<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): February 20, 1997
MORGAN STANLEY GROUP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 1-9085 13-2838811
(STATE OR OTHER (COMMISSION (I.R.S. EMPLOYER
JURISDICTION OF FILE NUMBER) IDENTIFICATION
INCORPORATION) NUMBER)
1585 Broadway, New York, New York 10036
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (212) 761-4000
<PAGE> 2
Item 5. Other Events
As previously disclosed in Morgan Stanley Group Inc.'s ("Morgan
Stanley") current report on Form 8-K dated February 5, 1997, Morgan Stanley and
Dean Witter, Discover & Co. ("Dean Witter") announced a definitive agreement to
merge (the "Merger"). The transaction is intended to be accounted for as a
pooling of interests and the new company will be named Morgan Stanley, Dean
Witter, Discover & Co. Under the terms of the merger agreement, each of
Morgan Stanley's common shares will be exchanged for 1.65 of Dean Witter's
common shares. The Merger, which is expected to be completed in mid-1997, is
subject to customary closing conditions, including certain regulatory approvals
and the approval of the stockholders of both companies.
Attached and incorporated by reference herein as Exhibits 99.1, 99.2
and 99.3, respectively, are certain financial information for Dean Witter and
unaudited pro forma combined financial information for the combined entity
giving effect to the Merger.
Attached and incorporated herein by reference as Exhibits 15.1 and
23.1, respectively, are copies of an acknowledgement letter and the consent of
Deloitte & Touche LLP.
Item 7(c). Financial Statements, Pro Forma Financial Statements and Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
15.1 Acknowledgement Letter of Deloitte & Touche LLP.
23.1 Consent of Deloitte & Touche LLP.
99.1 The audited consolidated balance sheets of Dean Witter as
of December 31, 1995 and 1994, and the related
consolidated statements of income, cash flows and changes
in shareholders' equity for each of the years in the three
year period ended December 31, 1995 (incorporated by
reference from pages 37 to 52 of Dean Witter's 1995 Annual
Report which are filed as part of Exhibit 13 to Dean
Witter's Annual Report on Form 10-K for the year ended
December 31, 1995 (File no. 1-11758)).
99.2 The unaudited consolidated balance sheet of Dean Witter as
of September 30, 1996 and the unaudited consolidated
statements of income and cash flows of Dean Witter for the
nine months ended September 30, 1996 and 1995
(incorporated by reference from pages 1 to 9 of Dean
Witter's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1996 (File no. 1-11758)).
99.3 The Morgan Stanley, Dean Witter, Discover & Co. unaudited
pro forma condensed combined statement of financial
condition at August 31, 1996,
</TABLE>
2
<PAGE> 3
<TABLE>
<S> <C>
and unaudited pro forma condensed combined statements of
income for the twelve months ended November 30, 1995, 1994
and 1993 and for the nine months ended August 31, 1996 and
1995.
</TABLE>
3
<PAGE> 4
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned hereunto duly authorized.
MORGAN STANLEY GROUP INC.
Registrant
Date: February 20, 1997 /s/ Eileen K. Murray
------------------------------
Eileen K. Murray
Treasurer and
Chief Accounting Officer
4
<PAGE> 5
Index to Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
15.1 Acknowledgement Letter of Deloitte & Touche LLP.
23.1 Consent of Deloitte & Touche LLP.
99.1 The audited consolidated balance sheets of Dean Witter as
of December 31, 1995 and 1994, and the related
consolidated statements of income, cash flows and changes
in shareholders' equity for each of the years in the three
year period ended December 31, 1995 (incorporated by
reference from pages 37 to 52 of Dean Witter's 1995 Annual
Report which are filed as part of Exhibit 13 to Dean
Witter's Annual Report on Form 10-K for the year ended
December 31, 1995 (File no. 1-11758)).
99.2 The unaudited consolidated balance sheet of Dean Witter as
of September 30, 1996 and the unaudited consolidated
statements of income and cash flows of Dean Witter for the
nine months ended September 30, 1996 and 1995
(incorporated by reference from pages 1 to 9 of Dean
Witter's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 1996 (File no. 1-11758)).
99.3 The Morgan Stanley, Dean Witter, Discover & Co. unaudited
pro forma condensed combined statement of financial
condition at August 31, 1996, and unaudited pro forma
condensed combined statements of income for the twelve
months ended November 30, 1995, 1994 and 1993 and for the
nine months ended August 31, 1996 and 1995.
</TABLE>
<PAGE> 1
EXHIBIT 15.1
To the Board of Directors and Shareholders of
Dean Witter, Discover & Co.:
We have made a review, in accordance with standards established by the American
Institute of Certified Public Accountants, of the unaudited interim consolidated
financial information of Dean Witter, Discover & Co. and subsidiaries as of
September 30, 1996 and for the three and nine month periods ended September 30,
1996 and 1995, as indicated in our report dated November 13, 1996; because we
did not perform an audit, we expressed no opinion on that information.
We are aware that our report referred to above, which is included in your
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, is being
used in the following Registration Statements of Morgan Stanley Group Inc.:
Filed on Form S-3:
Registration Statement No. 333-18005
Registration Statement No. 333-01655
Registration Statement No. 33-58611
Registration Statement No. 33-51413
Filed on Form S-8:
Registration Statement No. 333-08571
Registration Statement No. 33-13177
Registration Statement No. 33-37652
Registration Statement No. 33-18184
Registration Statement No. 33-42464
We are also aware that the aforementioned report, pursuant to Rule 436(c) under
the Securities Act of 1933, is not considered a part of the Registration
Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of Sections 7 and 11 of that Act.
/s/ Deloitte & Touche LLP
New York, New York
February 20, 1997
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the following Registration
Statements of Morgan Stanley Group Inc. of our reports dated February 21, 1996,
appearing in and incorporated by reference in the Annual Report on Form 10-K of
Dean Witter, Discover & Co. for the year ended December 31, 1995:
Filed on Form S-3:
Registration Statement No. 333-18005
Registration Statement No. 333-01655
Registration Statement No. 33-58611
Registration Statement No. 33-51413
Filed on Form S-8:
Registration Statement No. 333-08571
Registration Statement No. 33-13177
Registration Statement No. 33-37652
Registration Statement No. 33-18184
Registration Statement No. 33-42464
/s/ Deloitte & Touche LLP
New York, New York
February 20, 1997
<PAGE> 1
EXHIBIT 99.1
MANAGEMENT'S STATEMENT OF FINANCIAL
REPORTING RESPONSIBILITY
The management of Dean Witter, Discover & Co. and its subsidiaries prepared the
accompanying consolidated financial statements and related footnotes and is
responsible for their integrity and objectivity. The consolidated financial
statements, which include amounts that are based on management's estimates and
judgments, were prepared in accordance with generally accepted accounting
principles. Management also prepared the other information in this annual report
and is responsible for its accuracy and consistency with the consolidated
financial statements.
Management maintains a system of internal controls over the preparation
of its consolidated financial statements. In management's opinion, these
internal controls provide reasonable assurance that assets are safeguarded and
that transactions are properly recorded and executed in accordance with
management's authorization. Judgments are required to assess and balance the
relative cost and expected benefits of these internal controls. To assure the
effectiveness of the system of internal controls, the organizational structure
provides for defined lines of responsibility and delegation of authority.
Further, the Company maintains an internal audit function that independently
assesses the effectiveness of internal controls and the Company's compliance
with established policies and procedures.
The Company's consolidated financial statements have been audited by
Deloitte & Touche LLP, independent auditors, and their report follows. They have
advised the Company that their audits were conducted in accordance with
generally accepted auditing standards and considered the Company's internal
accounting controls in determining the auditing procedures they deem necessary
to express an opinion on the consolidated financial statements.
The Audit Committee of the Board of Directors, composed solely of
outside directors, meets with the internal auditors, management and independent
auditors to review their work and discuss the Company's financial controls and
audit and reporting practices. The independent auditors and the internal
auditors independently have full and free access to the Audit Committee, without
the presence of management, to discuss any matters that they feel require
attention.
/s/ Philip J. Purcell
- ---------------------
Philip J. Purcell
Chairman and Chief Executive Officer
/s/ Thomas C. Schneider
- -----------------------
Thomas C. Schneider
Executive Vice President and Chief Financial Officer
/s/ Robert P. Seass
- -------------------
Robert P. Seass
Senior Vice President and Controller
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Dean Witter, Discover & Co.:
We have audited the accompanying consolidated balance sheets of Dean Witter,
Discover & Co. and subsidiaries as of December 31, 1995 and 1994, and the
related consolidated statements of income, cash flows and changes in
shareholders' equity for each of the three years in the period ended December
31, 1995. These financial statements, appearing on pages 38 through 52, 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 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 accompanying consolidated financial statements
present fairly, in all material respects, the consolidated financial position of
Dean Witter, Discover & Co. and subsidiaries at December 31, 1995 and 1994 and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1995 in conformity with
generally accepted accounting principles.
/s/ Deloitte & Touche LLP
New York, New York
February 21, 1996
-37-
<PAGE> 2
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share data)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 1994 1993
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Merchant and cardmember fees $1,135.3 $ 940.0 $ 770.4
Commissions 1,022.5 874.3 904.0
Asset management and administration fees 1,006.8 973.0 838.0
Servicing fees 696.9 586.4 533.2
Principal transactions 478.9 421.9 405.1
Investment banking 181.5 197.9 394.9
Other 93.5 101.9 66.8
-------------------------------------
Total non-interest revenues 4,615.4 4,095.4 3,912.4
-------------------------------------
Interest revenue 3,319.0 2,507.2 1,909.2
Interest expense 1,514.8 1,048.5 815.3
-------------------------------------
Net interest income 1,804.2 1,458.7 1,093.9
Provision for losses on receivables 743.7 548.4 457.6
-------------------------------------
Net credit income 1,060.5 910.3 636.3
-------------------------------------
Net operating revenues 5,675.9 5,005.7 4,548.7
-------------------------------------
Employee compensation and benefits 1,981.6 1,764.2 1,703.9
Marketing and business development 735.1 607.2 470.4
Information processing and communications 687.5 596.7 545.9
Facilities and equipment 235.5 228.1 217.8
Other 640.3 594.9 614.5
-------------------------------------
Total non-interest expenses 4,280.0 3,791.1 3,552.5
-------------------------------------
Income before income taxes 1,395.9 1,214.6 996.2
Income tax expense 539.5 473.7 392.6
-------------------------------------
Net income $ 856.4 $ 740.9 $ 603.6
- ---------------------------------------------------------------------------------------------------
Earnings per common share
Primary $ 4.88 $ 4.27 $ 3.62
Fully Diluted 4.88 4.27 3.62
- ---------------------------------------------------------------------------------------------------
Average common shares outstanding
Primary 175.4 173.4 166.9
Fully Diluted 175.5 173.4 166.9
- ---------------------------------------------------------------------------------------------------
Proforma earnings per common share
Primary $ 3.44
Fully Diluted 3.44
- ---------------------------------------------------------------------------------------------------
Proforma common shares outstanding
Primary 175.4
Fully Diluted 175.5
- ---------------------------------------------------------------------------------------------------
</TABLE>
See notes to the consolidated financial statements.
