914 37,525
-------------- -------------
$ 4,275,325 $ 7,099,208
============= =============
</TABLE>
NOTE 5: LONG-TERM BORROWINGS
Long-term borrowings at June 30, 2000 and December 31, 1999 consisted of the
following:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------------- --------------
U.S. Dollar-Denominated:
<S> <C> <C>
Fixed Rate Notes $ 2,608,917 $ 2,757,851
Fixed Rate Subordinated Notes 198,809 174,765
Medium-Term Senior Notes 2,186,350 2,143,010
Medium-Term Subordinated Notes 85,200 148,200
Other 11,037 -
Non-U.S. Dollar-Denominated:
Medium-Term Notes 118,823 -
------------- -------------
$ 5,209,136 $ 5,223,826
============= =============
</TABLE>
At June 30, 2000, interest rates on the U.S. dollar-denominated fixed rate notes
and fixed rate subordinated notes ranged from 6.25 percent to 9.25 percent and
the weighted-average interest rate was 7.19 percent. Interest on the notes is
payable semi-annually. The fixed rate notes and fixed rate subordinated notes
outstanding at June 30, 2000 had an average maturity of 5.6 years.
At June 30, 2000, the Company had outstanding U.S. dollar-denominated fixed rate
Medium-Term Notes of $1,292,100 and variable rate Medium-Term Notes of $979,450.
The Medium-Term Notes outstanding at June 30, 2000 had an average maturity of
3.9 years and a weighted-average interest rate of 6.36 percent.
At June 30, 2000, the Non-U.S. dollar-denominated Medium-Term Notes outstanding
had a weighted-average interest rate of 1.18 percent and an average maturity of
2.4 years.
6
<PAGE> 8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In 2000, the Company issued to certain employees, 6.25% Convertible Debentures
(the "Debentures") due 2007. The Debentures are convertible, at the option of
the holders, into 1,931,250 shares of Convertible Preferred Stock, which are
then convertible into 1,931,250 shares of common stock of the Company. The
Debentures are convertible beginning on January 20, 2003.
At June 30, 2000 and December 31, 1999, the fair values of long-term borrowings
were $4,998,397 and $5,140,331, respectively, as compared to the carrying
amounts of $5,209,136 and $5,223,826, respectively. The estimated fair value of
long-term borrowings is based upon quoted market prices for the same or similar
issues and pricing models. However, for substantially all of its fixed rate
debt, the Company enters into interest rate swap agreements to convert its fixed
rate payments into floating rate payments.
The net fair values of the interest rate swaps were $125,726 and $127,097
payable at June 30, 2000 and December 31, 1999, respectively. The fair value of
interest rate swaps used to hedge the Company's long-term borrowings is based
upon the amounts the Company would receive or pay to terminate the agreements,
taking into account current interest rates.
The carrying amounts of the interest rate swap agreements included in the
Company's Condensed Consolidated Statements of Financial Condition at June 30,
2000 and December 31, 1999 were net receivables of $6,233 and $12,075,
respectively. See Note 7 for further discussion of interest rate swap agreements
used for hedging purposes.
NOTE 6: CAPITAL REQUIREMENTS
PWI, a registered broker-dealer, is subject to the Securities and Exchange
Commission Uniform Net Capital Rule and New York Stock Exchange Growth and
Business Reduction capital requirements. Under the method of computing capital
requirements adopted by PWI, minimum net capital shall not be less than 2
percent of combined aggregate debit items arising from client transactions, plus
excess margin collected on securities purchased under agreements to resell, as
defined. A reduction of business is required if net capital is less than 4
percent of such aggregate debit items. Business may not be expanded if net
capital is less than 5 percent of such aggregate debit items. As of June 30,
2000, PWI's net capital of $1,196,312 was 9.1 percent of aggregate debit items
and its net capital in excess of the minimum required was $921,545.
Effective June 9, 2000, the Company completed its merger with J.C. Bradford, a
registered broker-dealer. As a registered broker-dealer, J.C. Bradford is
subject to the Securities and Exchange Commission Uniform Net Capital Rule and
New York Stock Exchange Growth and Business Reduction capital requirements,
similar to PWI. As of June 30, 2000, J.C. Bradford's net capital of $376,146 was
41.3 percent of aggregate debit items and its net capital in excess of the
minimum required was $357,940.
NOTE 7: FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Held or Issued for Trading Purposes
Set forth below are the gross contract or notional amounts of the Company's
outstanding off-balance-sheet derivative and other financial instruments held or
issued for trading purposes. These amounts are not reflected in the Condensed
Consolidated Statements of Financial Condition and are indicative only of the
volume of activity at June 30, 2000 and December 31, 1999. They do not represent
amounts subject to market risks, and in many cases, limit the Company's overall
exposure to market losses by hedging other on- and off-balance-sheet
transactions.
7
<PAGE> 9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
Notional or Contract Amount
-----------------------------------------------------------------------------------
June 30, 2000 December 31, 1999
-------------------------------------- ---------------------------------------
Purchases Sales Purchases Sales
----------------- ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Mortgage-backed forward contracts
and options written and purchased $14,862,935 $20,758,712 $14,417,186 $17,540,786
Foreign currency forward contracts,
futures contracts, and options
written and purchased 2,047,008 2,014,695 1,380,925 1,373,981
Equity securities contracts including
stock index futures, forwards, and
options written and purchased 202,385 359,693 144,034 239,682
Other fixed income securities contracts
including futures, forwards, and options
written and purchased 5,930,773 7,913,074 3,557,193 5,538,887
Interest rate swaps and caps 1,591,267 3,737,418 1,688,762 419,989
</TABLE>
Set forth below are the fair values of derivative financial instruments held or
issued for trading purposes as of June 30, 2000 and December 31, 1999. The fair
value amounts are netted by counterparty when specific conditions are met.
<TABLE>
<CAPTION>
Fair Value at Fair Value at
June 30, 2000 December 31, 1999
--------------------------------------- ---------------------------------------
Assets Liabilities Assets Liabilities
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Mortgage-backed forward contracts and
options written and purchased $93,514 $110,055 $159,228 $114,838
Foreign currency forward contracts,
futures contracts, and options
written and purchased 21,160 20,211 20,274 20,158
Equity securities contracts including
stock index futures, forwards, and
options written and purchased 41,655 16,051 152,024 48,835
Other fixed income securities contracts
including futures, forwards, and options
written and purchased 12,327 6,436 29,584 20,177
Interest rate swaps and caps 21,000 41,489 31,569 11,087
</TABLE>
Set forth below are the average fair values of derivative financial instruments
held or issued for trading purposes for the three months ended June 30, 2000 and
the twelve months ended December 31, 1999. The average fair value is based on
the average of the month-end balances during the periods indicated.
