<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-11758
Morgan Stanley Dean Witter & Co.
(Exact Name of Registrant as Specified in its Charter)
----------------
<TABLE>
<C> <S>
Delaware 36-3145972
(I.R.S. Employer
(State of Incorporation) Identification No.)
1585 Broadway 10036
New York, NY (Zip Code)
(Address of Principal
Executive Offices)
</TABLE>
Registrant's telephone number, including area code: (212) 761-4000
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
As of June 30, 1999 there were 565,381,696 shares of Registrant's Common
Stock, par value $.01 per share, outstanding.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended May 31, 1999
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I--Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition--May 31, 1999
(unaudited)
and November 30, 1998................................................ 1
Condensed Consolidated Statements of Income (unaudited)--Three and Six
Months Ended
May 31, 1999 and 1998................................................ 2
Condensed Consolidated Statements of Comprehensive Income
(unaudited)--Three and
Six Months Ended May 31, 1999 and 1998............................... 3
Condensed Consolidated Statements of Cash Flows (unaudited)--Six
Months Ended
May 31, 1999 and 1998................................................ 4
Notes to Condensed Consolidated Financial Statements (unaudited)...... 5
Independent Accountants' Report....................................... 14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 36
Part II--Other Information
Item 1. Legal Proceedings............................................... 37
Item 2. Changes in Securities and Use of Proceeds....................... 37
Item 4. Submission of Matters to a Vote of Security Holders............. 37
Item 6. Exhibits and Reports on Form 8-K................................ 38
</TABLE>
i
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in millions, except share and per share data)
<TABLE>
<CAPTION>
May 31, November 30,
1999 1998
------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 10,611 $ 16,878
Cash and securities deposited with clearing
organizations or segregated under federal and other
regulations (including securities at fair value of
$6,012 at May 31, 1999 and $7,518 at November 30,
1998)............................................... 9,180 10,531
Financial instruments owned:
U.S. government and agency securities............... 15,517 12,350
Other sovereign government obligations.............. 8,463 15,050
Corporate and other debt............................ 17,643 22,388
Corporate equities.................................. 15,887 14,289
Derivative contracts................................ 21,564 21,442
Physical commodities................................ 590 416
Securities purchased under agreements to resell...... 85,138 79,570
Receivable for securities provided as collateral..... 8,354 4,388
Securities borrowed.................................. 88,009 69,338
Receivables:
Consumer loans (net of allowances of $768 at May
31, 1999 and $787 at November 30, 1998)............ 13,820 15,209
Customers, net...................................... 28,091 18,785
Brokers, dealers and clearing organizations......... 5,755 4,432
Fees, interest and other............................ 3,302 3,359
Office facilities, at cost (less accumulated
depreciation and amortization of $1,541 at May 31,
1999 and $1,375 at November 30, 1998)............... 2,121 1,834
Other assets......................................... 8,300 7,331
-------- --------
Total assets......................................... $342,345 $317,590
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Commercial paper and other short-term borrowings..... $ 24,322 $ 28,137
Deposits............................................. 8,809 8,197
Financial instruments sold, not yet purchased:
U.S. government and agency securities............... 10,557 11,305
Other sovereign government obligations.............. 7,894 13,899
Corporate and other debt............................ 3,190 3,093
Corporate equities.................................. 25,978 11,501
Derivative contracts................................ 19,458 21,198
Physical commodities................................ 729 348
Securities sold under agreements to repurchase....... 101,961 92,327
Obligation to return securities received as
collateral.......................................... 11,349 6,636
Securities loaned.................................... 25,382 23,152
Payables:
Customers........................................... 39,111 40,606
Brokers, dealers and clearing organizations......... 2,329 5,244
Interest and dividends.............................. 6,356 371
Other liabilities and accrued expenses............... 9,742 8,623
Long-term borrowings................................. 28,782 27,435
-------- --------
325,949 302,072
-------- --------
Capital Units........................................ 647 999
-------- --------
Preferred Securities Issued by Subsidiaries.......... 400 400
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock..................................... 672 674
Common stock ($0.01 par value, 1,750,000,000 shares
authorized, 605,842,952 and 605,842,952 shares
issued, 566,786,999 and 565,670,808 shares
outstanding at May 31, 1999 and November 30,
1998).............................................. 6 6
Paid-in capital..................................... 3,721 3,746
Retained earnings................................... 13,973 12,080
Employee stock trust................................ 1,862 1,913
Cumulative translation adjustments.................. (36) (12)
-------- --------
Subtotal.......................................... 20,198 18,407
Note receivable related to sale of preferred stock
to ESOP............................................ (60) (60)
Common stock held in treasury, at cost ($0.01 par
value, 39,055,953 and 40,172,144 shares at May 31,
1999 and November 30, 1998......................... (2,927) (2,702)
Common stock issued to employee trust............... (1,862) (1,526)
-------- --------
Total shareholders' equity........................ 15,349 14,119
-------- --------
Total liabilities and shareholders' equity........... $342,345 $317,590