-38-
<PAGE> 3
CONSOLIDATED BALANCE SHEETS
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 1,464.5 $ 1,334.1
Cash and securities segregated under federal and other regulations 1,926.4 1,494.4
Receivables
Consumer loans (net of allowances of $721.8 in 1995 and $565.7 in 1994) 20,834.6 15,608.4
Securities clients (net of allowances of $16.2 in 1995 and $11.7 in 1994) 2,588.8 2,579.8
Brokers or dealers 2,683.7 2,750.4
Other 732.4 658.3
Amounts due from asset securitizations 653.4 422.0
Securities purchased under agreements to resell 3,571.9 3,476.5
Securities owned, at market value 1,848.8 1,738.6
Deferred income taxes 736.9 643.5
Office facilities, at cost (less accumulated depreciation
and amortization of $380.5 in 1995 and $335.3 in 1994) 341.0 280.6
Goodwill 161.9 164.9
Other assets 663.9 707.9
- ----------------------------------------------------------------------------------------------------------
Total assets $38,208.2 $31,859.4
- ----------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Commercial paper $ 4,688.5 $ 2,497.2
Other short-term borrowings 1,637.0 1,552.4
Deposits 6,191.1 5,208.7
Payables
Securities clients 3,183.0 2,736.0
Brokers or dealers 2,629.7 2,807.1
Drafts 485.5 475.0
Income taxes 99.3 125.5
Securities sold under agreements to repurchase 3,813.4 3,398.0
Securities sold but not yet purchased, at market value 1,125.2 1,314.4
Other liabilities and accrued expenses 2,789.4 2,344.5
Long-term borrowings 6,732.4 5,292.6
- ----------------------------------------------------------------------------------------------------------
Total liabilities 33,374.5 27,751.4
- ----------------------------------------------------------------------------------------------------------
Shareholders' Equity
Preferred stock ($0.01 par value, 10.0 shares authorized, none issued) - -
Common stock ($0.01 par value, 500.0 and 250.0 shares authorized, 171.0
and 171.0 shares issued, 168.8 and 168.9 shares outstanding at
December 31, 1995 and 1994) 1.7 1.7
Paid-in capital 2,718.3 2,726.0
Retained earnings 2,165.7 1,418.3
------------------------
4,885.7 4,146.0
Common stock held in treasury, at cost ($0.01 par value, 2.2 and 2.1 shares
at December 31, 1995 and 1994) (106.8) (74.6)
Stock compensation plans 85.1 42.2
Employee stock benefit trust (21.5) -
Unearned stock compensation (8.8) (5.6)
------------------------
Total shareholders' equity 4,833.7 4,108.0
- ----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $38,208.2 $31,859.4
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See notes to the consolidated financial statements.
-39-
<PAGE> 4
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(in millions)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK
------------------- ------------------
TOTAL
NUMBER PAID-IN RETAINED NUMBER SHAREHOLDERS'
OF SHARES AMOUNT CAPITAL EARNINGS OF SHARES AMOUNT OTHER EQUITY
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1993 - $ - $1,843.0 $ 830.3 - $ - $ - $2,673.3
Net income 603.6 603.6
Dividends to common shareholders (51.1) (51.1)
Dividends to Sears, prior to
March 1, 1993 (620.2) (620.2)
Recapitalization prior to
initial public offering 136.2 1.4 (1.4) -
Issuance of common stock
Initial public offering 33.8 0.3 856.8 857.1
Stock option exercises 0.2 6.5 6.5
Restricted stock grants 0.4 10.3 (1.7) 8.6
Capital contributions from Sears 0.1 0.1
Unearned stock compensation,
net of amortization 0.5 0.5
Minimum pension liability adjustment (1.3) (1.3)
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1993 170.6 1.7 2,715.3 762.6 - - (2.5) 3,477.1
Net income 740.9 740.9
Dividends to common shareholders (85.2) (85.2)
Purchase of treasury stock, at cost (2.3) (82.0) (82.0)
Issuance of common stock
Employee stock purchase plan (0.8) 0.1 4.3 3.5
Stock option exercises 0.4 11.0 0.1 3.1 14.1
Restricted stock grants 0.5 0.5
Unearned stock compensation,
net of amortization (4.4) (4.4)
Stock compensation plans 42.2 42.2
Minimum pension liability adjustment 1.3 1.3
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1994 171.0 1.7 2,726.0 1,418.3 (2.1) (74.6) 36.6 4,108.0
Net income 856.4 856.4
Dividends to common shareholders (109.0) (109.0)
Purchase of treasury stock, at cost (2.5) (121.2) (121.2)
Issuance of common stock
Employee stock purchase plan (0.6) 0.4 15.3 14.7
Employee benefit plans 0.1 1.1 41.4 41.5
Stock option exercises (7.5) 0.9 33.2 25.7
Restricted stock grants 0.2 0.2
Unearned stock compensation,
net of amortization (3.2) (3.2)
Stock compensation plans 0.1 (0.9) 42.9 42.1
Employee stock benefit trust (21.5) (21.5)
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 171.0 $1.7 $2,718.3 $2,165.7 (2.2) $(106.8) $ 54.8 $4,833.7
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to the consolidated financial statements.
-40-
<PAGE> 5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income $ 856.4 $ 740.9 $ 603.6
Adjustments to reconcile net income to net cash flows from
operating activities
Depreciation and amortization 70.0 58.8 51.3
Provision for losses on receivables 743.7 548.4 457.6
Employee compensation settled through the issuance of
common stock 57.2 37.0 -
Deferred income taxes (93.4) (155.6) (102.4)
Decrease (increase) in operating assets
Cash and securities segregated under federal and other regulations (432.0) 227.9 (410.1)
Receivables
Securities clients (22.2) 70.9 (559.2)
Brokers or dealers 66.7 (268.1) (323.6)
Other (74.1) (111.4) 15.8
Amounts due from asset securitizations (231.4) 269.6 592.5
Matched securities purchased under agreements to resell, net (27.1) 4.0 111.3
Securities owned and securities sold but not yet purchased, at
market value, net (299.4) 1,023.3 (295.5)
Other assets 32.9 (15.1) (145.2)
Increase (decrease) in operating liabilities
Payables
Securities clients 447.0 (40.9) 539.4
Brokers or dealers (177.4) 148.9 318.3
Drafts 10.5 2.9 50.0
Income taxes (26.2) (89.5) (38.3)
Other liabilities and accrued expenses 575.6 424.4 485.1
----------------------------------------
Cash provided by operating activities 1,476.8 2,876.4 1,350.6
----------------------------------------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Net principal disbursed on consumer loans (7,429.2) (6,166.3) (5,407.6)
Purchases of consumer loans (306.9) (85.8) (687.0)
Sales of consumer loans 1,827.3 1,970.1 3,399.4
Other (116.2) (118.7) (77.3)
----------------------------------------
Cash used in investing activities (6,025.0) (4,400.7) (2,772.5)
----------------------------------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Proceeds from issuance of commercial paper, net 2,061.9 194.0 2,190.7
Net increase (decrease) in other short-term borrowings 36.4 343.1 (4,629.7)
Deposits, net 982.4 320.6 31.0
Proceeds from issuance of long-term borrowings, net 1,433.5 2,142.1 3,122.1
Securities sold under agreements to repurchase, net 347.3 (826.3) 236.0
Dividends paid (102.3) (81.1) (690.3)
Proceeds from issuance of common stock 40.6 17.7 857.1
Purchase of treasury stock (121.2) (82.0) -
----------------------------------------
Cash provided by financing activities 4,678.6 2,028.1 1,116.9
----------------------------------------
Increase (decrease) in cash and cash equivalents 130.4 503.8 (305.0)
Cash and cash equivalents, beginning of period 1,334.1 830.3 1,135.3
- ---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 1,464.5 $ 1,334.1 $ 830.3
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
See notes to the consolidated financial statements.
-41-
<PAGE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTRODUCTION AND
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Dean Witter,
Discover & Co. and subsidiaries (the "Company"). The Company is a financial
services organization that provides a broad range of credit and investment
products, with a primary focus on individual customers. Through its wholly-owned
subsidiary NOVUS Credit Services Inc. ("NCSI"), the Company conducts its credit
services business, including the operation of the NOVUS(sm) Network, a
proprietary network of merchant and cash access locations, and the issuance of
proprietary general purpose credit cards. The Company's securities business is
conducted primarily through its wholly-owned subsidiaries Dean Witter Reynolds
Inc. ("DWR") and Dean Witter InterCapital Inc. All material intercompany
balances and transactions have been eliminated.
Prior to March 1, 1993, the Company was a wholly-owned subsidiary of
Sears, Roebuck and Co. ("Sears"). On March 1, 1993, the Company completed an
initial public offering of 33.8 million shares of its common stock (the "IPO")
resulting in net proceeds to the Company of $857.1 million, which were used
primarily to repay indebtedness to Sears. On June 30, 1993, Sears divested its
remaining ownership of the Company's common stock by means of a special dividend
to Sears shareholders (the "Spin-off").
The preparation of the consolidated financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts in the financial
statements.
Certain reclassifications have been made to prior year amounts to
conform to the current presentation.
2. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments not held
for resale with maturities, when purchased, of three months or less.
CONSUMER LOANS
Consumer loans, which consist primarily of credit card loans, real
estate-secured and other consumer installment loans, are reported at their
principal amounts outstanding, less applicable allowances and unearned finance
charges. Interest on consumer loans is credited to income as earned.
Interest is accrued on credit card loans until the date of charge-off,
which generally occurs at the end of the month during which an account becomes
180 days past due, except in the case of bankruptcies, where loans are charged
off upon receipt and processing of written notification, and in fraudulent
transactions, where loans are charged off when identified. The interest portion
of charged off credit card loans is written off against interest revenue.
Origination costs related to credit card issuances are charged to earnings over
periods not exceeding twelve months.
Interest generally is not accrued on real estate-secured loans which
are delinquent by six monthly payments and other consumer installment loans
which are delinquent by four or more monthly payments. Origination fees, net of
certain direct loan origination costs, are deferred and amortized over the
estimated life of the loans using the interest method. Any unamortized net
origination fees and costs on real estate-secured and other consumer installment
loans fully repaid are recognized as income or expense in the period such loans
are repaid.
Periodically, the Company purchases consumer loans from third parties.
These loans are recorded at their principal amounts outstanding less any
allowance for loan losses. Any difference between this amount and the fair value
of the loans acquired is recorded as a discount or premium and amortized over
the estimated life of the consumer loans. Any excess consideration given over
the fair value of the loans acquired is recorded as an intangible asset and
amortized over the expected term of the customer relationship.
ALLOWANCE FOR CONSUMER LOAN LOSSES
The allowance for loan losses is established through a charge to the provision
for loan losses. The allowance is an estimate, based on evaluations of the
collectibility of loans and prior loan loss experience, of the amount adequate
to absorb losses on existing loans that may become uncollectible. The
evaluations take into consideration such factors as changes in the nature and
volume of the loan portfolio, overall portfolio quality, review of specific
problem loans and current economic conditions that may affect the borrower's
ability to pay.
SECURITIZATION OF CONSUMER LOANS
The Company periodically sells consumer loans through asset securitizations and
continues to service these loans. The revenues derived from servicing these
loans are recorded in the consolidated statements of income as servicing fees
over the term of the securitized loans rather than at the time the
-42-
<PAGE> 7
loans are sold. The effects of recording these revenues over the term of the
securitized loans rather than at the time the loans were sold have not been
material. The Company maintains an allowance for loan losses for securitized
loans in other liabilities and accrued expenses.
Amounts due from asset securitizations in the consolidated balance
sheets represent cash and receivables from third parties. These receivables
include the Company's share of cash collections on certain securitized credit
card loans which are held by third parties and paid to the Company during the
month subsequent to collection, credit enhancement reserve funds maintained with
third parties and advances made by the Company as the servicer of the
securitized loans.
SECURITIES TRANSACTIONS
Clients' securities transactions are recorded on a settlement date basis with
related commission revenues and expenses recorded on trade date. Principal
securities transactions are recorded on trade date. Securities are recorded at
market, with gains and losses reflected in income.
Securities transactions under agreements to resell and repurchase are
collateralized financing transactions and are carried at the contract amounts at
which the securities will be resold or reacquired, including accrued interest.
OFFICE FACILITIES
Office facilities are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization of buildings and improvements are
provided principally by the straight-line method, while depreciation and
amortization of furniture, fixtures and equipment is provided principally by
accelerated methods. Property and equipment are depreciated over the estimated
useful lives of the related assets, while leasehold improvements are amortized
over the lesser of the economic useful life of the asset or the term of the
lease.
GOODWILL
Goodwill is amortized on a straight-line basis over periods not exceeding 40
years. Substantially all goodwill is related to Sears' purchase of the Company
in 1981.
INCOME TAXES
Income tax expense is calculated using the asset and liability method, under
which deferred tax assets and liabilities are determined based upon the
differences between financial statement carrying amounts and the tax bases of
assets and liabilities and are measured at the tax rates that will be in effect
when these differences are expected to reverse.
Prior to 1993, and for the period January 1, 1993 through June 30,
1993, the Company was included in the Sears consolidated federal income tax
return. Federal income tax expense was calculated on a separate return basis.
Federal income taxes were paid to or received from Sears in accordance with an
intercompany tax allocation agreement. As a result of the Spin-off, the Company
is no longer includable in the Sears return.
CARDMEMBER REWARDS
The liability for cardmember rewards expense, included in other liabilities and
accrued expenses, is accrued at the time that qualified cardmember purchases are
made or interest is accrued and is calculated on an individual cardmember basis.