8
<PAGE> 10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
Average Fair Value Average Fair Value
June 30, 2000 December 31, 1999
--------------------------------------- ---------------------------------------
Assets Liabilities Assets Liabilities
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Mortgage-backed forward contracts and
options written and purchased $121,674 $112,297 $171,113 $163,954
Foreign currency forward contracts,
futures contracts, and options
written and purchased 31,807 31,218 22,549 22,377
Equity securities contracts including
stock index futures, forwards, and
options written and purchased 88,125 31,563 63,624 40,321
Other fixed income securities contracts
including futures, forwards, and options
written and purchased 16,163 6,017 11,932 49,800
Interest rate swaps and caps 29,344 26,051 18,593 6,754
</TABLE>
The Company also sells securities, at predetermined prices, which have not yet
been purchased. The Company is exposed to market risk since to satisfy the
obligation, the Company must acquire the securities at market prices, which may
exceed the values reflected on the Condensed Consolidated Statements of
Financial Condition.
The off-balance-sheet derivative trading transactions are generally short-term.
At June 30, 2000 substantially all of the off-balance-sheet trading-related
derivative and other financial instruments had remaining maturities of less than
one year.
The Company's risk of loss in the event of counterparty default is limited to
the current fair value or the replacement cost on contracts in which the Company
has recorded an unrealized gain. These amounts are reflected as assets on the
Company's Condensed Consolidated Statements of Financial Condition and amounted
to $189,656 and $392,679 at June 30, 2000 and December 31, 1999, respectively.
Options written do not expose the Company to credit risk since they do not
obligate the counterparty to perform. Transactions in futures contracts are
conducted through regulated exchanges which have margin requirements, and are
settled in cash on a daily basis, thereby minimizing credit risk.
The following table summarizes the Company's principal transactions revenues by
business activity for the three months and six months ended June 30, 2000 and
1999. Principal transactions revenues include realized and unrealized gains and
losses on trading positions and principal investing activities, including
hedges. In assessing the profitability of its trading activities, the Company
views net interest and principal transactions revenues in the aggregate.
<TABLE>
<CAPTION>
Principal Transactions Revenues
-----------------------------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ---------------------------
2000 1999 2000 1999
----------- ------------ ------------ ---------
<S> <C> <C> <C> <C>
Taxable fixed income (includes futures, forwards,
options contracts and other securities) $ 61,901 $137,646 $119,672 $332,050
Equities (includes stock index futures, forwards and options contracts) 71,983 107,424 278,805 192,331
Municipals (includes futures and options contracts) 47,544 34,776 92,240 69,673
-------- -------- -------- --------
$181,428 $279,846 $490,717 $594,054
======== ======== ======== ========
</TABLE>
9
<PAGE> 11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Held or Issued for Purposes Other Than Trading
The Company enters into interest rate swap agreements to manage the interest
rate characteristics of its assets and liabilities. As of June 30, 2000 and
December 31, 1999, the Company had outstanding interest rate swap agreements
with commercial banks with notional amounts of $3,896,010 and $4,206,010,
respectively. These agreements effectively converted substantially all of the
Company's fixed rate debt at June 30, 2000 into floating rate debt. The interest
rate swap agreements entered into have had the effect of increasing net interest
expense on the Company's fixed rate debt by $2,359 for the six months ended June
30, 2000, and decreasing net interest expense by $13,791 for the six months
ended June 30, 1999. The Company had no deferred gains or losses related to
terminated swap agreements on the Company's long-term borrowings at June 30,
2000 and December 31, 1999. The Company is subject to market risk as interest
rates fluctuate. The interest rate swaps contain credit risk to the extent the
Company is in a receivable or gain position and the counterparty defaults.
However, the counterparties to the agreements generally are large financial
institutions, and the Company has not experienced defaults in the past, and
management does not anticipate any counterparty defaults in the foreseeable
future. See Note 5 for further discussion of interest rate swap agreements used
for hedging purposes.
NOTE 8: RISK MANAGEMENT
Transactions involving derivative and non-derivative financial instruments
involve varying degrees of both market and credit risk. The Company monitors its
exposure to market and credit risk on a daily basis and through a variety of
financial, security position and credit exposure reporting and control
procedures.
Market Risk
Market risk is the potential change in value of the financial instrument caused
by unfavorable changes in interest rates, equity prices, and foreign currency
exchange rates. The Company has a variety of methods to monitor its market risk
profile. The senior management of each business group is responsible for
reviewing trading positions, exposures, profits and losses, and trading
strategies. The Company also has an independent risk management group which
reviews the Company's risk profile and aids in setting and monitoring risk
management policies of the Company, including monitoring adherence to the
established limits, performing market risk modeling, and reviewing trading
positions and hedging strategies. The Asset/Liability Management Committee,
comprised of senior corporate and business group managers, is responsible for
establishing trading position and exposure limits.
Market risk modeling is based on estimating loss exposure through sensitivity
testing. These results are compared to established limits, and exceptions are
subject to review and approval by senior management. Other market risk control
procedures include monitoring inventory agings, reviewing traders' marks and
holding regular meetings between the senior management of the business groups
and the risk management group.
Credit Risk in Proprietary Transactions
Counterparties to the Company's proprietary trading, hedging, financing and
arbitrage activities are primarily financial institutions, including banks,
brokers and dealers, investment funds and insurance companies. Credit losses
could arise should counterparties fail to perform and the value of any
collateral proves inadequate. The Company manages credit risk by monitoring net
exposure to individual counterparties on a daily basis, monitoring credit limits
and requiring additional collateral where appropriate.
Derivative credit exposures are calculated, aggregated and compared to
established limits by the credit department. Credit reserve requirements are
determined by senior management in conjunction with the Company's continuous
credit monitoring procedures. Historically, reserve requirements arising from
instruments with off-balance-sheet risk have not been material.
Receivables and payables with brokers and dealers, agreements to resell and
repurchase securities, and securities borrowed and loaned are generally
collateralized by cash, government and government-agency securities, and letters
of credit. The market value of the initial collateral received approximates or
is greater than the contract value. Additional collateral is requested when
considered necessary. The Company may pledge clients' margined securities as
collateral in support of securities loaned and bank loans, as well as to satisfy
margin requirements at clearing organizations. The amounts loaned or pledged are
limited to the extent permitted by applicable margin regulations. Should the
counterparty fail to return the clients' securities, the Company may be required
to replace them at prevailing market prices. At June 30, 2000, the market value
of client securities loaned to other brokers approximated the amounts due or
collateral obtained.