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
1
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(dollars in millions, except share and per share data)
<TABLE>
<CAPTION>
Three Months Six Months
Ended May 31, Ended May 31,
----------------------- -----------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Investment banking........... $ 1,022 $ 988 $ 1,979 $ 1,788
Principal transactions:
Trading..................... 1,926 1,091 3,617 1,994
Investments................. 150 101 415 173
Commissions.................. 789 611 1,454 1,158
Fees:
Asset management,
distribution and
administration............. 765 741 1,479 1,417
Merchant and cardmember..... 357 404 698 832
Servicing................... 310 232 563 403
Interest and dividends....... 3,689 4,213 7,169 8,146
Other........................ 46 47 85 102
----------- ----------- ----------- -----------
Total revenues.............. 9,054 8,428 17,459 16,013
Interest expense............. 3,278 3,554 6,155 6,699
Provision for consumer loan
losses...................... 119 275 296 680
----------- ----------- ----------- -----------
Net revenues................ 5,657 4,599 11,008 8,634
----------- ----------- ----------- -----------
Non-interest expenses:
Compensation and benefits... 2,413 2,017 4,776 3,805
Occupancy and equipment..... 153 143 299 283
Brokerage, clearing and
exchange fees.............. 127 135 241 256
Information processing and
communications............. 315 275 624 542
Marketing and business
development................ 381 286 776 580
Professional services....... 191 156 353 284
Other....................... 219 190 409 355
----------- ----------- ----------- -----------
Total non-interest
expenses................. 3,799 3,202 7,478 6,105
----------- ----------- ----------- -----------
Income before income taxes
and cumulative effect of
accounting change........... 1,858 1,397 3,530 2,529
Provision for income taxes... 707 545 1,342 986
----------- ----------- ----------- -----------
Income before cumulative
effect of accounting
change...................... 1,151 852 2,188 1,543
Cumulative effect of
accounting change........... -- -- -- (117)
----------- ----------- ----------- -----------
Net income................... $ 1,151 $ 852 $ 2,188 $ 1,426
=========== =========== =========== ===========
Preferred stock dividend
requirements................ $ 10 $ 14 $ 21 $ 29
=========== =========== =========== ===========
Earnings applicable to common
shares(1)................... $ 1,141 $ 838 $ 2,167 $ 1,397
=========== =========== =========== ===========
Basic earnings per share:
Income before cumulative
effect of accounting
change..................... $ 2.06 $ 1.44 $ 3.91 $ 2.59
Cumulative effect of
accounting change.......... -- -- -- (0.20)
----------- ----------- ----------- -----------
Net income.................. $ 2.06 $ 1.44 $ 3.91 $ 2.39
=========== =========== =========== ===========
Diluted earnings per share:
Income before cumulative
effect of accounting
change..................... $ 1.95 $ 1.37 $ 3.71 $ 2.47
Cumulative effect of
accounting change.......... -- -- -- (0.19)
----------- ----------- ----------- -----------
Net income.................. $ 1.95 $ 1.37 $ 3.71 $ 2.28
=========== =========== =========== ===========
Average common shares
outstanding
Basic....................... 554,146,582 581,326,618 553,788,197 583,502,306
=========== =========== =========== ===========
Diluted..................... 586,655,685 612,625,354 585,508,185 614,179,415
=========== =========== =========== ===========
</TABLE>
- --------
(1) Amounts shown are used to calculate basic earnings per common share.
See Notes to Condensed Consolidated Financial Statements.
2
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in millions)
<TABLE>
<CAPTION>
Three Months Six Months
Ended May 31, Ended May 31,
-------------- ----------------
1999 1998 1999 1998
------- ----- ------- -------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net income..................................... $ 1,151 $ 852 $ 2,188 $ 1,426
Other comprehensive income, net of tax:
Foreign currency translation adjustment....... (5) (13) (24) (7)
------- ----- ------- -------
Comprehensive income........................... $ 1,146 $ 839 $ 2,164 $ 1,419
======= ===== ======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements
3
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
<TABLE>
<CAPTION>
Six Months
Ended May 31,
----------------
1999 1998
------- -------
(unaudited)
<S> <C> <C>
Cash flows from operating activities
Net income................................................... $ 2,188 $ 1,426
Adjustments to reconcile net income to net cash used for
operating activities:
Cumulative effect of accounting change................... -- 117
Other non-cash charges included in net income............ 616 963
Changes in assets and liabilities:
Cash and securities deposited with clearing organizations
or segregated under federal and other regulations....... 1,372 (917)
Financial instruments owned, net of financial instruments
sold, not yet purchased................................. 13,395 5,943
Securities borrowed, net of securities loaned............ (16,441) (23,257)
Receivables and other assets............................. (11,260) (2,661)
Payables and other liabilities........................... 2,518 15,122
------- -------
Net cash used for operating activities....................... (7,612) (3,264)
------- -------
Cash flows from investing activities
Net (payments for) proceeds from:
Office facilities.......................................... (454) (193)
Purchase of AB Asesores, net of cash acquired............ (223) --
Net principal (disbursed) received on consumer loans..... (1,480) 106
Sales of consumer loans.................................. 2,467 2,203
------- -------
Net cash provided by investing activities.................... 310 2,116
------- -------
Cash flows from financing activities
Net (payments) proceeds related to short-term borrowings... (3,866) 5,489
Securities sold under agreements to repurchase, net of
securities purchased under agreements to resell........... 4,066 (5,967)
Proceeds from:
Deposits................................................. 612 140
Issuance of common stock................................. 188 136