INTEREST RATE CONTRACTS
The Company has entered into various interest rate contracts as hedges against
specific assets, liabilities or anticipated transactions. These contracts
include interest rate swap, cost of funds and interest rate cap agreements. For
contracts that are designated as hedges of the Company's assets and liabilities,
gains and losses are deferred and recognized as adjustments to interest income
or expense over the remaining life of the underlying assets or liabilities. For
contracts that are hedges of asset securitizations, gains and losses are
recognized as adjustments to servicing fees.
ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1995, the Company adopted Statement of Financial Accounting
Standards ("SFAS") Nos. 114 and 118, "Accounting by Creditors for Impairment of
a Loan and Income Recognition and Disclosures", which revised the measurement
criteria for recognizing the impairment of certain types of loans. The Company's
consumer loans and receivables from securities clients are exempt from these
statements. The effect of the adoption of these statements was not material to
the Company's financial position or results of operations.
In 1996, the Company will be required to adopt SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", which generally requires that long-lived assets be reported at
the lower of their carrying cost or net realizable value. Additionally, in 1996,
the Company will be required to adopt SFAS No. 122, "Accounting for Mortgage
Servicing Rights, an amendment of FASB Statement No. 65", which requires that
rights to service mortgage loans for others, however acquired, be recorded as
separate assets when the mortgage loans are sold and the servicing rights are
retained.
-43-
<PAGE> 8
This statement also requires that capitalized mortgage servicing rights be
assessed for impairment based on the fair value of those rights. The Company
believes the effect of the adoption of these statements will not be material to
its financial position or results of operations.
The Financial Accounting Standards Board has issued SFAS No. 123,
"Accounting for Stock-Based Compensation", effective for fiscal years beginning
after December 15, 1995. The Company has elected, as permitted by SFAS No. 123,
to adopt the disclosure requirement of that standard but continue to account
for stock-based compensation under APB Opinion No. 25, "Accounting for Stock
Issued to Employees."
3. CONSUMER LOANS
Consumer loans were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Credit card $20,440.4 $15,286.4
Real estate-secured and
other consumer installment 1,233.1 1,057.6
- --------------------------------------------------------------------------------
21,673.5 16,344.0
Less
Unearned finance charges and
unamortized discounts and fees 117.1 169.9
Allowance for loan losses 721.8 565.7
- --------------------------------------------------------------------------------
Consumer loans, net $20,834.6 $15,608.4
- --------------------------------------------------------------------------------
</TABLE>
In 1995 and 1994, the Company purchased credit card loans in the amounts of
$371.5 million and $229.9 million from Tandy Corporation ("Tandy"). In 1993, the
Company purchased credit card loans from Sears in the amount of $687.0 million.
Activity in the allowance for consumer loan losses was as follows.
<TABLE>
<CAPTION>
1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1 $565.7 $436.8 $335.3
Additions
Provision for loan losses 730.5 537.0 443.0
Purchase of loan portfolios 30.6 4.3 25.4
- --------------------------------------------------------------------------------
Total additions 761.1 541.3 468.4
- --------------------------------------------------------------------------------
Deductions
Charge-offs 716.8 470.6 418.7
Recoveries (121.3) (89.1) (73.3)
- --------------------------------------------------------------------------------
Net charge-offs 595.5 381.5 345.4
- --------------------------------------------------------------------------------
Other(1) (9.5) (30.9) (21.5)
- --------------------------------------------------------------------------------
Balance, December 31 $721.8 $565.7 $436.8
- --------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Primarily reflects net transfers related to asset securitizations.
Interest accrued on loans subsequently charged off, recorded as a reduction of
interest revenue, was $114.8 million, $69.8 million and $56.5 million for the
years ended December 31, 1995, 1994 and 1993.
At December 31, 1995 and 1994, $7,000.2 million and $5,131.2 million of
the Company's consumer loans had minimum contractual maturities of less than one
year. Because of the uncertainty regarding consumer loan repayment patterns,
which historically have been higher than contractually required minimum
payments, and variable rate loan pricing utilized by the Company, this amount
may not necessarily be indicative of the Company's consumer loan repricing
schedule.
At December 31, 1995 and 1994, the Company had commitments to extend
credit in the amounts of $133.3 billion and $98.0 billion. Commitments to extend
credit arise from agreements to extend to customers unused lines of credit on
certain credit cards and home equity lines of credit issued by the Company
provided there is no violation of conditions established in the related
agreement. These commitments, substantially all of which the Company can
terminate at any time and which do not necessarily represent future cash
requirements, are periodically reviewed based on account usage and customer
creditworthiness.
The Company received proceeds from asset securitizations of $1,827.3
million, $1,970.1 million, and $3,086.2 million in 1995, 1994 and 1993. In
addition, prior to the Spin-off, the Company sold certain loans to Sears, the
proceeds from which amounted to $313.2 million in 1993. Through February 21,
1996, the Company completed asset securitizations of $2.6 billion. The
uncollected balances of consumer loans sold through asset securitizations were
$10,219.5 million and $9,876.4 million at December 31, 1995 and 1994. The
allowance for loan losses related to securitized loans, included in other
liabilities and accrued expenses, was $341.7 million and $326.4 million at
December 31, 1995 and 1994. The Company had, under the provisions of certain
asset securitizations, limited recourse obligations at December 31, 1995 and
1994 of $123.9 million and $89.0 million, of which $30.0 million and $24.0
million were included in the allowance for loan losses related to securitized
loans.
The Company's consumer loan portfolio, including securitized loans, is
geographically diverse, with a distribution approximating that of the population
of the United States.
-44-
<PAGE> 9
4. SECURITIES -- AT MARKET VALUE
Securities owned and securities sold but not yet purchased, at market value,
were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Owned
U.S. government and agency obligations $1,023.2 $ 955.1
Corporate bonds 615.7 575.2
Municipal bonds 159.9 163.7
Other 50.0 44.6
- --------------------------------------------------------------------------------
Total $1,848.8 $1,738.6
- --------------------------------------------------------------------------------
Sold but not yet purchased
U.S. government and agency obligations $ 994.2 $1,190.6
Corporate bonds 116.0 81.6
Other 15.0 42.2
- --------------------------------------------------------------------------------
Total $1,125.2 $1,314.4
- --------------------------------------------------------------------------------
</TABLE>
Securities sold but not yet purchased represent obligations of the Company to
deliver specified securities at contracted prices, thereby creating a liability
to purchase the securities at prevailing market prices.
5. BORROWINGS
SHORT-TERM BORROWINGS
Short-term borrowings and related interest rates were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
AMOUNT INTEREST AMOUNT INTEREST
OUTSTANDING RATE(1) OUTSTANDING RATE(1)
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial paper $4,688.5 5.84% $2,497.2 5.98%
Other
Bank notes 529.6 5.85 494.0 6.07
Federal funds
purchased 720.0 5.79 483.0 5.83
Bank borrowings 385.3 6.75 400.2 6.73
Note payable
to Tandy 2.1 6.49 175.2 6.49
- --------------------------------------------------------------------------------
Total $6,325.5 5.89% $4,049.6 6.07%
- --------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Interest rates are presented on a weighted average basis and exclude the
effects of interest rate contracts.
At December 31, 1995 and 1994, short-term borrowings were subject to interest
rate exchange agreements of $1,002.3 million and $692.3 million, and interest
rate cap agreements of $405.0 million and $805.0 million. The interest rate
exchange agreements, which consist of interest rate swap and cost of funds
agreements, primarily converted the related borrowings to fixed rates. At
December 31, 1995 and 1994, the interest rate cap agreements set weighted
average rate limits of 5.99% and 6.09% for the related borrowings. At December
31, 1995 and 1994, the weighted average interest rates on short-term borrowings,
including the effects of interest rate contracts, were 5.97% and 6.03%.
The Company maintains a senior bank credit facility to support general
liquidity needs, including the issuance of commercial paper at the corporate
level. In 1995, the Company renewed this facility and increased its amount to
$3.25 billion from $2.5 billion. The facility expires in May 1996 and may be
extended, at the Company's option, an additional six months for amounts then
outstanding. The Company currently plans to renew or replace this facility prior
to its expiration. This facility contains covenants that require the Company to
maintain minimum net worth requirements and specified financial ratios. The
Company believes that the covenant restrictions will not impair its ability to
pay its current level of dividends. As of December 31, 1995, the Company had
never borrowed from its senior bank credit facility.
Riverwoods Funding Corporation ("RFC"), an entity included in the
consolidated financial statements of the Company, maintains a senior bank credit
facility to support the issuance of asset-backed commercial paper. In 1995, RFC
renewed this facility and increased its amount to $1.75 billion from $770.0
million. RFC currently plans to renew or replace this facility prior to its
expiration in November 1996. Under the terms of the asset-backed commercial
paper program, certain assets of RFC were subject to a lien in the amount of
$1.8 billion at December 31, 1995. RFC has never borrowed from its senior bank
credit facility.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
At December 31, 1995 and 1994, the weighted average interest rates on amounts
borrowed through repurchase agreements were 5.24% and 4.99%. Substantially all
of the Company's proprietary positions in U.S. government and agency obligations
are pledged as collateral in connection with repurchase agreements.
-45-
<PAGE> 10
LONG-TERM BORROWINGS
Long-term borrowings, which consisted of senior long-term notes net of
unamortized discount, and related interest rates were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
AMOUNT INTEREST AMOUNT INTEREST
OUTSTANDING RATE(1) OUTSTANDING RATE(1)
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Floating rate notes $3,275.5 6.05% $2,144.7 6.32%
Fixed rate notes 3,456.9 6.36 3,147.9 6.42
- --------------------------------------------------------------------------------
Total $6,732.4 6.21% $5,292.6 6.38%
- --------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Interest rates are presented on a weighted average basis and exclude the
effects of interest rate exchange agreements.
At December 31, 1995 and 1994, the use of interest rate exchange agreements
effectively converted $2,130.4 million and $1,869.3 million of fixed rate
borrowings to floating rates and $75.0 million and $225.0 million of floating
rate borrowings to fixed rates. In both years, $325.0 million of floating rate
borrowings were converted to floating rates with different repricing indices. At
December 31, 1995 and 1994, the weighted average interest rates on long-term
borrowings, including the effects of interest rate exchange agreements, were
6.28% and 6.57%.
At December 31, 1995, floating rate notes had maturities ranging from
two to seven years from the date of issuance and a weighted average remaining
maturity of three years. At December 31, 1995, fixed rate notes had maturities
ranging from one to twenty years from the date of issuance and a weighted
average remaining maturity of six years.
At December 31, 1995, the principal amounts of long-term borrowings
maturing over the next five years were as follows.
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
1996 $1,267.4
1997 763.1
1998 976.0
1999 394.8
2000 1,510.0
- --------------------------------------------------------------------------------
</TABLE>
Through February 21, 1996, the Company issued $1,125.0 million of senior
long-term notes with a weighted average maturity of seven years from the date of
issuance.
Cash paid for interest for the Company's borrowings and deposits was
$1,997.9 million, $1,288.8 million and $774.2 million in 1995, 1994 and 1993.
6. DEPOSITS
Deposits were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Demand, passbook, and money market accounts $1,552.0 $1,165.8
Consumer certificate accounts 1,222.2 758.1
$100,000 minimum certificate accounts 3,416.9 3,284.8
- --------------------------------------------------------------------------------
Total $6,191.1 $5,208.7
- --------------------------------------------------------------------------------
</TABLE>
The weighted average interest rates of interest-bearing deposits outstanding
during 1995 and 1994 were 6.55% and 6.22%.
At December 31, 1995 and 1994, $20.0 million and $101.1 million of the
Company's deposits were converted to fixed rates through the use of interest
rate exchange agreements. At December 31, 1995 and 1994, the effects of these
agreements on the weighted average interest rates of the Company's deposits were
not material.
At December 31, 1995, certificate accounts maturing over the next five
years were as follows.
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
1996 $1,795.4
1997 395.3
1998 1,021.7
1999 407.1
2000 330.9
- --------------------------------------------------------------------------------
</TABLE>
7. EMPLOYEE BENEFIT PLANS
PENSION PLANS
Substantially all employees of the Company are eligible to participate, after
meeting certain age and service requirements, in Company sponsored
non-contributory defined benefit pension plans. Pension benefits are based on
length of service and average annual compensation. The Company's policy is to
contribute an amount at or above that which is required under the Employee
Retirement Income Security Act. Contributions to the pension plans were $29.7
million, $33.0 million and $26.8 million in 1995, 1994 and 1993.