10
<PAGE> 12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Credit Risk in Client Activities
Client transactions are entered on either a cash or margin basis. In a margin
transaction, the Company extends credit to a client for the purchase of
securities, using the securities purchased and/or other securities in the
client's account as collateral for amounts loaned. Receivables from customers
are substantially collateralized by customer securities. Amounts loaned are
limited by margin regulations of the Federal Reserve Board and other regulatory
authorities and are subject to the Company's credit review and daily monitoring
procedures. Market declines could, however, reduce the value of any collateral
below the principal amount loaned, plus accrued interest, before the collateral
can be sold.
Client transactions include positions in commodities and financial futures,
trading liabilities and written options. The risk to the Company's clients in
these transactions can be substantial, principally due to price volatility which
can reduce the clients' ability to meet their obligations. Margin deposit
requirements pertaining to commodity futures and exchange-traded options
transactions are generally lower than those for exchange-traded securities. To
the extent clients are unable to meet their commitments to the Company and
margin deposits are insufficient to cover outstanding liabilities, the Company
may take market action and credit losses could be realized.
Client trades are recorded on a settlement date basis. Should either the client
or broker fail to perform, the Company may be required to complete the
transaction at prevailing market prices. Trades pending at June 30, 2000 were
settled without material adverse effect on the Company's consolidated financial
statements, taken as a whole.
Concentrations of Credit Risk
Concentrations of credit risk that arise from financial instruments (whether on-
or off-balance-sheet) exist for groups of counterparties when they have similar
economic characteristics that would cause their ability to meet obligations to
be similarly affected by economic, industry or geographic factors. As a major
securities firm, the Company engages in underwriting and other financing
activities with a broad range of clients, including other financial
institutions, municipalities, governments, financing companies, and commercial
real estate investors and operators. These activities could result in
concentrations of credit risk with a particular counterparty, or group of
counterparties operating in a particular geographic area or engaged in business
in a particular industry. The Company seeks to control its credit risk and the
potential for risk concentration through a variety of reporting and control
procedures described above.
The Company's most significant industry concentration, which arises within its
normal course of business activities, is financial institutions including banks,
brokers and dealers, investment funds, and insurance companies.
NOTE 9: COMMITMENTS AND CONTINGENCIES
At June 30, 2000 and December 31, 1999, the Company was contingently liable
under unsecured letters of credit totaling $204,868 and $139,156, respectively,
which approximated fair value. At June 30, 2000 and December 31, 1999 certain of
the Company's subsidiaries were contingently liable as issuer of approximately
$45,000 of notes payable to managing general partners of various limited
partnerships pursuant to certain partnership agreements. In addition, as part of
the 1995 limited partnership settlements, the Company has agreed, under certain
circumstances, to provide to class members additional consideration including
assignment of fees the Company is entitled to receive from certain partnerships.
In the opinion of management, these contingencies will not have a material
adverse effect on the Company's consolidated financial statements, taken as a
whole.
In meeting the financing needs of certain of its clients, the Company may also
issue standby letters of credit which are collateralized by customer margin
securities. At June 30, 2000 and December 31, 1999, the Company had outstanding
$142,503 and $101,400, respectively, of such standby letters of credit. At June
30, 2000 and December 31, 1999, securities with fair value of $3,414,277 and
$2,536,073, respectively, had been loaned or pledged as collateral for
securities borrowed of approximately equal fair value.
In the normal course of business, the Company enters into when-issued
transactions, underwriting and other commitments. Also, at June 30, 2000 and
December 31, 1999, the Company had commitments of $1,411,297 and $858,122,
respectively, consisting of secured credit lines to real estate operators,
mortgage and asset-backed originators, and commitments to investment
partnerships, in certain of which key employees are limited partners. Settlement
of these transactions at June 30, 2000 would not have had a material impact on
the Company's consolidated financial statements, taken as a whole.
11
<PAGE> 13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has been named as defendant in numerous legal actions in the
ordinary course of business. While the outcome of such matters cannot be
predicted with certainty, in the opinion of management of the Company, after
consultation with various counsel handling such matters, these actions will be
resolved with no material adverse effect on the Company's consolidated financial
statements, taken as a whole.
NOTE 10: COMPREHENSIVE INCOME
Comprehensive income is calculated in accordance with SFAS No. 130, "Reporting
Comprehensive Income." Comprehensive income combines net income and certain
items that directly affect stockholders' equity, such as foreign currency
translation adjustments. The components of comprehensive income for the three
months and six months ended June 30, 2000 and 1999 were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------- -----------------------------------------
2000 1999 2000 1999
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Net income $127,506 $ 163,504 $303,855 $324,103
Foreign currency translation adjustment (2,396) (1,419) (3,278) (2,931)
----------------- ----------------- ----------------- -----------------
Total comprehensive income $125,110 $ 162,085 $300,577 $321,172
----------------- ----------------- ----------------- -----------------
</TABLE>
NOTE 11: EARNINGS PER COMMON SHARE
Earnings per common share are computed in accordance with SFAS No. 128,
"Earnings Per Share." Basic earnings per share excludes the dilutive effects of
options and convertible securities and is calculated by dividing income
available to common shareholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects all potentially
dilutive securities.
Set forth below is the reconciliation of net income applicable to common shares
and weighted-average common and common equivalent shares of the basic and
diluted earnings per common share computations:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ -----------------
June 30, June 30,
-------- -------
2000 1999 2000 1999
-------------- -------------- -------------- -----------
<S> <C> <C> <C> <C>
NUMERATOR:
Net income $ 127,506 $ 163,504 $ 303,855 $ 324,103
Preferred stock dividends - (5,949) - (11,898)
-------------- -------------- -------------- -----------
Net income applicable to common shares
for basic earnings per share 127,506 157,555 303,855 312,205
============== ============== ============== ===========
Net income applicable to common shares
for diluted earnings per share $ 127,506 $ 157,555 $ 303,855 $ 312,205
============== ============== ============== ===========
DENOMINATOR:
Weighted-average common shares for basic
earnings per share 146,067,820 145,742,741 145,324,940 145,631,920
Weighted-average effect of dilutive
employee stock options and awards 8,508,584(1) 9,217,656 7,908,935(1) 8,673,875
-------------- ------------- -------------- ------------
Dilutive potential common shares 8,508,584 9,217,656 7,908,935 8,673,875
-------------- ------------- -------------- ------------
Weighted-average common and common equivalent
shares for diluted earnings per share 154,576,404 154,960,397 153,233,875 154,305,795
============== ============= ============== ============
EARNINGS PER SHARE:
Basic $ 0.87 $ 1.08 $ 2.09 $ 2.14
============== ============== ============== ============
Diluted $ 0.82 $ 1.02 $ 1.98 $ 2.02
============== ============== ============== ============
</TABLE>
----------------------------
(1) Included in the calculation of employee stock options and awards was the
dilutive effective of 1,931,250 instruments related to convertible debentures.