Issuance of long-term borrowings......................... 6,553 7,902
Preferred Securities Issued by Subsidiaries.............. -- 400
Payments for:
Repurchases of common stock.............................. (933) (1,487)
Repayments of long-term borrowings....................... (4,943) (4,184)
Redemption of Capital Units.............................. (352) --
Cash dividends........................................... (290) (265)
------- -------
Net cash provided by financing activities.................... 1,035 2,164
------- -------
Net (decrease) increase in cash and cash equivalents......... (6,267) 1,016
Cash and cash equivalents, at beginning of period............ 16,878 8,255
------- -------
Cash and cash equivalents, at end of period.................. $10,611 $ 9,271
======= =======
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Introduction and Basis of Presentation
The Company
The condensed consolidated financial statements include the accounts of
Morgan Stanley Dean Witter & Co. and its U.S. and international subsidiaries
(the "Company"), including Morgan Stanley & Co. Incorporated ("MS&Co."),
Morgan Stanley & Co. International Limited ("MSIL"), Morgan Stanley Japan
Limited ("MSJL"), Dean Witter Reynolds Inc. ("DWR"), Morgan Stanley Dean
Witter Advisors Inc. and NOVUS Credit Services Inc.
The Company, through its subsidiaries, provides a wide range of financial
and securities services on a global basis and provides credit services
nationally. Its Securities and Asset Management businesses include securities
underwriting, distribution and trading; merger, acquisition, restructuring,
real estate, project finance and other corporate finance advisory activities;
asset management; private equity and other principal investment activities;
brokerage and research services; the trading of foreign exchange and
commodities as well as derivatives on a broad range of asset categories, rates
and indices; securities lending and on-line securities services offered by
Discover Brokerage Direct, Inc. The Company's Credit Services businesses
include the issuance of the Discover Card(R) and other proprietary general
purpose credit cards, and the operation of the Discover/Novus(R) Network, a
proprietary network of merchant and cash access locations. The Company's
services are provided to a large and diversified group of clients and
customers, including corporations, governments, financial institutions and
individuals.
Basis of Financial Information
The condensed consolidated financial statements are prepared in accordance
with generally accepted accounting principles, which require management to
make estimates and assumptions regarding certain trading inventory valuations,
consumer loan loss levels, the potential outcome of litigation and other
matters that affect the financial statements and related disclosures.
Management believes that the estimates utilized in the preparation of the
condensed consolidated financial statements are prudent and reasonable. Actual
results could differ materially from these estimates.
Certain reclassifications have been made to prior year amounts to conform to
the current presentation. All material intercompany balances and transactions
have been eliminated.
The condensed consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K (the "Form 10-K")
for the fiscal year ended November 30, 1998. The condensed consolidated
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) which are, in the opinion of management, necessary for
the fair statement of the results for the interim period. The results of
operations for interim periods are not necessarily indicative of results for
the entire year.
Financial instruments, including derivatives, used in the Company's trading
activities are recorded at fair value, and unrealized gains and losses are
reflected in trading revenues. Interest and dividend revenue and interest
expense arising from financial instruments used in trading activities are
reflected in the condensed consolidated statements of income as interest and
dividend revenue or interest expense. The fair values of trading positions
generally are based on listed market prices. If listed market prices are not
available or if liquidating the Company's positions would reasonably be
expected to impact market prices, fair value is determined based on other
relevant factors, including dealer price quotations and price quotations for
similar instruments traded in different markets, including markets located in
different geographic areas. Fair values for certain derivative
5
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
contracts are derived from pricing models which consider current market and
contractual prices for the underlying financial instruments or commodities, as
well as time value and yield curve or volatility factors underlying the
positions. Purchases and sales of financial instruments are recorded in the
accounts on trade date. Unrealized gains and losses arising from the Company's
dealings in over-the-counter ("OTC") financial instruments, including
derivative contracts related to financial instruments and commodities, are
presented in the accompanying condensed consolidated statements of financial
condition on a net-by-counterparty basis, when appropriate.
Equity securities purchased in connection with private equity and other
principal investment activities are initially carried in the condensed
consolidated financial statements at their original costs. The carrying value
of such equity securities is adjusted when changes in the underlying fair
values are readily ascertainable, generally as evidenced by listed market
prices or transactions which directly affect the value of such equity
securities. Downward adjustments relating to such equity securities are made
in the event that the Company determines that the eventual realizable value is
less than the carrying value. The carrying value of investments made in
connection with principal real estate activities which do not involve equity
securities are adjusted periodically based on independent appraisals,
estimates prepared by the Company of discounted future cash flows of the
underlying real estate assets or other indicators of fair value.