-46-
<PAGE> 11
Pension expense consisted of the following.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 27.5 $ 35.0 $ 28.0
Interest on projected benefit obligation 37.1 35.7 34.3
Actual return on plan assets (68.9) (12.7) (46.2)
Net amortization and deferral 34.4 (19.9) 18.6
Curtailment loss - - 0.7
- --------------------------------------------------------------------------------
Total $ 30.1 $ 38.1 $ 35.4
- --------------------------------------------------------------------------------
</TABLE>
The expected long-term rate of return on plan assets was 9.0% in 1995, 9.0% in
1994 and 9.0% to 9.5% in 1993.
The funded status of these plans was as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Vested benefit obligation $470.5 $367.9
Accumulated benefit obligation 497.5 394.7
- --------------------------------------------------------------------------------
Projected benefit obligation $595.9 $463.2
Plan assets at fair value 478.7 413.4
- --------------------------------------------------------------------------------
Plan assets less than projected benefit obligation 117.2 49.8
Unrecognized transitional obligation (13.4) (16.0)
Unrecognized net (loss) gain (56.3) 14.0
Unrecognized prior service cost (3.1) (3.4)
Adjustment required to recognize minimum liability 1.4 0.3
- --------------------------------------------------------------------------------
Accrued pension liability $ 45.8 $ 44.7
- --------------------------------------------------------------------------------
</TABLE>
Assumptions used in calculating the projected benefit obligation were as
follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 7.25% 8.50% 7.00%
Rate of increase in compensation levels 5.00 5.00 5.00
================================================================================
</TABLE>
The changes in assumptions increased the projected benefit obligation by $110.8
million at December 31, 1995 and decreased the projected benefit obligation by
$104.4 million at December 31, 1994.
OTHER PLANS
The Company has unfunded postretirement benefit plans that provide medical and
life insurance for eligible retirees, employees and dependents. At December 31,
1995 and 1994, the Company's obligation for these benefits was $32.9 million and
$26.6 million. Employees of the Company are eligible to participate in the
Company's 401(k) plan upon meeting certain eligibility requirements. The Company
matches a portion of each participant's contribution. The Company's
contributions to the 401(k) plan were $37.3 million and $34.3 million in 1995
and 1994.
8. SHAREHOLDERS' EQUITY
EARNINGS PER SHARE
The calculations of earnings per common share were based on the weighted average
number of common shares outstanding in 1995, 1994 and 1993, adjusted for the
dilutive effects of stock options and unissued stock awards under deferred
compensation plans.
The calculations of pro forma earnings per common share for the year
ended December 31, 1993 were based on the weighted average number of shares
outstanding in 1995 as described above.
RECAPITALIZATION OF COMMON STOCK
Prior to the IPO, while still a wholly-owned subsidiary of Sears, the Company
increased the number of authorized shares of common stock to 250.0 million,
issued 136.2 million shares, and reduced the par value from $1.00 to $0.01 per
share.
TREASURY STOCK AND STOCK REPURCHASE
The Company purchases shares of common stock under a general repurchase plan and
for issuance in equity-based compensation plans. In 1995, the Company purchased
2.5 million shares of its common stock and recorded these shares at cost. At
December 31, 1995 and 1994, 2.2 million and 2.1 million shares were held in
treasury. At December 31, 1995, 1.5 million of these shares were held for
issuance under equity-based compensation plans.
In January 1996, the board of directors of the Company increased the
Company's authorization to repurchase shares of its outstanding common stock by
$250.0 million.
DIVIDENDS
Dividends paid by the Company to Sears in 1993 included special dividends of
$560.0 million and $25.0 million. The Company paid additional dividends to Sears
related to January and February 1993 net income in the amount of $35.2 million.
For the period March 1, 1993 through the Spin-off, Sears received dividends at
the same rate as all common shareholders.
SHAREHOLDER RIGHTS PLAN
In 1995, the Board of Directors adopted a Shareholder Rights Plan which
generally provides that one right be attached to each share of the Company's
common stock. Each right has an exercise price of $175, subject to adjustment.
Generally, the right cannot be exercised or traded apart from the common stock
until a third party, without the prior consent of the Company, either announces
it has acquired
-47-
<PAGE> 12
beneficial ownership of 15% or more of the Company's outstanding common stock or
commences a tender or exchange offer that would result in it acquiring
beneficial ownership of 15% or more of the Company's outstanding common stock.
Each right, upon becoming exercisable, generally entitles the holder to
purchase, at the right's then current exercise price, shares of the Company's
common stock (or in certain circumstances receive shares of common stock of an
acquiring third party) having a value of twice the right's then current exercise
price. The rights expire at the close of business April 21, 1995 unless redeemed
earlier by the Company.
9. STOCK PLANS
The Company maintains equity-based incentive plans under which various types of
stock awards are granted to officers, directors and key employees of the
Company.
EQUITY-BASED EMPLOYEE INCENTIVE AWARDS
The Company is authorized to issue up to 21.6 million shares of its common stock
in connection with awards under several equity-based employee incentive plans.
Stock option activity under these plans was as follows.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
NUMBER AVERAGE NUMBER AVERAGE
OF OPTION OF OPTION
SHARES PRICE SHARES PRICE
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Options outstanding at
beginning of the year 8.3 $25.06 8.8 $24.87
Granted 6.6 35.30 0.1 38.46
Exercised (0.9) 22.78 (0.5) 22.72
Forfeited (0.2) 30.87 (0.1) 24.52
- --------------------------------------------------------------------------------
Options outstanding at
year end 13.8 $29.99 8.3 $25.06
- --------------------------------------------------------------------------------
Eligible for exercise at
year end 5.6 $24.72 4.2 $23.80
- --------------------------------------------------------------------------------
</TABLE>
At December 31, 1995, 5.8 million shares were available for future grant under
these plans.
DEFERRED COMPENSATION AWARDS
The Company is authorized to issue up to 10.5 million shares of its common stock
in connection with three deferred compensation plans. These plans provide for
the deferral of a portion of certain employees' compensation with payment made
in the form of shares of the Company's common stock. In 1995 and 1994, the
Company recorded compensation expense of $57.2 million and $37.0 million and
unearned compensation of $6.1 million and $5.2 million in connection with the
award in both years of approximately 1.2 million shares of common stock under
these plans. These shares were issued in 1996 and 1995 and are held in custodial
or trust accounts pending employee eligibility to receive the shares. Unearned
compensation is recognized over the related plan vesting periods.
NON-EMPLOYEE DIRECTOR AWARDS
Prior to the IPO, Sears as sole shareholder authorized the issuance of up to 0.1
million shares of the Company's common stock in connection with option grants
under the Company's Stock Plan for Non-Employee Directors.
EMPLOYEE STOCK PURCHASE PLAN
Under the Employee Stock Purchase Plan, employees may purchase shares of the
Company's common stock at not less than 85% of the fair market value on the date
of purchase. The Company is authorized to issue up to 2.0 million shares of
common stock under this plan. Employees of the Company purchased 0.4 million and
0.1 million shares of common stock in 1995 and 1994.
10. INCOME TAXES
Income tax expense (benefit) was as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $537.5 $ 540.3 $ 418.7
State and local 95.4 89.0 76.3
- --------------------------------------------------------------------------------
632.9 629.3 495.0
- --------------------------------------------------------------------------------
Deferred:
Federal (75.0) (136.2) (92.6)
State and local (18.4) (19.4) (9.8)
- --------------------------------------------------------------------------------
(93.4) (155.6) (102.4)
- --------------------------------------------------------------------------------
Total $539.5 $ 473.7 $ 392.6
================================================================================
</TABLE>
Deferred income taxes were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Loan loss allowances, including allowances
for securitized loans $366.7 $314.3
Deferred compensation 207.8 162.4
Other valuation and liability allowances 279.9 253.9
Other deferred tax assets 87.2 80.5
- --------------------------------------------------------------------------------
941.6 811.1
- --------------------------------------------------------------------------------
Liabilities:
Prepaid commissions (125.8) (134.0)
Other deferred tax liabilities (78.9) (33.6)
- --------------------------------------------------------------------------------
(204.7) (167.6)
- --------------------------------------------------------------------------------
Total $736.9 $643.5
================================================================================
</TABLE>
-48-
<PAGE> 13
A reconciliation from the statutory federal income tax rate to the effective tax
rate was as follows.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
U.S. statutory rate 35.0% 35.0% 35.0%
State and local taxes, net of federal benefit 3.5 3.5 4.4
Other 0.1 0.5 -
- --------------------------------------------------------------------------------
Effective tax rate 38.6% 39.0% 39.4%
- --------------------------------------------------------------------------------
</TABLE>
In conjunction with the Spin-off, the Company and Sears entered into an
agreement under which the Company is responsible for additional taxes arising as
the result of amendment or audit that are attributable to the business of the
Company for any period during which it was owned by Sears. Sears will reimburse
the Company for any tax benefits attributable to the business of the Company for
the applicable periods.
The Company had available net operating loss carryforwards at December
31, 1995 in the amount of $14.0 million, which begin to expire in 2005.
Cash paid for income taxes in 1995, 1994 and 1993 was $653.9 million,
$719.0 million and $528.5 million.
11. REGULATORY CAPITAL REQUIREMENTS
Under regulatory net capital requirements adopted by the Federal Deposit
Insurance Corporation ("FDIC") and other regulatory capital guidelines, FDIC
insured financial institutions must maintain (a) 3% to 5% of Tier 1 capital, as
defined, to total assets ("leverage ratio") and (b) 8% combined Tier 1 and Tier
2 capital, as defined, to risk-weighted assets ("risk-weighted capital ratio").
At December 31, 1995, the leverage ratio and risk-weighted capital ratio of each
of the Company's FDIC insured financial institutions exceeded these and all
other regulatory minimums.
DWR, the Company's primary broker-dealer, is subject to the Uniform Net
Capital Rule of the Securities and Exchange Commission ("SEC"). Under the
alternative method permitted by this Rule, the required net capital, as defined,
shall not be less than the greater of (a) one million dollars, (b) 2% of
aggregate debit balances arising from client transactions pursuant to SEC Rule
15c3-3, or (c) 4% of the funds required to be segregated pursuant to the
Commodity Exchange Act. The New York Stock Exchange, Inc. may also require a
member organization to reduce its business if its net capital is less than the
greater of (a) 4% of aggregate debit balances or (b) 6% of the funds required to
be segregated, and may prohibit a member organization from expanding its
business and declaring cash dividends if its net capital is less than the
greater of (a) 5% of aggregate debit balances or (b) 7% of the funds required to
be segregated. At December 31, 1995, DWR's net capital was $492.9 million and
net capital in excess of the minimum required was $384.6 million. DWR's net
capital was 18.32% of aggregate debit balances and 18.21% of funds required to
be segregated.
The regulatory capital requirements referred to above, and certain
covenants contained in various agreements governing indebtedness of the Company,
may restrict the Company's ability to withdraw capital from its subsidiaries. At
December 31, 1995, approximately $1.5 billion of net assets of consolidated
subsidiaries may be restricted as to the payment of cash dividends and advances
to the Company.
12. COMMITMENTS AND CONTINGENT
LIABILITIES
The Company has non-cancelable operating leases covering office space and
equipment. At December 31, 1995, future minimum rental commitments under such
leases (net of subleases, principally on office rentals) were as follows.
<TABLE>
- --------------------------------------------------------------------------------
<S> <C>
1996 $ 154.3
1997 141.9
1998 125.0
1999 113.8
2000 103.5
Thereafter 507.6
- --------------------------------------------------------------------------------
Total $1,146.1
- --------------------------------------------------------------------------------
</TABLE>
Occupancy lease agreements, in addition to base rentals, generally provide for
rent and operating expense escalations resulting from increased assessments for
real estate taxes and other charges. Total rent expense, net of sublease rental
income, was $153.1 million, $148.5 million and $149.3 million in 1995, 1994 and
1993.
The Company has an agreement with Advantis, a joint venture between
Sears and IBM, under which the Company receives information processing, data
networking and related services. Under the terms of the agreement, the Company
has an aggregate minimum annual commitment of $166.0 million subject to annual
cost of living adjustments.