12
<PAGE> 14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12: SEGMENT REPORTING DATA
The Company offers a wide variety of products and services, primarily those of a
full service domestic broker-dealer to a domestic market, through its two
operating segments: Individual and Institutional. The Individual segment offers
brokerage services and products (such as the purchase and sale of securities,
insurance annuity contracts, mutual funds, wrap fee products, and margin and
securities lending), asset management and other investment advisory and
portfolio management products and services, and execution and clearing services
for transactions originated by individual investors. The Institutional segment
principally includes capital market products and services (such as the placing
of securities and other financial instruments for - and the execution of trades
on behalf of - institutional clients, investment banking services such as the
underwriting of debt and equity securities, and mergers and acquisitions
advisory services).
Segment revenues and expenses in the table below consist of those that are
directly attributable to the segment under which they are reported, combined
with segment amounts based on Company allocation methodologies (for example,
allocating a portion of investment banking revenues to the Individual segment;
relative utilization of the Company's square footage for certain cost
allocations).
<TABLE>
<CAPTION>
Three months ended June 30, 2000
--------------------------------------------------------------
Individual Institutional Total
------------------ -------------------- ----------------------
<S> <C> <C> <C>
Total revenues $1,422,061 $ 894,365 $2,316,426
Net revenues 1,142,750 268,422 1,411,172
Income before taxes and
minority interest 199,050 13,020 212,070
</TABLE>
<TABLE>
<CAPTION>
Three months ended June 30, 1999
--------------------------------------------------------------
Individual Institutional Total
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Total revenues $1,135,946 $835,032 $1,970,978
Net revenues 980,018 367,889 1,347,907
Income before taxes and
minority interest 152,980 116,687 269,667
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30, 2000
--------------------------------------------------------------
Individual Institutional Total
------------------ -------------------- ----------------------
<S> <C> <C> <C>
Total revenues $2,892,812 $1,828,735 $4,721,547
Net revenues 2,394,028 614,249 3,008,277
Income before taxes and
minority interest 398,244 104,045 502,289
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30, 1999
-------------------------------------------------------------
Individual Institutional Total
-------------------- -------------------- -------------------
<S> <C> <C> <C>
Total revenues $2,240,355 $1,653,933 $3,894,288
Net revenues 1,935,131 727,667 2,662,798
Income before taxes and
minority interest 304,873 229,813 534,686
</TABLE>
Total assets for the Individual and Institutional segments were $26,786,776 and
$39,615,726, respectively, at June 30, 2000 and $21,828,324 and $39,784,052,
respectively at December 31, 1999.
13
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company's principal business activities are, by their nature, affected by
many factors, including general economic and financial conditions, the level and
volatility of interest rates, currency and security valuations, competitive
conditions, counterparty risk, transactional volume, market liquidity and
technological changes. As a result, revenues and profitability have been in the
past, and are likely to continue to be, subject to fluctuations reflecting the
impact of these factors.
Certain statements included in this discussion and in other parts of this report
include "forward-looking statements" that involve known and unknown risks and
uncertainties including (without limitation) those mentioned above, the impact
of current, pending and future legislation and regulation, and other risks and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements. The Company disclaims any obligation or
undertaking to update publicly or revise any forward-looking statements.
During the second quarter of 2000, economic conditions in the U.S. were
generally positive, but the performance of the financial markets was mixed. The
annualized rate of U.S. Real Gross Domestic Product growth in the second quarter
was 5.2 percent, versus 4.8 percent in the first quarter of 2000 and 2.5 percent
in the second quarter of 1999. Inflation was above year-ago levels. The Consumer
Price Index rose 3.6 percent in the second quarter of 2000, slightly below the
4.0 percent rate in the first quarter of 2000 but well above 2.6 percent in the
second quarter of 1999. To reduce inflationary pressure, the Federal Reserve
tightened monetary policy in May, raising the Fed funds rate from 6.0 percent to
6.5 percent. However, interest rates ended the quarter at the same levels that
they began it. Despite considerable intra-quarter volatility, the yield on the
90-day U.S. Treasury bill held steady at 5.88 percent and the 10-year Treasury
bond remained at 6.03 percent.
The equity market was somewhat weak during the second quarter of 2000. The Dow
Jones Industrial Average declined 4.3 percent during the second quarter of 2000,
compared to a 12.1 percent increase during the second quarter of 1999. The S&P
500 declined 2.9 percent as compared to a 6.7 percent increase during the second
quarter of 1999. The NASDAQ Composite Index fell 13.3 percent in the second
quarter of 2000, as compared to a 9.1 percent gain in the second quarter of
1999. Despite relatively weak stock prices, equity market volume was heavy,
easily beating the 1999 figures. Average daily volume on the New York Stock
Exchange was 970 million shares in the second quarter of 2000, as compared with
791 million in the year-ago quarter. NASDAQ volume was 1.5 billion shares per
day in the second quarter of 2000, 54 percent above the volume in the second
quarter of 1999.
SUBSEQUENT EVENT
On July 12, 2000, PWG entered into an agreement and plan of merger with UBS AG
("UBS") and a subsidiary of UBS, pursuant to which PWG will merge with and into
that subsidiary. Under the terms of the agreement, PWG's shareholders will have
the right to elect to receive either $73.50 in cash or 0.4954 of an ordinary
share of UBS AG stock for each share of PWG's common stock, $1 par value
("common stock") that they own. The percentage of PWG's common stock that will
be converted into the right to receive UBS AG stock is fixed at 50 percent.
Adjustments to elections may therefore be necessary so that, in the aggregate,
50 percent of the shares of PWG's common stock is converted into the right to
receive UBS AG stock, and 50 percent is converted into the right to receive
cash. The transaction, which is expected to be completed in the fourth quarter
of 2000, has been approved by PWG's Board of Directors and is subject to
customary closing conditions, including certain regulatory approvals and the
approval of PWG's shareholders.
MERGER WITH J.C. BRADFORD
On June 9, 2000, the Company completed its merger with J.C. Bradford & Co.