Loans made in connection with private equity and investment banking
activities are carried at cost plus accrued interest less reserves, if deemed
necessary, for estimated losses.
The Company has entered into various contracts as hedges against specific
assets, liabilities or anticipated transactions. These contracts include
interest rate swaps, foreign exchange forwards and foreign currency swaps. The
Company uses interest rate and currency swaps to manage the interest rate and
currency exposure arising from certain borrowings and to match the refinancing
characteristics of consumer loans with the borrowings that fund these loans.
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 revenue 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. Gains and losses
resulting from the termination of hedge contracts prior to their stated
maturity are recognized ratably over the remaining life of the instrument
being hedged. The Company also uses foreign exchange forward contracts to
manage the currency exposure relating to its net monetary investment in non-
U.S. dollar functional currency operations. The gain or loss from revaluing
these contracts is deferred and reported within cumulative translation
adjustments in shareholders' equity, net of tax effects, with the related
unrealized amounts due from or to counterparties included in receivables from
or payables to brokers, dealers and clearing organizations.
Accounting Change
In the fourth quarter of fiscal 1998, the Company adopted American Institute
of Certified Public Accountants ("AICPA") Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), with respect to
the accounting for offering costs paid by investment advisors of closed-end
funds where such costs are not specifically reimbursed through separate
advisory contracts. In accordance with SOP 98-5 and per an announcement by the
Financial Accounting Standards Board ("FASB") staff in September 1998, such
costs are to be considered start-up costs and expensed as incurred. Prior to
the adoption of SOP 98-5, the Company deferred such costs and amortized them
over the life of the fund. The Company recorded a charge to earnings for the
cumulative effect of the accounting change as of December 1, 1997, of $117
million, net of taxes of $79 million. The second quarter of fiscal 1998 was
also retroactively restated to reflect this change, decreasing net income by
$2 million.
6
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accounting Pronouncements
As of December 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." This
statement establishes standards for the reporting and presentation of
comprehensive income.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. As
issued, SFAS No. 133 was effective for fiscal years beginning after June 15,
1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133". SFAS No. 137 defers the effective date of SFAS No. 133 for
one year to fiscal years beginning after June 15, 2000. The Company is in the
process of evaluating the impact of adopting SFAS No. 133.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which revises and
standardizes pension and other postretirement benefit plan disclosures that
are to be included in the employers' financial statements. SFAS No. 132 does
not change the measurement or recognition rules for pensions and other
postretirement benefit plans.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement establishes the
standards for determining an operating segment and the required financial
information to be disclosed.
2. Consumer Loans
Activity in the allowance for consumer loan losses was as follows (dollars
in millions):
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
May 31, May 31,
-------------- ------------
1999 1998 1999 1998
------ ------ ----- -----
<S> <C> <C> <C> <C>
Balance, beginning of period...................... $ 777 $ 905 $ 787 $ 884
Provision for loan losses......................... 119 275 296 680
Less deductions:
Charge-offs..................................... 211 348 482 794
Recoveries...................................... (30) (56) (62) (99)
------ ------ ----- -----
Net charge-offs................................. 181 292 420 695
------ ------ ----- -----
Other(1).......................................... 53 (64) 105 (45)
------ ------ ----- -----
Balance, end of period............................ $ 768 $ 824 $ 768 $ 824
====== ====== ===== =====
</TABLE>
- --------
(1) Primarily reflects transfers related to asset securitizations and the
fiscal 1998 sale of the Company's Prime Option MasterCard portfolio.
Interest accrued on loans subsequently charged off, recorded as a reduction
of interest revenue, was $63 million in the quarter ended May 31, 1999 and $47
million in the quarter ended May 31, 1998.
The Company received net proceeds from asset securitizations of $1,942
million in the quarter ended May 31, 1999 and $1,835 million in the quarter
ended May 31, 1998. The uncollected balances of consumer loans sold through
asset securitizations were $18,217 million at May 31, 1999 and $16,506 million
at November 30, 1998.
3. Long-Term Borrowings
Long-term borrowings at May 31, 1999 scheduled to mature within one year
aggregated $5,171 million.
7
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During the six month period ended May 31, 1999 the Company issued senior
notes aggregating $6,540 million, including non-U.S. dollar currency notes
aggregating $2,009 million, primarily pursuant to its public debt shelf
registration statements. The weighted average coupon interest rate of these
notes was 4.2% at May 31, 1999; the Company has entered into certain
transactions to obtain floating interest rates based primarily on short-term
LIBOR trading levels. Maturities in the aggregate of these notes by fiscal
year are as follows: 2000, $938 million; 2001, $1,061 million; 2002, $1,469
million; 2004, $2,406 million; and thereafter, $666 million. In the six month
period ended May 31, 1999, $4,943 million of senior notes were repaid.