At December 31, 1995, the Company had outstanding letters of credit of
approximately $72.4 million which expire on various dates through September 1,
1996. The letters of credit are written in favor of clearing associations
-49-
<PAGE> 14
to satisfy margin requirements and with the trustee for various unit investment
trust underwritings. Annual fees of 0.25% are paid on the amounts of these
letters of credit.
At December 31, 1995 and 1994, the Company held investments consisting
of leveraged and unleveraged fee interests, secured and unsecured loans and
advances to various public and private real estate-related partnerships
aggregating to $70.6 million and $81.7 million. These investments are recorded
at the lower of cost or fair value and are included in other receivables in the
consolidated balance sheets. At December 31, 1995, the Company had maximum
commitments of $30.0 million with respect to its real estate-related activities.
In the normal course of business, the Company has been named as a
defendant in various lawsuits. Some of these lawsuits involve claims for
substantial amounts. Although the ultimate outcome of these suits cannot be
ascertained at this time, it is the opinion of management, after consultation
with outside counsel, that the resolution of such suits will not have a material
adverse effect on the consolidated financial condition of the Company, but may
be material to the Company's operating results for any particular period,
depending upon the level of the Company's income for such period.
13. FINANCIAL INSTRUMENTS
TRADING ACTIVITIES
Certain market and credit risks arise from the Company's securities brokerage
activities. These activities primarily facilitate clients' trading and financing
transactions in financial instruments, which may include derivatives.
The Company's client activities involve the execution, settlement and
financing of various client securities and commodities transactions. Client
securities activities are transacted on either a cash or margin basis, and
client commodity transactions are generally transacted on a margin basis subject
to individual exchange regulations. These transactions include the purchase and
sale of securities, the writing of options and the purchase and sale of
commodity futures and forward contracts. These activities may expose the Company
to off-balance sheet risk from clients that may fail to satisfy their
obligations, requiring the Company to purchase or sell financial instruments at
prevailing market prices. The Company believes that the settlement of these
transactions will not have a material effect on the Company's consolidated
financial statements.
The Company's exposure to credit risk associated with these
transactions is measured on an individual basis, as well as by groups that share
similar attributes. The Company services a diverse group of domestic and foreign
corporations, governments and, institutional and individual investors.
Concentrations of credit risk can be affected by changes in geographic, industry
or economic factors. The Company seeks to control risks associated with its
clients' activities by requiring clients to maintain collateral in compliance
with internal and regulatory guidelines. The Company monitors required margin
levels and established credit limits daily and, pursuant to such guidelines,
requires clients to deposit additional collateral, or reduce positions, when
necessary.
The Company's client financing and securities settlement activities may
require the Company to pledge client securities as collateral (1) in support of
various secured financing sources such as bank loans, securities loaned and
repurchase agreements and (2) to satisfy margin requirements on various
exchanges. In the event the counterparty is unable to meet its contractual
obligation to return the client securities pledged as collateral, the Company
may be exposed to the risk of acquiring the securities at prevailing market
prices in order to satisfy its client obligations. The Company controls this
risk by monitoring the market value of securities pledged on a daily basis and
by requiring adjustments of collateral levels in the event of excess market
exposure. Additionally, the Company establishes credit limits for such
activities and monitors compliance on a daily basis. At December 31, 1995, the
market value of client securities pledged under these secured financing
transactions approximated the amounts due.
The Company's derivative trading activities are generally limited to
facilitating client trading activity. The Company's derivative trading
activities primarily involve foreign currency forward contracts and foreign
currency options. All financial instruments are carried at market value. Gains
and losses from financial instruments are recorded in the consolidated
statements of income as principal transactions revenue. Market risk is generally
controlled by holding substantially offsetting purchase and sell positions. In
certain cases, the Company has entered into master netting agreements which
allow for net settlement of offsetting transactions with counterparties. The
table on page 51 presents the Company's trading derivatives. Where derivative
instruments are subject to netting arrangements, the amounts disclosed are
presented on a net settlement basis.
Foreign currency forward contracts represent obligations to purchase or
sell with the seller agreeing to make delivery at a specified future date and a
specified price. Foreign currency options provide the holder the right, but not
the obligation, to purchase or sell on a certain date and at a specified price.
The fair values of these instruments represent quoted market prices.
-50-
<PAGE> 15
Principal transactions revenues include revenues from purchases and
sales in which the Company acts as a principal, as well as gains and losses on
securities held for resale. Revenues from principal trading activities for 1995
were $261.6 million for fixed income securities and $217.3 million for equity
securities. In 1995, gains or losses from derivative financial instruments were
not material.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------------
CONTRACT OR AVERAGE CONTRACT OR AVERAGE
NOTIONAL FAIR FAIR NOTIONAL FAIR FAIR
AMOUNT VALUE VALUE AMOUNT VALUE VALUE
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Foreign currency forward contracts(1)
Assets $5,640.2 $5,643.0 $11,237.3 $7,805.3 $7,823.7 $17,375.0
Liabilities 5,584.2 5,586.9 11,251.1 7,806.0 7,825.3 17,493.0
Foreign currency options
Assets 1,589.1 1,588.0 1,448.3 1,649.4 1,687.6 1,758.0
Liabilities 1,589.1 1,588.0 1,448.3 1,649.4 1,687.6 1,758.0
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Period-end numbers, for 1994, reflect certain master netting agreements
entered into effective December 1994.
OTHER THAN TRADING ACTIVITIES
The Company uses interest rate contracts, which consist of interest rate
exchange agreements and purchased interest rate cap agreements, as part of its
interest rate risk management program. This program is designed to reduce the
volatility of earnings resulting from changes in interest rates, including the
interest rate risk inherent in servicing fees received by the Company from
consumer loans sold through asset securitizations. This is accomplished
primarily through matched financing, which entails matching the repricing
schedules of consumer loans and the related financing. Where asset and funding
repricing characteristics are not matched effectively the Company utilizes
interest rate contracts. These contracts are entered into as hedges of interest
rate risk, and gains or losses from these contracts generally offset
counterbalancing gains or losses on hedged risk. The Company attempts to match
the recognition of the gains or losses in the periods in which the hedged risk
is realized. Thus, gains or losses may be recognized as part of periodic
settlements or, upon early termination of an interest rate contract, deferred
and amortized over the remaining period of the hedged risk to achieve the
appropriate matching. Interest rate contracts are subject to credit risk for
counterparty nonperformance. The fair value of these agreements is the estimated
amount that the Company would receive (or pay) to terminate the underlying
contract, taking into account current market conditions.
Interest rate exchange agreements, which include interest rate swap and
cost of funds agreements, are settled by reference to the difference between the
base interest rates being exchanged, multiplied by the notional amount of the
contract. These agreements subject the Company to market risk in excess of
amounts recorded in the consolidated balance sheets in the event of unfavorable
market interest rate movements. Interest rate swap agreements are derivative
financial instruments which are entered into with institutions that are
established dealers and that maintain certain minimum credit criteria
established by the Company. Cost of funds agreements are entered into as part of
agreements pursuant to which the Company provides private label credit card
processing services to certain of its merchant clients. Interest rate exchange
agreements outstanding were as follows.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- ---------------------------------------------------------------------------------------------------------
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate swaps
Pay floating rate,
receive fixed rate $4,223.9 $ 76.8 $3,416.5 $(295.5)
Pay fixed rate,
receive floating rate 837.7 (19.2) 678.7 21.1
Pay floating rate,
receive floating rate 425.0 (1.4) 425.0 (1.9)
Cost of funds agreements 631.3 0.9 560.2 23.6
- ---------------------------------------------------------------------------------------------------------
</TABLE>
Purchased interest rate cap agreements are derivative financial instruments
which, by their nature, have no off-balance sheet risk of loss due to
unfavorable interest rate movements. The Company pays an initial premium, which
is recorded on the balance sheet and amortized to interest expense over the term
of the cap agreement. Benefits received are recorded as a reduction of interest
expense. The Company had outstanding interest rate cap agreements with notional
amounts of $415.0 million and $820.0 million at December 31, 1995 and 1994, of
which $40.0 million and $445.0
-51-
<PAGE> 16
million were in effect at December 31, 1995 and 1994. At December 31, 1995 and
1994, the fair values of these agreements were $0.9 million and $11.2 million.
In connection with certain asset securitizations, the Company has
written interest rate cap agreements with notional amounts of $240.0 million and
strike rates of 11%. Any settlement payments made under these agreements will
generally be passed back to the Company through an adjustment of servicing fees,
although this is subject to the risk of counterparty nonperformance. At December
31, 1995 and 1994, the fair values of these agreements were not material. No
payments have been made by the Company under these agreements, which expire in
1997.
FAIR VALUE
The estimated fair value amounts of the Company's financial instruments have
been determined using available market information and appropriate valuation
methodologies. Considerable judgment is required to develop estimates of fair
value.
Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different assumptions or estimation methodologies may have
a material effect on the estimated fair value amounts.
The carrying amounts of the Company's financial assets and liabilities
were reasonable estimates of fair value.
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- -----------------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Consumer loans $20,834.6 $20,874.3 $15,608.4 $15,655.4
Financial liabilities:
Deposits 6,191.1 6,308.8 5,208.7 5,164.0
Long-term borrowings 6,732.4 6,847.6 5,292.6 5,073.6
- -----------------------------------------------------------------------------------------
</TABLE>
Consumer Loans -- For consumer loans, fair value is generally estimated
by discounting the future cash flows using the current rates and effective
yields at which similar loans would be made for the same remaining maturities to
borrowers with similar credit ratings. For consumer loans which are indexed to
market rates, the carrying amount is a reasonable estimate of fair value.
Deposits -- For demand deposits and fixed rate deposits maturing within
three months, the carrying amount is a reasonable estimate of fair value. For
fixed rate deposits with longer maturities, fair value is estimated by
discounting future cash flows using current rates for deposits of similar
maturities.
Long-term Borrowings -- For long-term borrowings, fair value is
estimated by discounting future principal and interest payments using current
rates for instruments with similar maturities and credit quality.
14. SEGMENT INFORMATION
The Company is in the business of providing financial services, and operates in
two distinct business segments -- Credit Services and Securities. Credit
Services is engaged in the issuance and servicing of general purpose credit
cards, consumer lending and electronic transaction processing services.
Securities engages in delivering a broad range of financial products and
services to individual and institutional investors.
The following table presents certain information regarding these
business segments.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 1994 1993
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Total revenues
Credit Services $ 4,333.7 $ 3,460.2 $ 2,779.5
Securities 3,600.7 3,142.4 3,042.1
Income before income taxes
Credit Services 720.9 671.7 510.3
Securities 675.0 542.9 485.9
Identifiable assets at end of period(1)
Credit Services 23,857.5 17,901.4 13,620.3
Securities 14,350.7 13,958.0 14,042.0
- -----------------------------------------------------------------------------------------------------
</TABLE>
- ----------
(1) Corporate assets have been fully allocated to the Company's business
segments.
-52-
<PAGE> 1
EXHIBIT 99.2
PART I. FINANCIAL INFORMATION
DEAN WITTER, DISCOVER & CO.
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1996 1995 1996 1995
--------- --------- -------- --------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Merchant and cardmember fees............. $ 379.5 $ 285.8 $1,045.6 $ 791.7
Commissions.............................. 264.3 266.2 868.8 748.7
Asset management and administration fees. 289.8 251.7 850.5 748.2
Servicing fees........................... 222.7 187.8 614.5 534.3
Principal transactions................... 107.0 121.6 340.4 367.8
Investment banking....................... 45.7 45.1 168.0 132.7
Other.................................... 20.7 16.2 79.0 69.3
--------- --------- -------- --------
Total non-interest revenues............ 1,329.7 1,174.4 3,966.8 3,392.7
--------- --------- -------- --------
Interest revenue......................... 893.7 844.2 2,618.4 2,414.0
Interest expense......................... 390.4 374.7 1,160.8 1,112.0
--------- --------- -------- --------
Net interest income.................... 503.3 469.5 1,457.6 1,302.0
Provision for losses on receivables...... 307.0 192.7 809.2 451.0
--------- --------- -------- --------
Net credit income...................... 196.3 276.8 648.4 851.0
--------- --------- -------- --------
Net operating revenues................. 1,526.0 1,451.2 4,615.2 4,243.7
--------- --------- -------- --------
Employee compensation and benefits....... 525.8 511.5 1,649.0 1,484.7
Marketing and business development....... 209.9 204.4 603.2 511.1
Information processing and
communications.......................... 190.2 169.9 558.2 496.0
Facilities and equipment................. 63.8 60.8 188.7 173.6
Other.................................... 143.3 148.9 434.6 475.0
--------- --------- -------- --------
Total non-interest expenses............ 1,133.0 1,095.5 3,433.7 3,140.4
--------- --------- -------- --------
Income before income taxes............... 393.0 355.7 1,181.5 1,103.3
Income tax expense....................... 154.0 137.0 457.9 425.0
--------- --------- -------- --------
Net income............................... $ 239.0 $ 218.7 $ 723.6 $ 678.3
========= ========= ======== ========
Primary net income per share............. $ 1.42 $ 1.24 $ 4.21 $ 3.87
========= ========= ======== ========
Primary average common shares
outstanding............................. 168.9 176.5 171.7 175.2
========= ========= ======== ========
Fully diluted net income per share....... $ 1.41 $ 1.23 $ 4.21 $ 3.83
========= ========= ======== ========
Fully diluted average common shares
outstanding............................. 169.2 177.3 171.9 176.9
========= ========= ======== ========
</TABLE>
See notes to the consolidated financial statements.