L.L.C. ("J.C. Bradford"), a leading privately-held brokerage firm in the
Southeastern U.S., for approximately $622 million in cash. The merger was
accounted for as a purchase and, accordingly, the excess of the purchase cost
over the fair value of the net assets acquired of approximately $185 million,
resulted in the Company recording $560 million in goodwill, which is being
amortized over 25 years on a straight-line basis. The consolidated financial
statements of the Company include the results of J.C. Bradford from the
closing date. As a result of the merger, the Company recorded after-tax costs
of approximately $18.8 million ($30.0 million pre-tax) relating primarily to
elimination of the Company's duplicate facilities, severance and other costs.
14
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(CONTINUED)
RESULTS OF OPERATIONS
Quarter Ended June 30, 2000 compared to Quarter Ended June 30, 1999
The Company's net income for the quarter ended June 30, 2000, was $146.3
million, or $1.00 per basic share ($0.95 per diluted share), before
merger-related after-tax costs of $18.8 million ($30.0 million pre-tax)
associated with the Company's merger with J.C. Bradford. Including these costs,
the Company's net income was $127.5 million, or $0.87 per basic share ($0.82 per
diluted share). This compares to net income of $163.5 million, or $1.08 per
basic share ($1.02 per diluted share) earned during the second quarter of 1999.
During the second quarter of 2000, revenues, net of interest expense, were
$1,411.2 million, 4.7% higher than the second quarter of 1999.
Commission revenues earned during the second quarter of 2000 were $560.5
million, 14.7 percent higher than the $488.9 million earned during the prior
year quarter. Mutual fund and insurance commissions increased $50.5 million or
38.6 percent, commissions from over-the-counter securities and commodities
increased $11.8 million or 16.5 percent and commissions on the sale of listed
securities and options increased $9.3 million or 3.3 percent compared to the
prior year quarter.
Principal transactions revenues declined from the second quarter of 1999 to
$181.4 million from $279.8 million, or 35.2 percent. The decline was
attributable to lower results in taxable fixed income and equities slightly
offset by an increase in municipals.
Asset management fees increased $76.2 million, or 34.0 percent to a record
$300.7 million, reflecting higher revenues earned on managed and fee-based
accounts. Average assets in wrap and trust accounts during the second quarter of
2000 were approximately 50 percent higher than during the second quarter of
1999. At June 30, 2000, assets in wrap and trust accounts reached a record $58.5
billion. The increase in revenues also reflects higher investment advisory fees
earned on assets managed in long-term and money market funds. The average assets
under management in money market, institutional and long-term mutual funds were
approximately $72 billion during the second quarter of 2000 and approximately
$62 billion during the second quarter of 1999. At June 30, 2000, assets under
management were $73.1 billion.
Investment banking revenues earned during the second quarter of 2000 were $155.6
million, $4.5 million less than the $160.1 million earned during the second
quarter of 1999. The current year quarter reflects decreases in municipal and
corporate securities underwriting fees, management fees and selling concessions
on lower volume of lead-managed and co-managed issues while private placement
and other fees remained relatively flat.
Net interest increased $21.8 million, or 14.8 percent to $169.0 million
primarily due to an increased level of margin lending to clients during the
period.
In June 2000, the Company recorded $30.0 million in pre-tax costs associated
with the Company's merger with J.C. Bradford. These costs relate primarily to
elimination of the Company's duplicate facilities, severance and other costs and
are reflected in compensation and benefits, and other operating expenses.
Compensation and benefits expenses for the quarter ended June 30, 2000 were
$839.6 million, a 7.6 percent increase as compared to $780.1 million during the
prior year quarter. The number of employees at June 30, 2000 increased
approximately 4,700, or 26 percent, as compared to June 30, 1999 reflecting an
additional 1,436 Private Client Group financial advisors (including 831 J.C.
Bradford financial advisors), related financial advisor support personnel, and
technology specialists hired to implement the Company's technology initiatives.
The ratio of compensation and benefits as a percent of net revenues increased to
59.5 percent versus 57.9 percent in the prior year quarter.
All other operating expenses increased $61.3 million, or 20.6 percent to $359.5
million, as compared to $298.2 million for the prior year quarter. Office and
equipment expenses increased $10.4 million, or 11.6 percent principally due to
J.C. Bradford merger-related costs as well as an increase in office space and
equipment necessary to support the additional headcount. Professional services
expenses increased $18.1 million, or 55.7 percent principally due to consultants
used in the Company's advanced technology implementation, recruiting fees and
other consulting expenses. Business development expenses increased $13.2
million, or 46.4 percent reflecting higher promotional costs associated with
PaineWebber EDGE and PaineWebber InsightOne and other expenses associated with
increased business
15
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
activities. Other expenses increased $18.7 million, or 22.9 percent principally
due to increased meeting and seminar expenses and other office-related expenses
associated with increased business activities, as well as J.C. Bradford
merger-related costs. The ratio of non-compensation expenses as a percentage of
net revenues was 25.5 percent for the quarter ended June 30, 2000 compared to
22.1 percent for the prior year quarter.
The effective income tax rate was 36.1 percent for the quarter ended June 30,
2000 which was comparable to the 36.4 percent from the prior year quarter.
Six Months Ended June 30, 2000 compared to Six Months Ended June 30, 1999
The Company's net income was $322.6 million, for the six months ended June 30,
2000, or $2.22 per basic share ($2.11 per diluted share), before merger-related
after-tax costs of $18.8 million ($30.0 million pre-tax) associated with the
Company's merger with J.C. Bradford. Including these costs, the Company's net
income for the six months ended June 30, 2000 was $303.9 million, or $2.09 per
basic share ($1.98 per diluted share). This compares to net income of $324.1
million, or $2.14 per basic share ($2.02 per diluted share) earned during the
first six months of 1999. During the first six months of 2000, revenues, net of
interest expense, were a record $3,008.3 million, 13.0 percent higher than the
corresponding period a year ago.
Commission revenues earned during the first six months of 2000 were a record
$1,236.7 million, 27.8 percent higher than the $967.8 million earned during the
prior year period. Mutual fund and insurance commissions increased $122.8
million or 48.1 percent, commissions from over-the-counter securities and
commodities increased $80.1 million or 57.4 percent, and commissions on the sale
of listed securities and options increased $65.4 million or 11.4 percent.
Principal transactions revenues decreased $103.3 million, or 17.4 percent, to
$490.7 million attributable to lower results in taxable fixed income offset by
increases in equities and municipals.
Asset management fees increased $148.5 million, or 34.5 percent to a record
$579.0 million, reflecting higher revenues earned on managed accounts. Average
assets in wrap and trust accounts during the first six months of 2000 were
approximately 51 percent higher than during the corresponding period of 1999. At
June 30, 2000, assets in wrap and trust accounts reached a record $58.5 billion.