4. Preferred Stock, Capital Units and Preferred Securities Issued by
Subsidiaries
Preferred stock is composed of the following issues:
<TABLE>
<CAPTION>
Shares Outstanding at Balance at
---------------------- --------------------
May 31, November 30, May 31, November 30,
1999 1998 1999 1998
--------- ------------ ------- ------------
(dollars in
millions)
<S> <C> <C> <C> <C> <C>
ESOP Convertible Preferred
Stock, liquidation
preference $35.88............ 3,536,398 3,581,964 $127 $129
Series A Fixed/Adjustable Rate
Cumulative Preferred
Stock, stated value $200..... 1,725,000 1,725,000 345 345
7- 3/4% Cumulative Preferred
Stock, stated value $200..... 1,000,000 1,000,000 200 200
---- ----
Total....................... $672 $674
==== ====
</TABLE>
Each issue of outstanding preferred stock ranks in parity with all other
outstanding preferred stock of the Company.
The Company has Capital Units outstanding which were issued by the Company
and Morgan Stanley Finance plc ("MS plc"), a U.K. subsidiary. A Capital Unit
consists of (a) a Subordinated Debenture of MS plc guaranteed by the Company
and having maturities from 2013 to 2017 and (b) a related Purchase Contract
issued by the Company, which may be accelerated by the Company beginning
approximately one year after the issuance of each Capital Unit, requiring the
holder to purchase one Depositary Share representing shares (or fractional
shares) of the Company's Cumulative Preferred Stock.
Effective March 1, 1999, the Company and MS plc redeemed all of the
outstanding 7.82% Capital Units and 7.80% Capital Units. The aggregate
principal amount of the Capital Units redeemed was $352 million. During the
quarter ended May 31, 1999, the Company and MS plc repurchased in a series of
transactions in the open market approximately $69 million of the $134 million
outstanding 8.03% Capital Units. The Company and MS plc intend to retire these
repurchased Capital Units in the Company's third fiscal quarter.
In fiscal 1998, MSDW Capital Trust I, a Delaware statutory business trust
(the "Capital Trust"), all of the common securities of which are owned by the
Company, issued $400 million of 7.10% Capital Securities (the "Capital
Securities") that are guaranteed by the Company. The Capital Trust issued the
Capital Securities and invested the proceeds in 7.10% Junior Subordinated
Deferrable Interest Debentures issued by the Company, which are due February
28, 2038.
5. Common Stock and Shareholders' Equity
MS&Co. and DWR are registered broker-dealers and registered futures
commission merchants and, accordingly, are subject to the minimum net capital
requirements of the Securities and Exchange Commission, the New York Stock
Exchange and the Commodity Futures Trading Commission. MS&Co. and DWR have
consistently operated in excess of these net capital requirements. MS&Co.'s
net capital totaled $3,250 million at May 31, 1999, which exceeded the amount
required by $2,811 million. DWR's net capital totaled $832 million
8
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
at May 31, 1999 which exceeded the amount required by $713 million. MSIL, a
London-based broker-dealer subsidiary, is subject to the capital requirements
of the Securities and Futures Authority, and MSJL, a Tokyo-based broker-
dealer, is subject to the capital requirements of the Japanese Ministry of
Finance. MSIL and MSJL have consistently operated in excess of their
respective 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 May 31, 1999, 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.
Certain other U.S. and non-U.S. subsidiaries are subject to various
securities, commodities and banking regulations, and capital adequacy
requirements promulgated by the regulatory and exchange authorities of the
countries in which they operate. These subsidiaries have consistently operated
in excess of their local capital adequacy requirements.
In June 1999, in an effort to enhance the Company's ongoing stock repurchase
program, the Company sold put options on an aggregate of 768,500 shares of its
common stock to a third party. These put options entitle the holder to sell
shares of the Company's common stock to the Company on certain dates at
specified prices. The maturity dates of the put options range from July 1999
through November 1999. The Company may elect cash settlement of the put
options instead of taking delivery of the stock.