1
<PAGE> 2
DEAN WITTER, DISCOVER & CO.
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Cash and cash equivalents........................... $ 1,102.2 $ 1,464.5
Cash and securities segregated under federal and
other regulations.................................. 1,801.8 1,926.4
Receivables
Consumer loans (net of allowances of $688.1 in 1996
and $721.8 in 1995)............................... 19,594.6 20,834.6
Securities clients (net of allowances of $15.7 in
1996 and $16.2 in 1995)........................... 2,739.6 2,588.8
Brokers or dealers................................. 3,197.4 2,683.7
Other.............................................. 732.7 732.4
Amounts due from asset securitizations.............. 852.6 653.4
Securities purchased under agreements to resell..... 3,524.4 3,571.9
Securities owned, at market value................... 1,695.8 1,848.8
Deferred income taxes............................... 776.6 736.9
Office facilities, at cost (less accumulated
depreciation and amortization of $435.1 in 1996 and
$380.5 in 1995).................................... 376.8 341.0
Goodwill............................................ 161.1 161.9
Other assets........................................ 635.7 663.9
--------- ---------
Total assets..................................... $37,191.3 $38,208.2
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Commercial paper................................... $ 1,966.9 $ 4,688.5
Other short-term borrowings........................ 430.3 1,637.0
Deposits........................................... 6,598.2 6,191.1
Payables
Securities clients................................ 2,822.0 3,183.0
Brokers or dealers................................ 3,204.2 2,629.7
Drafts............................................ 400.5 485.5
Income taxes...................................... 162.8 99.3
Securities sold under agreements to repurchase..... 3,425.9 3,813.4
Securities sold but not yet purchased, at market
value............................................. 1,302.7 1,125.2
Other liabilities and accrued expenses............. 3,076.4 2,789.4
Long-term borrowings............................... 8,823.2 6,732.4
--------- ---------
Total liabilities................................ 32,213.1 33,374.5
--------- ---------
Shareholders' Equity
Preferred stock ($0.01 par value, 10.0 shares
authorized, none issued).......................... -- --
Common stock ($0.01 par value, 500.0 shares
authorized, 171.0 and 171.0 shares issued, 161.3
and 168.8 shares outstanding at September 30, 1996
and December 31, 1995)............................ 1.7 1.7
Paid-in capital.................................... 2,708.0 2,718.3
Retained earnings.................................. 2,780.1 2,165.7
--------- ---------
5,489.8 4,885.7
--------- ---------
Common stock held in treasury, at cost ($0.01 par
value, 9.7 and 2.2 shares at September 30, 1996 and
December 31, 1995)................................. (507.2) (106.8)
Stock compensation plans............................ 46.6 85.1
Employee stock benefit trust........................ (46.0) (21.5)
Unearned stock compensation......................... (5.0) (8.8)
--------- ---------
Total shareholders' equity....................... 4,978.2 4,833.7
--------- ---------
Total liabilities and shareholders' equity....... $37,191.3 $38,208.2
========= =========
</TABLE>
See notes to the consolidated financial statements.
2
<PAGE> 3
DEAN WITTER, DISCOVER & CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1996 1995
--------- ---------
(UNAUDITED)
<S> <C> <C>
Cash flows provided by (used in) operating activities
Net income............................................... $ 723.6 $ 678.3
Adjustments to reconcile net income to net cash flows
from operating activities
Depreciation and amortization........................... 58.8 50.8
Provision for losses on receivables..................... 809.2 451.0
Deferred income taxes................................... (39.7) (68.8)
Decrease (increase) in operating assets
Cash and securities segregated under federal and other
regulations............................................ 124.6 (225.2)
Receivables
Securities clients..................................... (159.5) 144.8
Brokers or dealers..................................... (513.7) (51.3)
Other.................................................. (0.3) 24.9
Amounts due from asset securitizations.................. (199.2) (166.7)
Matched securities purchased under agreements to resell,
net.................................................... (132.9) 179.9
Securities owned and securities sold but not yet
purchased, at market value, net........................ 330.5 (547.5)
Other assets............................................ (3.8) 41.6
Increase (decrease) in operating liabilities
Payables
Securities clients..................................... (361.0) (172.9)
Brokers or dealers..................................... 574.5 42.0
Drafts................................................. (85.0) (66.0)
Income taxes........................................... 63.5 (27.1)
Other liabilities and accrued expenses.................. 377.2 499.6
--------- ---------
Cash provided by (used in) operating activities....... 1,566.8 787.4
--------- ---------
Cash flows provided by (used in) investing activities
Net principal disbursed on consumer loans............... (4,373.3) (3,016.5)
Purchases of consumer loans............................. (5.1) (296.6)
Sales of consumer loans................................. 4,817.9 1,677.3
Other................................................... (61.8) (58.1)
--------- ---------
Cash provided by (used in) investing activities....... 377.7 (1,693.9)
--------- ---------
Cash flows provided by (used in) financing activities
Proceeds from issuance (repayments) of commercial paper,
net.................................................... (2,811.8) (965.7)
Net decrease in other short-term borrowings............. (1,206.6) (991.7)
Deposits, net........................................... 407.1 490.0
Proceeds from issuance of long-term borrowings, net..... 2,093.5 1,574.7
Securities sold under agreements to repurchase, net..... (207.3) 454.7
Dividends paid.......................................... (98.4) (75.2)
Proceeds from issuance of common stock.................. 34.8 34.7
Purchase of treasury stock.............................. (518.1) (16.1)
--------- ---------
Cash provided by (used in) financing activities....... (2,306.8) 505.4
--------- ---------
Decrease in cash and cash equivalents.................... (362.3) (401.1)
Cash and cash equivalents, beginning of period........... 1,464.5 1,334.1
--------- ---------
Cash and cash equivalents, end of period................. $ 1,102.2 $ 933.0
========= =========
</TABLE>
See notes to the consolidated financial statements.
3
<PAGE> 4
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTRODUCTION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Dean Witter,
Discover & Co. and subsidiaries (the "Company"). The Company is a financial
services organization that provides a broad range of credit and investment
products, with a primary focus on individual customers. Through its wholly-
owned subsidiary NOVUS Credit Services Inc. ("NCSI"), the Company conducts its
credit services business, including the operation of the NOVUSSM Network, a
proprietary network of merchant and cash access locations, and the issuance of
proprietary general purpose credit cards. The Company's securities business is
conducted primarily through its wholly-owned subsidiaries Dean Witter Reynolds
Inc. ("DWR") and Dean Witter InterCapital Inc.
The interim consolidated financial statements as of September 30, 1996, and
for the three and nine months ended September 30, 1996 and 1995, are
unaudited; however, in the opinion of management, all adjustments, consisting
only of normal recurring accruals necessary for fair presentation, have been
reflected. All material intercompany balances and transactions have been
eliminated.
The consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto for the year ended
December 31, 1995 incorporated by reference in the Company's 1995 Annual
Report on Form 10-K filed by the Company under the Securities Exchange Act of
1934. The results of operations for interim periods are not necessarily
indicative of results for the entire year. Certain reclassifications have been
made to prior period amounts to conform to the current presentation.
The calculations of earnings per common share were based on the weighted
average number of common shares outstanding during the three and nine month
periods ended September 30, 1996 and 1995, adjusted for the dilutive effects
of stock options and unissued stock awards under deferred compensation plans.
2. ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") Nos. 121 and 122. SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of", generally requires that long-lived assets be reported at the lower of
their carrying cost or net realizable value. SFAS No. 122, "Accounting for
Mortgage Servicing Rights, an amendment of SFAS No. 65", requires that rights
to service mortgage loans for others, however acquired, be recorded as
separate assets when the mortgage loans are sold and the servicing rights are
retained. This statement also requires that capitalized mortgage servicing
rights be assessed for impairment based on the fair value of those rights. The
adoption of these statements was not material to the Company's financial
position or results of operations.
The Financial Accounting Standards Board has issued SFAS No. 123,
"Accounting for Stock-Based Compensation", effective for fiscal years
beginning after December 15, 1995. The Company has elected, as permitted by
SFAS No. 123, to adopt the disclosure requirement of that standard but
continue to account for stock-based compensation under APB Opinion No. 25,
"Accounting for Stock Issued to Employees."
The Financial Accounting Standards Board has also issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," effective for transfers of financial assets
made after December 31, 1996. (The Financial Accounting Standards Board has
recently proposed to delay the effective date of this statement for twelve
months for transfers of certain financial assets.) This statement provides
financial reporting standards for the derecognition and recognition of
financial assets, including the distinction between transfers of financial
assets which should be recorded as sales and those which should be recorded as
secured borrowings. SFAS No. 125 supersedes and incorporates the essential
provisions of SFAS No. 122. The Company believes that the effect of the
adoption of SFAS No. 125 will not be material to its financial position or
results of operations.
4
<PAGE> 5
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. RISKS AND UNCERTAINTIES
The preparation of the consolidated financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the financial statements.
Actual results could differ from these estimates.
The allowance for consumer loan losses is a significant estimate that is
regularly evaluated by management for adequacy on a portfolio by portfolio
basis. The evaluations take into consideration such factors as changes in the
nature and volume of the loan portfolio, overall portfolio quality, review of
specific problem loans and current economic conditions that may affect the
borrower's ability to pay.
The Company uses the results of these evaluations to provide an allowance
for loan losses. The exposure for credit losses for owned loans is influenced
by the performance of the portfolio and other factors discussed above, with
the Company absorbing all related losses. The exposure for credit losses for
securitized loans is represented by the Company retaining a contingent risk
based on the amount of credit enhancement provided.
Management believes that its estimates have been historically prudent in
light of the need to allow the market for asset securitizations, in particular
those backed by credit card receivables, to mature, and in light of the
uncertainty of accounting standards for asset securitizations. In the third
quarter of 1996, the Company revised its estimate of the allowance for losses
for loans intended to be securitized. This revision was based on the Company's
experience with credit losses related to securitized loans in a mature asset
securitization market and the recent issuance of SFAS No. 125 which eliminated
the uncertainty surrounding the appropriate accounting treatment for asset
securitization transactions. The Company intends to maintain existing loan
loss allowances for securitizations outstanding until the related loans are
liquidated. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" on page 16 for the effect of this change on the
provision for loan losses.
4. CONSUMER LOANS
Consumer loans, classified as to type, were as follows (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Credit card...................................... $19,204.4 $20,440.4
Real estate-secured and other consumer
installment..................................... 1,163.6 1,233.1
--------- ---------
Total............................................ 20,368.0 21,673.5
Less
Unearned finance charges and unamortized loan
discounts and fees............................. 85.3 117.1
Allowance for loan losses....................... 688.1 721.8
--------- ---------
Consumer loans, net.............................. $19,594.6 $20,834.6
========= =========
</TABLE>
5
<PAGE> 6
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Activity in the allowance for consumer loan losses was as follows (in
millions).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- -------------------
1996 1995 1996 1995
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Balance, beginning of period...... $ 671.0 $ 604.6 $ 721.8 $ 565.7
Additions
Provision for loan losses....... 304.2 190.2 800.5 443.4
Purchase of loan portfolios..... -- -- 0.1 29.8
--------- --------- --------- --------
Total additions............... 304.2 190.2 800.6 473.2
--------- --------- --------- --------
Deductions
Charge-offs..................... 300.6 183.6 833.2 478.7
Recoveries...................... (36.7) (29.9) (107.6) (87.7)
--------- --------- --------- --------
Net charge-offs............... 263.9 153.7 725.6 391.0
--------- --------- --------- --------
Other(1).......................... (23.2) (15.7) (108.7) (22.5)
--------- --------- --------- --------
Balance, end of period............ $ 688.1 $ 625.4 $ 688.1 $ 625.4
========= ========= ========= ========
</TABLE>
- ---------
(1) Primarily reflects net transfers related to asset securitizations.