The increase also reflects higher investment advisory and distribution fees
earned on assets managed in long-term and money market funds. The average assets
under management in money market, institutional and long-term mutual funds were
approximately $71 billion during the first six months of 2000, up from the
approximately $62 billion during the first six months of 1999.
Investment banking revenues earned during the first six months of 2000 were
$277.8 million, $8.3 million lower than the $286.1 million earned during the
same period last year. The current year period reflects declines in underwriting
fees, management fees and selling concessions on lower volume of lead-managed
and co-managed corporate issues. Partially offsetting these declines were
increases in private placement and other fees.
Net interest increased $46.5 million, or 15.7 percent to a record $342.5 million
reflecting primarily an increased level of margin lending to clients during the
period.
In June 2000, the Company recorded $30.0 million in pre-tax costs associated
with the Company's merger with J.C. Bradford. These costs relate primarily to
elimination of the Company's duplicate facilities, severance and other costs and
are reflected in compensation and benefits, and other operating expenses.
Compensation and benefits expenses for the six months ended June 30, 2000 were
$1,789.4 million, a 15.5 percent increase as compared to $1,548.8 million during
the prior year period. The number of employees at June 30, 2000 increased
approximately 4,700, or 26 percent, as compared to June 30, 1999 reflecting an
additional 1,436 Private Client Group financial advisors (including 831 J.C.
Bradford financial advisors), related financial advisor support personnel, and
technology specialists hired to implement the Company's technology initiatives.
The ratio of compensation and benefits as a percent of net revenues increased to
59.5 percent versus 58.2 percent in the prior year period.
All other operating expenses increased $137.3 million, or 23.7 percent to $716.6
million, as compared to $579.3 million for the prior year period. Office and
equipment expenses increased $25.5 million, or 14.9 percent principally due to
an
16
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
increase in office space and equipment necessary to support the additional
headcount and J.C. Bradford merger-related costs. Professional services expenses
increased $37.0 million, or 58.9 percent principally due to consultants used in
the Company's advanced technology implementation, recruiting fees and other
consulting expenses. Business development expenses increased $28.3 million, or
54.0 percent reflecting higher promotional costs associated with PaineWebber
EDGE and PaineWebber InsightOne and other expenses associated with increased
business activities. Other expenses increased $40.7 million, or 25.3 percent
principally due to increased meeting and seminar expenses and other
office-related expenses associated with increased business activities, as well
as J.C. Bradford merger-related costs. The ratio of non-compensation expenses as
a percentage of net revenues was 23.8 percent for the six months ended June 30,
2000 compared to 21.8 percent for the prior year period.
The effective income tax rate for the six months ended June 30, 2000 was 36.3
percent which was comparable to the 36.4 percent from the prior year period.
LIQUIDITY AND CAPITAL RESOURCES
The primary objectives of the Company's funding policies are to ensure ample
liquidity at all times and a strong capital base. These objectives are met by
maximization of self-funded assets, diversification of funding sources,
maintenance of prudent liquidity and capital ratios, and contingency planning.
Liquidity
The Company maintains a highly liquid balance sheet with the majority of assets
consisting of trading assets, securities purchased under agreements to resell,
securities borrowed, and receivables from clients, brokers and dealers, which
are readily convertible into cash. The nature of the Company's business as a
securities dealer results in carrying significant levels of trading assets and
liabilities in order to meet its client and proprietary trading needs. The
Company's total assets may fluctuate from period to period as the result of
changes in the level of trading positions held to facilitate client
transactions, the volume of resale and repurchase transactions, and proprietary
trading strategies. These fluctuations depend significantly upon economic and
market conditions, and transactional volume.
The Company's total assets at June 30, 2000 were $66.4 billion compared to $61.6
billion at December 31, 1999, primarily attributable to an increase in
receivables from clients and financial instruments owned. The majority of the
Company's assets are financed by daily operations such as securities sold under
agreements to repurchase, free credit balances in client accounts and securities
lending activity. The Company regularly reviews its mix of assets and
liabilities to maximize self-funding. Additional financing sources are available
through bank loans and commercial paper, committed and uncommitted lines of
credit, and long-term borrowings.
The Company maintains committed and uncommitted credit facilities from a diverse
group of banks. The Company has a $1.2 billion unsecured revolving credit
agreement, which extends through September 2000, with provisions for renewal
through 2001. This credit agreement is in the process of being renewed. Certain
of the Company's subsidiaries also have a secured revolving credit facility to
provide up to an aggregate of $1.0 billion through August 2000. The secured
borrowings under this facility can be collateralized using a variety of
securities. The facilities are available for general corporate purposes and are
tested on a regular basis. The Company is in the process of replacing this
facility with a new $1.0 billion revolving credit agreement. At June 30, 2000,
there were no outstanding borrowings under either facility. Additionally, the
Company had $5.1 billion in uncommitted lines of credit at June 30, 2000.
The Company maintains public shelf registration statements with the SEC for the
issuance of debt securities of the Company and for the issuance of preferred
securities of PWG Capital Trusts III, IV and V ("Preferred Trust Securities"),
business trusts formed under the Delaware law which are wholly owned
subsidiaries of the Company. During the second quarter of 2000, the Company
issued $156.6 million of debt under these registration statements. At June 30,
2000, the Company had $757.6 million in debt securities available for issuance
under a shelf registration statement and $706.2 million in Preferred Trust
Securities and debt securities of the Company available for issuance under
another registration statement.
Capital Resources and Capital Adequacy
The Company's businesses are capital intensive. In addition to a funding policy
that provides for diversification of funding sources and maximization of
liquidity, the Company maintains a strong capital base.
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<PAGE> 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
The Company's total capital base, which includes long-term borrowings, Preferred
Trust Securities and stockholders' equity, grew to $8.8 billion, an increase of
$259.0 million from December 31, 1999. The growth in total capital is primarily
due to the net increase in stockholders' equity of $273.7 million offset by a
net decrease in long-term borrowings of $14.7 million.