9
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Earnings per Share
Basic EPS reflects no dilution from common stock equivalents. Diluted EPS
reflects dilution from common stock equivalents and other dilutive securities
based on the average price per share of the Company's common stock during the
period. The following table presents the calculation of basic and diluted EPS
(in millions, except for per share data):
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
May 31, May 31,
------------- --------------
1999 1998 1999 1998
------ ----- ------ ------
<S> <C> <C> <C> <C>
Basic EPS:
Income before cumulative effect of accounting
change....................................... $1,151 $ 852 $2,188 $1,543
Cumulative effect of accounting change........ -- -- -- (117)
Preferred stock dividend requirements......... (10) (14) (21) (29)
------ ----- ------ ------
Net income available to common shareholders... $1,141 $ 838 $2,167 $1,397
====== ===== ====== ======
Weighted-average common shares outstanding.... 554 581 554 584
====== ===== ====== ======
Basic EPS before cumulative effect of
accounting change............................ $ 2.06 $1.44 $ 3.91 $ 2.59
Cumulative effect of accounting change........ -- -- -- (0.20)
------ ----- ------ ------
Basic EPS..................................... $ 2.06 $1.44 $ 3.91 $ 2.39
====== ===== ====== ======
Diluted EPS:
Income before cumulative effect of accounting
change....................................... $1,151 $ 852 $2,188 $1,543
Cumulative effect of accounting change........ -- -- -- (117)
Preferred stock dividend requirements......... (9) (13) (18) (26)
------ ----- ------ ------
Net income available to common shareholders... $1,142 $ 839 $2,170 $1,400
====== ===== ====== ======
Weighted-average common shares outstanding.... 554 581 554 584
Effect of dilutive securities:
Stock options................................ 21 20 20 18
ESOP convertible preferred stock............. 12 12 12 12
------ ----- ------ ------
Weighted-average common shares outstanding and
common stock equivalents..................... 587 613 586 614
====== ===== ====== ======
Diluted EPS before cumulative effect of
accounting change............................ $ 1.95 $1.37 $ 3.71 $ 2.47
Cumulative effect of accounting change........ -- -- -- (0.19)
------ ----- ------ ------
Diluted EPS................................... $ 1.95 $1.37 $ 3.71 $ 2.28
====== ===== ====== ======
</TABLE>
7. Commitments and Contingencies
In the normal course of business, the Company has been named as a defendant
in various lawsuits and has been involved in certain investigations and
proceedings. Some of these matters involve claims for substantial amounts.
Although the ultimate outcome of these matters cannot be ascertained at this
time, it is the opinion of management, after consultation with outside
counsel, that the resolution of such matters 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 net income for such period.
The Company had approximately $7.2 billion and $5.7 billion of letters of
credit outstanding at May 31, 1999 and at November 30, 1998, respectively, to
satisfy various collateral requirements.
10
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Derivative Contracts
In the normal course of business, the Company enters into a variety of
derivative contracts related to financial instruments and commodities. The
Company uses swap agreements in managing its interest rate exposure. The
Company also uses forward and option contracts, futures and swaps in its
trading activities; these derivative instruments also are used to hedge the
U.S. dollar cost of certain foreign currency exposures. In addition, financial
futures and forward contracts are actively traded by the Company and are used
to hedge proprietary inventory. The Company also enters into delayed delivery,
when-issued, and warrant and option contracts involving securities. These
instruments generally represent future commitments to swap interest payment
streams, exchange currencies or purchase or sell other financial instruments
on specific terms at specified future dates. Many of these products have
maturities that do not extend beyond one year; swaps and options and warrants
on equities typically have longer maturities. For further discussion of these
matters, refer to "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Derivative Financial Instruments" and Note 9 to the
consolidated financial statements for the fiscal year ended November 30, 1998,
included in the Form 10-K.
These derivative instruments involve varying degrees of off-balance sheet
market risk. Future changes in interest rates, foreign currency exchange rates
or the fair values of the financial instruments, commodities or indices
underlying these contracts ultimately may result in cash settlements exceeding
fair value amounts recognized in the condensed consolidated statements of
financial condition, which, as described in Note 1, are recorded at fair
value, representing the cost of replacing those instruments.
The Company's exposure to credit risk with respect to these derivative
instruments at any point in time is represented by the fair value of the
contracts reported as assets. These amounts are presented on a net-by-
counterparty basis (when appropriate), but are not reported net of collateral,
which the Company obtains with respect to certain of these transactions to
reduce its exposure to credit losses.
11
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The credit quality of the Company's trading-related derivatives at May 31,
1999 and November 30, 1998 is summarized in the tables below, showing the fair
value of the related assets by counterparty credit rating. The credit ratings
are determined by external rating agencies or by equivalent ratings used by
the Company's Credit Department:
<TABLE>
<CAPTION>
Collateralized Other
Non-Investment Non-Investment
AAA AA A BBB Grade Grade Total
------ ------ ------ ------ -------------- -------------- -------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C> <C>
At May 31, 1999
Interest rate and
currency swaps and
options (including
caps, floors and swap
options) and other
fixed income securities
contracts.............. $1,014 $4,015 $2,345 $1,101 $ 209 $ 124 $ 8,808
Foreign exchange forward
contracts and options.. 120 1,601 1,331 238 -- 174 3,464
Equity securities
contracts (including
equity swaps, warrants
and options)........... 1,588 1,368 517 132 3,092 164 6,861
Commodity forwards,
options and swaps...... 221 757 355 489 6 365 2,193
Mortgage-backed
securities forward
contracts, swaps and
options................ 73 66 88 5 1 5 238
------ ------ ------ ------ ------ ------ -------
Total.................. $3,016 $7,807 $4,636 $1,965 $3,308 $ 832 $21,564
====== ====== ====== ====== ====== ====== =======
Percent of total........ 14% 36% 22% 9% 15% 4% 100%
====== ====== ====== ====== ====== ====== =======
At November 30, 1998
Interest rate and
currency swaps and
options (including
caps, floors and swap
options) and other
fixed income securities
contracts.............. $ 894 $3,727 $3,694 $1,181 $ 98 $ 510 $10,104
Foreign exchange forward
contracts and options.. 306 1,413 1,435 337 -- 263 3,754
Equity securities
contracts (including
equity swaps, warrants
and options)........... 1,995 1,105 478 61 1,364 165 5,168
Commodity forwards,
options and swaps...... 71 448 401 708 46 534 2,208
Mortgage-backed
securities forward
contracts, swaps and
options................ 130 51 21 3 -- 3 208
------ ------ ------ ------ ------ ------ -------
Total.................. $3,396 $6,744 $6,029 $2,290 $1,508 $1,475 $21,442
====== ====== ====== ====== ====== ====== =======
Percent of total........ 16% 31% 28% 11% 7% 7% 100%
====== ====== ====== ====== ====== ====== =======
</TABLE>
A substantial portion of the Company's securities and commodities
transactions are collateralized and are executed with and on behalf of
commercial banks and other institutional investors, including other brokers
and dealers. Positions taken and commitments made by the Company, including
positions taken and underwriting and financing commitments made in connection
with its private equity and other principal investment activities, often
involve substantial amounts and significant exposure to individual issuers and
businesses, including non-investment grade issuers. The Company seeks to limit
concentration risk created in its businesses through a variety of separate but
complementary financial, position and credit exposure reporting systems,
including the use of trading limits based in part upon the Company's review of
the financial condition and credit ratings of its counterparties.