Interest accrued on loans subsequently charged off, recorded as a reduction
of interest revenue, was $45.6 million and $122.8 million in the three and
nine months ended September 30, 1996 and $28.8 million and $73.5 million in
the three and nine months ended September 30, 1995.
The Company received net proceeds from asset securitizations of $860.8
million and $4,527.5 million in the three and nine months ended September 30,
1996 compared to $1,052.6 million and $1,684.2 million in the three and nine
months ended September 30, 1995. The uncollected balances of consumer loans
sold through securitizations were $13,511.1 million and $10,219.5 million at
September 30, 1996 and December 31, 1995. The allowance for loan losses
related to securitized consumer loans, included in other liabilities and
accrued expenses, was $455.1 million and $341.7 million at September 30, 1996
and December 31, 1995. The Company had, under the provisions of certain
securitization transactions, limited recourse obligations at September 30,
1996 and December 31, 1995 of $137.1 million and $123.9 million, of which
$29.7 million and $30.0 million were included in the allowance for loan losses
related to securitized consumer loans.
6
<PAGE> 7
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. BORROWINGS
Short-term borrowings
Short-term borrowings consisted of the following (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Commercial paper................................. $1,966.9 $4,688.5
Other
Bank borrowings.................................. 410.3 385.3
Federal funds purchased.......................... 20.0 720.0
Bank notes....................................... -- 529.6
Note payable to Tandy............................ -- 2.1
-------- --------
Total............................................ $2,397.2 $6,325.5
======== ========
</TABLE>
The weighted average interest rate on short-term borrowings, including the
effects of interest rate contracts, was 5.82% at September 30, 1996 and 5.97%
at December 31, 1995.
To support the issuance of asset-backed commercial paper, Riverwoods Funding
Corporation ("RFC"), a consolidated subsidiary of the Company, renewed its
agreement with a syndicate of banks, effective October 18, 1996, for its
senior bank credit facility. This agreement will expire on October 17, 1997.
In conjunction with renewing this agreement the amount of the credit facility
was increased to $2.1 billion from the previous amount of $1.75 billion.
Long-term borrowings
Long-term borrowings, which consisted of senior long-term notes, net of
unamortized discount, were as follows (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Floating rate notes............................... $5,167.0 $3,275.5
Fixed rate notes.................................. 3,656.2 3,456.9
-------- --------
Total............................................. $8,823.2 $6,732.4
======== ========
</TABLE>
The weighted average interest rate on long-term borrowings, including the
effects of interest rate contracts, was 5.91% at September 30, 1996 and 6.28%
at December 31, 1995.
In April 1996, the Company renewed its senior bank credit facility and
increased its amount to $4.0 billion from $3.25 billion. The facility expires
in April 1997 and includes certain extension provisions. This facility
contains covenants that require the Company to maintain minimum net worth
requirements and specified financial ratios. The Company believes that the
covenant restrictions will not impair its ability to pay its current level of
dividends. As of September 30, 1996, the Company had never borrowed from its
senior bank credit facility.
In August 1996, the Company registered $2.0 billion of debt securities with
the Securities and Exchange Commission ("SEC").
7
<PAGE> 8
DEAN WITTER, DISCOVER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
6. REGULATORY CAPITAL REQUIREMENTS
Under regulatory net capital requirements adopted by the Federal Deposit
Insurance Corporation ("FDIC") and other regulatory capital guidelines, FDIC-
insured financial institutions must maintain (a) 3% to 5% of Tier 1 capital,
as defined, to total assets ("leverage ratio") and (b) 8% combined Tier 1 and
Tier 2 capital, as defined, to risk-weighted assets ("risk-weighted capital
ratio"). At September 30, 1996, the leverage ratio and risk-weighted capital
ratio of each of the Company's FDIC-insured financial institutions exceeded
these and all other regulatory minimums.
DWR, the Company's primary broker-dealer, is subject to the Uniform Net
Capital Rule of the SEC. Under the alternative method permitted by this Rule,
the required net capital, as defined, shall not be less than the greater of
(a) one million dollars, (b) 2% of aggregate debit balances arising from
client transactions pursuant to Securities Exchange Act of 1934 Rule 15c3-3,
or (c) 4% of the funds required to be segregated pursuant to the Commodity
Exchange Act. The New York Stock Exchange, Inc. may also require a member
organization to reduce its business if its net capital is less than the
greater of (a) 4% of aggregate debit balances or (b) 6% of the funds required
to be segregated, and may prohibit a member organization from expanding its
business and declaring cash dividends if its net capital is less than the
greater of (a) 5% of aggregate debit balances or (b) 7% of the funds required
to be segregated. At September 30, 1996, DWR's net capital was $655.4 million
and net capital in excess of the minimum required was $545.1 million. DWR's
net capital was 22.7% of aggregate debit balances and 23.8% of funds required
to be segregated.
7. CONTINGENT LIABILITIES
In the normal course of business, the Company has been named as a defendant
in various lawsuits. Some of these lawsuits involve claims for substantial
amounts. Although the ultimate outcome of these suits cannot be ascertained at
this time, it is the opinion of management, after consultation with outside
counsel, that the resolution of such suits will not have a material adverse
effect on the consolidated financial condition of the Company, but may be
material to the Company's operating results for any particular period,
depending upon the level of the Company's income for such period.
8
<PAGE> 9
INDEPENDENT ACCOUNTANTS' REPORT
To the Directors and Shareholders of
Dean Witter, Discover & Co.:
We have reviewed the accompanying consolidated balance sheet of Dean
Witter, Discover & Co. and subsidiaries as of September 30, 1996, and the
related consolidated statements of income for the three and nine month periods
ended September 30, 1996 and 1995, and cash flows for the nine month periods
ended September 30, 1996 and 1995. These financial statements are the
responsibility of the management of Dean Witter, Discover & Co.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the objective of which
is the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to such consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted
auditing standards, the consolidated balance sheet of Dean Witter, Discover &
Co. and subsidiaries as of December 31, 1995, and the related consolidated
statements of income, cash flows and changes in shareholders' equity for the
year then ended (not presented herein); and in our report dated February 21,
1996, we expressed an unqualified opinion on those consolidated financial
statements.
DELOITTE & TOUCHE LLP
New York, New York
November 13, 1996
<PAGE> 1
EXHIBIT 99.3
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS -
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
The following unaudited pro forma condensed combined statement of financial
condition combines the historical consolidated statement of financial condition
of Morgan Stanley Group Inc. ("Morgan Stanley") and the historical consolidated
balance sheet of Dean Witter, Discover & Co. ("Dean Witter") giving effect to
the Merger as though it had been consummated on the date of such statement after
giving effect to the pro forma adjustments described in the notes to the pro
forma combined financial statements. The following unaudited pro forma condensed
combined statements of income combine the historical consolidated statements of
income of Morgan Stanley and Dean Witter giving effect to the Merger, which is
intended to be accounted for as a pooling of interests after giving effect to
the pro forma adjustments described in the notes to the pro forma condensed
combined financial statements. This information should be read in conjunction
with the audited consolidated financial statements and other financial
information contained in Morgan Stanley's Annual Report on Form 10-K for the
fiscal period ended November 30, 1995 and the unaudited consolidated interim
financial statements contained in Morgan Stanley's Quarterly Report on Form
10-Q for the period ended August 31, 1996, including the notes thereto, and the
audited consolidated financial statements and other financial information
contained in Dean Witter's Annual Report on Form 10-K for the year ended
December 31, 1995 and the unaudited consolidated interim financial statements
contained in Dean Witter's Quarterly Report on Form 10-Q for the period ended
September 30, 1996, including the notes thereto, and in each case incorporated
by reference herein. These unaudited pro forma condensed combined financial
statements are not necessarily indicative of the operating results and
financial position that might have been achieved had the Merger occurred as of
the beginning of the earliest period presented nor are they necessarily
indicative of operating results and financial position which may occur in the
future.
<PAGE> 2
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
Morgan Stanley Dean Witter
Historical Historical Pro Forma Pro Forma
(Dollars in Millions) August 31, 1996 September 30, 1996 Adjustments (a) Combined
--------------- ------------------ --------------- --------
<S> <C> <C> <C> <C>
Assets
Cash and cash equivalents $ 3,460 $ 1,102 -- $ 4,562
Cash and securities deposited with clearing organizations
or segregated under federal and other regulations 2,758 1,802 -- 4,560
Financial instruments owned:
U.S. government and agency securities 10,232 961 -- 11,193
Other sovereign government obligations 13,598 -- -- 13,598
Corporate and other debt 13,347 696 -- 14,043
Corporate equities 9,352 39 -- 9,391
Derivative contracts 8,245 -- -- 8,245
Physical commodities 396 -- -- 396
Securities purchased under agreements to resell 61,673 3,524 -- 65,197
Securities borrowed 35,023 2,947 -- 37,970
Receivables:
Consumer loans (net of allowances of $688) -- 19,595 -- 19,595
Customers, net 5,087 2,739 -- 7,826
Brokers, dealers and clearing organizations 1,943 250 -- 2,193
Fees, interest and other 1,709 733 -- 2,442
Other assets 2,403 2,803 -- 5,206
--------- -------- --------- ---------
Total assets $ 169,226 $ 37,191 -- $ 206,417
========= ======== ========= =========
Liabilities and Stockholders' Equity
Commercial paper and other short-term borrowings $ 11,581 $ 2,397 -- $ 13,978
Deposits -- 6,598 -- 6,598
Financial instruments sold, not yet purchased:
U.S. government and agency securities 10,489 1,213 -- 11,702
Other sovereign government obligations 6,417 -- -- 6,417
Corporate and other debt 933 75 -- 1,008
Corporate equities 7,378 15 -- 7,393
Derivative contracts 6,733 -- -- 6,733
Physical commodities 76 -- -- 76
Securities sold under agreements to repurchase 76,992 3,426 -- 80,418
Securities loaned 7,726 3,124 -- 10,850
Payables:
Customers 15,486 2,822 -- 18,308
Brokers, dealers and clearing organizations 1,429 80 -- 1,509
Interest and dividends 1,142 176 -- 1,318
Other liabilities and accrued expenses 2,584 3,464 -- 6,048
Long-term borrowings 13,864 8,823 -- 22,687
--------- -------- --------- ---------
162,830 32,213 -- 195,043
--------- -------- --------- ---------
Capital Units 865 -- -- 865
--------- -------- --------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred stock 878 -- -- 878
Common Stock(1) 166 3 $ (163)(b) 6
Paid-in capital(1) 690 2,707 163 (b) 3,560
Retained earnings 4,473 2,780 (575)(b) 6,678
Cumulative translation adjustments (14) -- -- (14)
--------- -------- --------- ---------
Subtotal 6,193 5,490 (575) 11,108
--------- -------- --------- ---------
Less:
Stock compensation related deductions 87 5 -- 92
Common stock held in treasury, at cost 575 507 (575)(b) 507
--------- -------- --------- ---------
Total stockholders' equity 5,531 4,978 0 10,509
--------- -------- --------- ---------
--------- -------- --------- ---------
Total liabilities and stockholders' equity $ 169,226 $ 37,191 $ 0 $ 206,417
========= ======== ========= =========
</TABLE>
(1) Dean Witter historical amounts have been restated to reflect a two-for-one
stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE> 3
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley Dean Witter
Historical Historical
Nine Months Nine Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) August 31, 1996 September 30, 1996 Combined
--------------- ------------------ --------
<S> <C> <C> <C>
Revenues:
Investment banking $ 1,372 $ 168 $ 1,540
Principal transactions:
Trading 1,696 340 2,036
Investments 60 -- 60
Commissions 461 869 1,330
Merchant and cardmember fees -- 1,046 1,046
Servicing fees -- 614 614
Interest and dividends 6,023 2,618 8,641
Asset management and administration 402 851 1,253
Other 3 79 82
------------ ------------ ------------
Total revenues 10,017 6,585 16,602
Interest expense 5,753 1,161 6,914
Provision for losses on credit receivables -- 809 809
------------ ------------ ------------
Net revenues 4,264 4,615 8,879