The net decrease in long-term borrowings primarily reflected the maturity of
$200 million U.S. dollar-denominated 7 percent senior notes on March 1, 2000 and
net maturities of U.S. dollar-denominated medium-term notes of $25.7 million,
partially offset by the issuance of $119.1 million non-U.S. dollar-denominated
medium-term notes and the issuance of $73.5 million U.S. dollar-denominated 6.25
percent convertible debentures due 2007. The increase in stockholders' equity
was primarily the result of net income for the six months ended June 30, 2000 of
$303.9 million and the issuance of approximately 4,140,000 shares of common
stock related to employee compensation and stock purchase programs. Issuances
and tax credits related to these programs had the net effect of increasing
equity capital by $121.6 million in the first six months of 2000. These
increases were offset by the repurchase in the first six months of 2000 of
approximately 3,000,000 shares of common stock for $114.8 million and dividends
of $35.0 million. At June 30, 2000, the remaining number of shares authorized to
be repurchased, in the open market or otherwise, under the Company's common
stock repurchase program was approximately 34 million.
On August 2, 2000, the Board of Directors declared a regular quarterly cash
dividend on the Company's common stock of $0.12 per share payable on October 4,
2000 to stockholders of record on September 6, 2000.
PWI is subject to the net capital requirements of the Securities and Exchange
Commission, the New York Stock Exchange, Inc. and the Commodity Futures Trading
Commission which are designed to measure the financial soundness and liquidity
of broker-dealers. PWI has consistently maintained net capital in excess of the
minimum requirements imposed by these agencies. In addition, the Company has
other banking and securities subsidiaries, both domestic and foreign, which have
also consistently maintained net regulatory capital in excess of requirements.
Effective June 9, 2000, the Company merged with J.C. Bradford, a registered
broker-dealer, which is subject to net capital requirements similar to PWI.
Merchant Banking and Highly Leveraged Transactions
In connection with its merchant banking, principal investing, commercial real
estate, and asset finance activities, the Company has provided financing and
made investments in companies and other entities, some of which are involved in
highly leveraged transactions. Positions taken or commitments made by the
Company may involve credit or market risk from any one issuer or industry.
At June 30, 2000, the Company had investments which were affected by liquidity,
reorganization or restructuring issues amounting to $137.1 million. These
investments have not had a material effect on the Company's results of
operations.
The Company's activities include underwriting and market-making transactions in
high-yield corporate debt and non-investment-grade mortgage-backed securities,
and emerging market securities (collectively, "high-yield securities"). These
securities generally involve greater risks than investment-grade corporate debt
securities because these issuers usually have high levels of indebtedness and
lower credit ratings and are, therefore, more vulnerable to general economic
conditions. At June 30, 2000, the Company held $376.9 million of high-yield
securities, with approximately 24 percent of such securities attributable to
four issuers. The Company continually monitors its risk positions associated
with high-yield securities and establishes limits with respect to overall market
exposure, industry group and individual issuer. The Company accounts for these
positions at fair value, with unrealized gains and losses reflected in principal
transactions revenues. These high-yield securities have not had a material
effect on the Company's results of operations.
DERIVATIVE FINANCIAL INSTRUMENTS
A derivative financial instrument is a contractual agreement between
counterparties that derives its value from changes in the value of some
underlying asset such as the price of another security, interest rates, currency
exchange rates, specified rates (e.g. LIBOR) or indices (e.g. S&P 500), or other
value referenced in the contract. Derivatives, such as futures, certain option
contracts and structured products (e.g. indexed warrants) are traded on
exchanges, while derivatives such as forward contracts, certain option
contracts, interest rate swaps, caps and floors, and other structured products
are negotiated in over-the-counter markets.
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<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
In the normal course of business, the Company engages in a variety of derivative
transactions in connection with its proprietary trading activities and asset and
liability management, as well as on behalf of its clients. As a dealer, the
Company regularly makes a market in and trades a variety of securities. The
Company is also engaged in creating structured products that are sold to
clients. In connection with these activities, the Company attempts to reduce its
exposure to market risk by entering into offsetting hedging transactions, which
may include derivative financial instruments. The Company also enters into
interest rate swap contracts to manage the interest rate characteristics of its
assets and liabilities.
The notional amount of a derivative contract is used to measure the volume of
activity and is not reflected on the Condensed Consolidated Statement of
Financial Condition. The Company had off-balance-sheet derivative contracts
outstanding with gross notional amounts of $63.3 billion and $50.5 billion at
June 30, 2000 and December 31, 1999, respectively. These amounts included $33.2
billion and $30.9 billion, respectively, related to "to be announced"
mortgage-backed securities requiring forward settlement. Also included in these
amounts were $3.9 billion and $4.2 billion notional amounts of interest rate
swap agreements used to change the interest rate characteristics of the
Company's fixed rate debt at June 30, 2000 and December 31, 1999, respectively.
For further discussion on the Company's derivative financial instruments, see
Note 7 in the Notes to Condensed Consolidated Financial Statements.
The Company records any unrealized gains and losses on its derivative contracts
used in a trading capacity by marking-to-market the contracts on a daily basis.
The unrealized gain or loss is recorded on the Condensed Consolidated Statements
of Financial Condition with the related profit or loss reflected in principal
transactions revenues. The Company accrues interest income and expense on
interest rate swap agreements used to change the interest rate characteristics
of the Company's fixed rate debt. These interest rate swap agreements had the
effect of increasing net interest expense on the Company's fixed rate debt by
$2.4 million for the six months ended June 30, 2000 and of reducing net interest
expense on the Company's fixed rate debt $13.8 million for the six months ended
June 30, 1999, respectively. The Company had no deferred gains or losses
recorded at June 30, 2000 and December 31, 1999 related to terminated swap
agreements on the Company's long-term borrowings.
The fair value of an exchange-traded derivative financial instrument is
determined by quoted market prices, while over-the-counter derivatives are
valued based upon pricing models which consider time value and volatility, as
well as other economic factors. The fair values of the Company's derivative
financial instruments held for trading purposes at June 30, 2000 were $189.7
million and $194.2 million for assets and liabilities, respectively, and are
reflected on the Condensed Consolidated Statements of Financial Condition. The
fair values of these instruments at December 31, 1999 were $392.7 million and
$215.1 million for assets and liabilities, respectively.
The Company's exposure to market risk relates to changes in interest rates,
equity prices, foreign currency exchange rates or the market values of the
assets underlying the financial instruments. The Company's exposure to credit
risk at any point is represented by the fair value or replacement cost on
contracts in which the Company has recorded an unrealized gain. At June 30, 2000
and December 31, 1999, the fair values amounted to $189.7 million and $392.7
million, respectively. The risks inherent in derivative financial instruments
are managed consistent with the Company's overall risk management policies. (See
Risk Management section below)
RISK MANAGEMENT
Risk is an inherent part of the Company's principal business activities.
Managing risk is critical to the Company's profitability and to reducing the
likelihood of earnings volatility. The Company's risk management policies and
procedures have been established to continually identify, monitor and manage
risk. The Company's principal risks are market, credit, liquidity, legal and
operating risks. Included below is a discussion on market risk. For further
discussion on the Company's principal risks, see the Company's 1999 Annual
Report to Stockholders.