See also "Risk Management" in the Form 10-K for discussions of the Company's
risk management policies and procedures for its securities businesses.
12
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Business Acquisition
On March 25, 1999, the Company completed its acquisition of AB Asesores, the
largest independent financial services firm in Spain. AB Asesores has
strategic positions in personal investment, asset management, institutional
research and brokerage, and investment banking. The Company's fiscal 1999
results include the operations of AB Asesores since March 25, 1999, the date
of acquisition. In connection with this acquisition, the Company issued
688,943 shares of common stock having a fair value of $64 million on the date
of acquisition.
13
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Directors and Shareholders of
Morgan Stanley Dean Witter & Co.
We have reviewed the accompanying condensed consolidated statement of
financial condition of Morgan Stanley Dean Witter & Co. and subsidiaries as of
May 31, 1999, and the related condensed consolidated statements of income and
comprehensive income for the three and six month periods ended May 31, 1999
and 1998, and cash flows for the six month periods ended May 31, 1999 and
1998. These condensed consolidated financial statements are the responsibility
of the management of Morgan Stanley Dean Witter & 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 condensed 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 statement of financial condition of Morgan Stanley
Dean Witter & Co. and subsidiaries as of November 30, 1998, and the related
consolidated statements of income, cash flows and changes in shareholders'
equity for the fiscal year then ended (not presented herein) included in
Morgan Stanley Dean Witter & Co.'s Annual Report on Form 10-K for the fiscal
year ended November 30, 1998; and, in our report dated January 22, 1999, we
expressed an unqualified opinion on those consolidated financial statements
based on our audit (which report includes an explanatory paragraph for a
change in the method of accounting for certain offering costs of closed-end
funds).
/s/ Deloitte & Touche LLP
New York, New York
July 14, 1999
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
Morgan Stanley Dean Witter & Co. (the "Company") is a pre-eminent global
financial services firm that maintains leading market positions in each of its
businesses--Securities and Asset Management and Credit Services. The Company
combines global strength in investment banking (including underwriting public
offerings of securities and mergers and acquisitions advice) and institutional
sales and trading with strength in providing investment and global asset
management products and services and, primarily through its Discover Card(R)
brand, quality consumer credit products. The Company's business also includes
direct-marketed activities such as the on-line securities services offered by
Discover Brokerage Direct, Inc.
Results of Operations*
Certain Factors Affecting Results of Operations
The Company's results of operations may be materially affected by market
fluctuations and economic factors. In addition, results of operations in the
past have been and in the future may continue to be materially affected by
many factors of a global nature, including economic and market conditions; the
availability of capital; the level and volatility of equity prices and
interest rates; currency values and other market indices; technological
changes and events (such as the increased use of the Internet and the Year
2000 issue); the availability of credit; inflation; investor sentiment; and
legislative and regulatory developments. Such factors may also have an impact
on the Company's ability to achieve its strategic objectives on a global
basis, including (without limitation) continued increased market share in its
securities activities, growth in assets under management and the expansion of
its Discover Card brand.
The Company's Securities and Asset Management business, particularly its
involvement in primary and secondary markets for all types of financial
products, including derivatives, is subject to substantial positive and
negative fluctuations due to a variety of factors that cannot be predicted
with great certainty, including variations in the fair value of securities and
other financial products and the volatility and liquidity of global trading
markets. Fluctuations also occur due to the level of market activity, which,
among other things, affects the flow of investment dollars into mutual funds,
and the size, number and timing of transactions or client assignments
(including realization of returns from the Company's private equity
investments).