------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 2,100 1,649 3,749
Occupancy and equipment 172 189 361
Brokerage, clearing and exchange fees 199 33 232
Information processing and communications 194 525 719
Business development 116 603 719
Professional services 153 75 228
Other 119 359 478
------------ ------------ ------------
Total expenses excluding interest 3,053 3,433 6,486
------------ ------------ ------------
Income before income taxes 1,211 1,182 2,393
Provision for income taxes 418 458 876
------------ ------------ ------------
Net income $ 793 $ 724 $ 1,517
============ ============ ============
Preferred stock dividend requirements $ 48 -- $ 48
============ ============ ============
Earnings applicable to common shares(1) $ 745 $ 724 $ 1,469
============ ============ ============
Average common and common equivalent
shares outstanding(1) (2) 155,305,534 343,413,644 599,667,775
============ ============ ============
Primary earnings per share(2) $ 4.79 $ 2.11 $ 2.45
============ ============ ============
Fully diluted earnings per share(2) $ 4.59 $ 2.11 $ 2.40
============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE> 4
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley Dean Witter
Historical Historical
Nine Months Nine Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) August 31, 1995 September 30, 1995 Combined
--------------- ------------------ --------
<S> <C> <C> <C>
Revenues:
Investment banking $ 871 $ 133 $ 1,004
Principal transactions:
Trading 989 368 1,357
Investments 82 -- 82
Commissions 372 749 1,121
Merchant and cardmember fees -- 792 792
Servicing fees -- 534 534
Interest and dividends 5,501 2,414 7,915
Asset management and administration 275 748 1,023
Other 4 69 73
------------ ------------ ------------
Total revenues 8,094 5,807 13,901
Interest expense 5,139 1,112 6,251
Provision for losses on credit receivables -- 451 451
------------ ------------ ------------
Net revenues 2,955 4,244 7,199
------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 1,416 1,485 2,901
Occupancy and equipment 164 174 338
Brokerage, clearing and exchange fees 185 32 217
Information processing and communications 182 464 646
Business development 107 511 618
Professional services 121 61 182
Other 100 414 514
Relocation charge 59 -- 59
------------ ------------ ------------
Total expenses excluding interest 2,334 3,141 5,475
------------ ------------ ------------
Income before income taxes 621 1,103 1,724
Provision for income taxes 199 425 624
------------ ------------ ------------
Net income $ 422 $ 678 $ 1,100
============ ============ ============
Preferred stock dividend requirements $ 49 -- $ 49
============ ============ ============
Earnings applicable to common shares(1) $ 373 $ 678 $ 1,051
============ ============ ============
Average common and common equivalent
shares outstanding(1) (2) (3) 155,249,074 350,347,300 606,508,272
============ ============ ============
Primary earnings per share(2) (3) $ 2.41 $ 1.94 $ 1.73
============ ============ ============
Fully diluted earnings per share(2) (3) $ 2.29 $ 1.92 $ 1.69
============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
(3) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE> 5
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley Dean Witter
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) November 30, 1995 December 31, 1995 Combined
----------------- ----------------- --------
<S> <C> <C> <C>
Revenues:
Investment banking $ 1,374 $ 182 $ 1,556
Principal transactions:
Trading 1,206 479 1,685
Investments 121 -- 121
Commissions 510 1,023 1,533
Merchant and cardmember fees -- 1,135 1,135
Servicing fees -- 697 697
Interest and dividends 7,211 3,319 10,530
Asset management and administration 370 1,007 1,377
Other 5 93 98
------------ ------------ ------------
Total revenues 10,797 7,935 18,732
Interest expense 6,675 1,515 8,190
Provision for losses on credit receivables -- 744 744
------------ ------------ ------------
Net revenues 4,122 5,676 9,798
------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 2,023 1,982 4,005
Occupancy and equipment 219 235 454
Brokerage, clearing and exchange fees 247 42 289
Information processing and communications 243 646 889
Business development 139 735 874
Professional services 161 85 246
Other 135 555 690
Relocation charge 59 -- 59
------------ ------------ ------------
Total expenses excluding interest 3,226 4,280 7,506
------------ ------------ ------------
Income before income taxes 896 1,396 2,292
Provision for income taxes 287 540 827
------------ ------------ ------------
Net income $ 609 $ 856 $ 1,465
============ ============ ============
Preferred stock dividend requirements $ 65 -- $ 65
============ ============ ============
Earnings applicable to common shares(1) $ 544 $ 856 $ 1,400
============ ============ ============
Average common and common equivalent
shares outstanding(1) (2) (3) 156,073,008 350,725,970 608,246,433
============ ============ ============
Primary earnings per share(2) (3) $ 3.49 $ 2.44 $ 2.30
============ ============ ============
Fully diluted earnings per share(2) (3) $ 3.33 $ 2.44 $ 2.25
============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
(3) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE> 6
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley Dean Witter
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) November 30, 1994 December 31, 1994 Combined
----------------- ----------------- --------
<S> <C> <C> <C>
Revenues:
Investment banking $ 904 $ 198 $ 1,102
Principal transactions:
Trading 1,192 422 1,614
Investments 154 -- 154
Commissions 449 874 1,323
Merchant and cardmember fees -- 940 940
Servicing fees -- 586 586
Interest and dividends 6,208 2,507 8,715
Asset management and administration 344 973 1,317
Other 4 102 106
------------ ------------ ------------
Total revenues 9,255 6,602 15,857
Interest expense 5,649 1,048 6,697
Provision for losses on credit receivables -- 548 548
------------ ------------ ------------
Net revenues 3,606 5,006 8,612
------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 1,771 1,764 3,535
Occupancy and equipment 193 228 421
Brokerage, clearing and exchange fees 231 45 276
Information processing and communications 215 552 767
Business development 166 607 773
Professional services 159 85 244
Other 124 510 634
------------ ------------ ------------
Total expenses excluding interest 2,859 3,791 6,650
------------ ------------ ------------
Income before income taxes 747 1,215 1,962
Provision for income taxes 231 474 705
------------ ------------ ------------
Net income $ 516 $ 741 $ 1,257
============ ============ ============
Preferred stock dividend requirements $ 65 -- $ 65
============ ============ ============
Earnings applicable to common shares(1) $ 451 $ 741 $ 1,192
============ ============ ============
Average common and common equivalent
shares outstanding(1) (2) (3) 157,578,446 346,717,026 606,721,462
============ ============ ============
Primary earnings per share(2) (3) $ 2.86 $ 2.14 $ 1.96
============ ============ ============
Fully diluted earnings per share(2) (3) $ 2.75 $ 2.14 $ 1.93
============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
(3) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE> 7
MORGAN STANLEY, DEAN WITTER, DISCOVER & CO.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
<TABLE>
<CAPTION>
Morgan Stanley Dean Witter
Historical Historical
Twelve Months Twelve Months
Ended Ended Pro Forma
(Dollars in Millions, Except Share Data) November 30, 1993 December 31, 1993 Combined
----------------- ----------------- --------
<S> <C> <C> <C>
Revenues:
Investment banking $ 1,247 $ 395 $ 1,642
Principal transactions:
Trading 1,373 405 1,778
Investments 157 -- 157
Commissions 380 904 1,284
Merchant and cardmember fees -- 771 771
Servicing fees -- 533 533
Interest and dividends 5,427 1,909 7,336
Asset management and administration 236 838 1,074
Other 10 67 77
------------ ------------ ------------
Total revenues 8,830 5,822 14,652
Interest expense 4,805 815 5,620
Provision for losses on credit receivables -- 458 458
------------ ------------ ------------
Net revenues 4,025 4,549 8,574
------------ ------------ ------------
Expenses excluding interest:
Compensation and benefits 1,983 1,704 3,687
Occupancy and equipment 167 218 385
Brokerage, clearing and exchange fees 186 44 230
Information processing and communications 168 502 670
Business development 122 470 592
Professional services 115 74 189
Other 106 540 646
------------ ------------ ------------
Total expenses excluding interest 2,847 3,552 6,399
------------ ------------ ------------
Income before income taxes 1,178 997 2,175
Provision for income taxes 410 393 803
------------ ------------ ------------
Net income $ 768 $ 604 $ 1,372
============ ============ ============
Preferred stock dividend requirements $ 55 -- $ 55
============ ============ ============
Earnings applicable to common shares(1) $ 713 $ 604 $ 1,317
============ ============ ============
Average common and common equivalent
shares outstanding(1) (2) (3) 153,222,010 333,823,498 586,639,815
============ ============ ============
Primary earnings per share(2) (3) $ 4.65 $ 1.81 $ 2.24
============ ============ ============
Fully diluted earnings per share(2) (3) $ 4.44 $ 1.81 $ 2.20
============ ============ ============
</TABLE>
(1) Amounts shown are used to calculate primary earnings per share.
(2) All Morgan Stanley historical share and per share amounts have been
retroactively adjusted to give effect for a two-for-one stock split,
effected in the form of a 100% stock dividend, which became effective on
January 26, 1996.
(3) Dean Witter historical share and per share amounts have been restated to
reflect a two-for-one stock split which became effective January 14, 1997.
See Notes to Unaudited Pro Forma Condensed Combined Financial Statements.
<PAGE> 8
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
NOTE (a): BASIS OF PRESENTATION
The unaudited pro forma condensed combined statement of financial condition
combines the historical consolidated statement of financial condition of Morgan
Stanley at August 31, 1996 with the historical consolidated balance sheet of
Dean Witter at September 30, 1996. The unaudited pro forma condensed combined
statements of income combine the historical consolidated statements of income
of Morgan Stanley (recast to reflect a twelve month presentation) for the twelve
months ended November 30, 1995, 1994 and 1993 and the nine months ended August
31, 1996 and August 31, 1995 with the historical consolidated statements of
income of Dean Witter for the years ended December 31, 1995, 1994 and 1993 and
the nine months ended September 30, 1996 and September 30, 1995. Certain amounts
reflected in the historical financial statement presentations of both companies
have been reclassified to conform to the unaudited pro forma condensed combined
presentation.
The unaudited pro forma condensed combined financial statements exclude (i) the
positive effects of potential increased revenues or operating synergies which
may be achieved upon combining the resources of the companies (ii) investment
banking, legal and miscellaneous transaction costs of the Merger, which will be
reflected as an expense in the period the Merger is consummated, and (iii)
costs associated with the integration and consolidation of the companies which
are not presently estimable.
Transactions between Morgan Stanley and Dean Witter are not material in relation
to the unaudited pro forma condensed combined financial statements and
therefore, intercompany balances have not been eliminated from the pro forma
combined amounts. Morgan Stanley and Dean Witter are in the process of
reviewing their respective accounting policies and do not expect there to be
any significant adjustments necessary in order to conform such policies.
During 1996, Morgan Stanley acquired Miller Anderson & Sherrerd, LLP and Van
Kampen American Capital, Inc., both accounted for as purchase transactions.
Subsequent to fiscal 1996 year-end, the Company announced that it had reached an
agreement with Barclays PLC to acquire its institutional global custody
business. In January 1997, Dean Witter acquired Lombard Brokerage, Inc. which
was accounted for as a purchase transaction. No pro forma effect has been given
to these transactions as the effect is not material.
<PAGE> 9
NOTE (b): PRO FORMA ADJUSTMENTS
The pro forma adjustments to common stock, paid in capital, and retained
earnings at August 30, 1996 reflect (i) an exchange of 152.4 million shares of
common stock, par value $1.00 per share of Morgan Stanley for 251.5 million
shares (using the exchange ratio of 1.65) of common stock, par value $.01 per
share of Dean Witter and (ii) the cancellation and retirement of all shares of
Morgan Stanley common stock held in treasury. The number of shares of Dean
Witter common stock to be issued at consummation of the Merger will be based
upon the actual number of shares of Morgan Stanley common stock outstanding at
that time.
NOTE (c): PRO FORMA EARNINGS PER SHARE
The pro forma combined primary and fully diluted earnings per common share for
the respective periods presented is based on the combined weighted average
number of common shares and share equivalents of Morgan Stanley and Dean Witter.
The number of common shares and share equivalents of Morgan Stanley is based on
an exchange ratio of 1.65 shares of Dean Witter common shares for each issued
and outstanding share and share equivalent of Morgan Stanley.