The Company seeks to manage risk and its impact on earnings volatility through
strategic planning and by focusing on the diversification of its business
activities. Through capital allocation, and the establishment of trading limits
by product and credit limits by counterparty, the Company manages the risk
associated with the various businesses. The Company may reallocate or deploy
capital to the business groups based upon changes in market conditions or
opportunities in the marketplace that are consistent with the Company's
long-term strategy.
The discussion of the Company's principal risks and the estimated amounts of the
Company's market risk exposure generated from the sensitivity analysis performed
by the Company are forward-looking statements assuming certain adverse
conditions occur. Actual results in the future may differ materially from these
projected results due to actual
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<PAGE> 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
events in the markets in which the Company operates and other factors. The
analysis methods used by the Company to assess and mitigate risks discussed
below should not be considered projections of future events or losses.
Market Risk
All financial instruments involve market risk. Market risk is the potential
change in value of the financial instrument caused by unfavorable changes in
interest rates, equity prices and foreign currency exchange rates. Market risk
is inherent to both derivative and non-derivative financial instruments.
The Company actively monitors its market risk profile through a variety of
control procedures including market risk modeling, review of trading positions
and hedging strategies, and monitoring adherence to established limits. Each
department's trading positions, exposures, profits and losses, and trading
strategies are reviewed by the senior management of each business group.
Independent of the trading departments is a risk management group. The Company's
risk management group reviews the Company's risk profile and adherence to
established trading limits, and aids in the development of risk management
policies. In addition, the Company has in place committees and management
controls to review inventory positions, other asset accounts and asset agings on
a regular basis.
Trading position and exposure limits are established by the Asset/Liability
Management Committee, which meets regularly and is comprised of senior corporate
and business group managers.
The following is a discussion of the Company's primary market risk exposures at
June 30, 2000 and December 31, 1999 and how those exposures are managed:
Interest Rate Risk
In connection with the Company's dealer activities, the Company is exposed to
interest rate risk due to changes in the level or volatility of interest rates,
changes in the yield curve, mortgage prepayments and credit spreads. The Company
attempts to mitigate its exposure to interest rate risk by entering into hedging
transactions such as U.S. government and Eurodollar forwards and futures
contracts, options, and interest rate swap and cap agreements. The Company also
issues fixed rate instruments in connection with its nontrading activities,
which expose the Company to interest rate risk. The Company enters into interest
rate swap agreements that are designed to mitigate its exposure by effectively
converting its fixed rate liabilities into floating rate liabilities.
Equity Price Risk
In connection with the Company's dealer activities, the Company buys and sells
equity and equity derivative instruments. The Company is exposed to equity price
risk due to changes in the level or volatility of equity prices. The Company
attempts to mitigate its exposure to equity price risk by entering into hedging
transactions including equity option agreements.
Sensitivity Analysis
For purposes of the SEC disclosure requirements, the Company has elected to use
a sensitivity approach to express the potential loss in future earnings of its
financial instruments. In preparing the analysis, the Company has combined both
derivative and non-derivative financial instruments held for trading purposes
with those held for purposes other than trading because the amounts were not
material.
The sensitivity calculation employed to analyze interest rate risk on its fixed
income financial instruments was based on a proprietary methodology which
converted substantially all the Company's interest rate sensitive financial
instruments at June 30, 2000 and December 31, 1999, into a uniform benchmark (a
ten year U.S. Treasury note equivalent), and evaluated the impact assuming an 11
basis point change to the ten-year U.S. Treasury note at June 30, 2000 and
December 31, 1999, respectively. The hypothetical basis point change was derived
from a proprietary model which uses a one-day interval and a 95 percent
confidence level, and was based on historical data over a one-year period. This
analysis does not consider other factors that may influence these results, such
as credit spread risk, prepayment risk on mortgage-backed securities or changes
in the shape of the yield curve. The sensitivity calculation employed to analyze
equity price risk on its equity financial instruments was based on a proprietary
model which stress tests the firm inventory positions by shocking those
positions for a two standard deviation move in the market (95 percent confidence
interval) using historical data over a one-year period. Based upon the
aforementioned methodologies, the Company's potential daily loss in future
earnings at June 30, 2000 was approximately $4 million and $0.3 million for
interest rate risk and equity price risk, respectively, and the Company's
potential daily loss in future earnings at December 31, 1999 was approximately
$3 million and $0.1 million for interest rate risk and equity price risk,
respectively.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No significant events have occurred since the filing of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999 and Form 10-Q
for the quarter ended March 31, 2000, except as described below:
NEWTON V. MERRILL LYNCH, ET AL. SECURITIES LITIGATION
On May 12, 2000, the Third Circuit Court of Appeals granted plaintiffs
permission to file an immediate interlocutory appeal from the District Court's
denial of plaintiffs' motion for class certification.
ASKIN LITIGATION*
Kidder Peabody has moved for summary judgment, which motion is expected to be
fully briefed by September 1, 2000. There is no firm date set for trial of this
matter.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
Exhibit 12.1 - Computation of Ratio of Earnings to Fixed Charges
Exhibit 12.2 - Computation of Ratio of Earnings to Combined Fixed Charges
and Preferred Stock Dividends
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed a Current Report on Form 8-K dated July 14, 2000 with
the Securities and Exchange Commission reporting under "Item 5 - Other
Events" and "Item 7 - Exhibits" relating to the Company's press release
which reported that the Company entered into an agreement and plan of
merger with UBS AG and Neptune Merger Subsidiary, Inc., a subsidiary of
UBS AG and described certain terms of the agreement.
The Company filed a Current Report on Form 8-K dated July 17, 2000 with
the Securities and Exchange Commission reporting under "Item 5 - Other
Events" and "Item 7 - Exhibits" relating to the merger agreement entered
into between the Company, UBS AG and Neptune Merger Subsidiary, Inc., a
subsidiary of UBS AG.
-----------------------------------
* This item relates to a matter involving Kidder, Peabody & Co. Incorporated
which was acquired by the Company in August 1997. In connection with the
acquisition, the seller and its parent General Electric Company agreed to
indemnify the Company for all losses relating to this matter.
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SIGNATURE
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.
Paine Webber Group Inc.
-----------------------
(Registrant)
Date: August 14, 2000 By: /s/ Jerome T. Fadden
---------------- --------------------------
Jerome T. Fadden
Senior Vice President and Chief
Financial Officer
(principal financial and accounting
officer)
22