In the Company's Credit Services business, changes in economic variables may
substantially affect consumer loan levels and credit quality. Such variables
include the number and size of personal bankruptcy filings, the rate of
unemployment and the level of consumer debt as a percentage of income.
The Company's results of operations also may be materially affected by
competitive factors. In addition to competition from firms traditionally
engaged in the securities and asset management businesses, there has been
increased competition from other sources, such as commercial banks, insurance
companies, mutual fund groups, online service providers and other companies
offering financial services both in the U.S. and globally. As a result of
recent and pending legislative and regulatory initiatives in the U.S. to
remove or relieve certain restrictions on commercial banks, competition in
some markets that have traditionally been dominated by investment banks and
retail securities firms has increased and may continue to increase in the near
future. In addition, recent and continuing global convergence and
consolidation in the financial services industry will lead to increased
competition from larger diversified financial services organizations.
- --------
* This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements as well as a
discussion of some of the risks and uncertainties involved in the Company's
business that could affect the matters referred to in such statements.
15
<PAGE>
Such competition, among other things, affects the Company's ability to
attract and retain highly skilled individuals. Competitive factors also affect
the Company's success in attracting and retaining clients and assets through
its ability to meet investors' saving and investment needs by consistency of
investment performance and accessibility to a broad array of financial
products and advice. In the credit services industry, competition centers on
merchant acceptance of credit cards, credit card account acquisition and
customer utilization of credit cards. Merchant acceptance is based on both
competitive transaction pricing and the volume of credit cards in circulation.
Credit card account acquisition and customer utilization are driven by the
offering of credit cards with competitive and appealing features such as no
annual fees, low introductory interest rates and other customized features
targeting specific consumer groups and by having broad merchant acceptance.
As a result of the above economic and competitive factors, net income and
revenues in any particular period may not be representative of full-year
results and may vary significantly from year to year and from quarter to
quarter. The Company intends to manage its businesses for the long term and
help mitigate the potential effects of market downturns by strengthening its
competitive position in the global financial services industry through
diversification of its revenue sources and enhancement of its global
franchise. The Company's overall financial results will continue to be
affected by its ability and success in maintaining high levels of profitable
business activities, emphasizing fee-based assets that are designed to
generate a continuing stream of revenues, managing risks in both the
Securities and Asset Management and Credit Services businesses, evaluating
credit product pricing and monitoring costs. In addition, the complementary
trends in the financial services industry of consolidation and globalization
present, among other things, technological, risk management and other
infrastructure challenges that will require effective resource allocation in
order for the Company to remain competitive.
Global Market and Economic Conditions in the Quarter Ended May 31, 1999
Global market and economic conditions in the quarter ended May 31, 1999 were
generally favorable. Financial markets in many regions continued to exhibit
signs of recovery from the financial and economic problems that existed in the
third and fourth quarters of fiscal 1998, during which periods of extreme
volatility, low levels of liquidity and increased credit spreads created
difficult market conditions.
In the U.S., financial markets benefited from the overall strength of the
domestic economy, which continued to exhibit positive fundamentals and a
steady rate of growth. The strength of the U.S. economy reflected several
favorable domestic trends, including low unemployment and high levels of
consumer confidence and spending. In addition, the U.S. economy benefited from
the ongoing economic and financial recovery in certain foreign markets,
including those in the Far East and in certain emerging markets. During the
quarter, the Federal Reserve Board (the "Fed") left the overnight lending rate
unchanged after lowering interest rates by 0.25% on three separate occasions
during the fourth quarter of fiscal 1998. However, in response to concerns
regarding the potential for accelerating inflation and in light of the
improved conditions in non-U.S. markets, the Fed announced that it was
shifting its bias toward the tightening of interest rates. As a result, bond
yields increased and equity prices declined toward the end of the quarter as
investors became concerned that the Fed would raise the overnight lending rate
in the near future.
Conditions in European markets were stable during the quarter. European
financial markets have benefited from positive investor sentiment relating to
the European Economic and Monetary Union ("EMU"). EMU commenced on January 1,
1999 when the European Central Bank (the "ECB") assumed control of monetary
policy for the 11 European Union ("EU") countries participating in EMU. Since
its inception, the euro has emerged as a new funding alternative for many
issuers. However, during the quarter the ECB's decision to allow Italy to
exceed its budget deficit targets illustrated the difficulties associated with
maintaining a common currency. This development, along with slowing economic
growth within the EU, contributed to the euro's depreciation relative to the
U.S. dollar during much of the quarter. In response to the sluggish economic
growth rates within Europe, during the quarter the ECB cut interest rates by
0.50%, and the Bank of England reduced interest rates by 0.25%. European
economic growth has been affected by a decline in exports, which have been
negatively impacted by the economic difficulties that have existed in Asia,
Russia and Latin America.
16
<PAGE>
Economic and financial difficulties have existed in the Far East region
since the latter half of fiscal 1997. The Japanese economy has suffered from
its worst recession since the end of World War II, and has been adversely
affected by shrinking consumer demand, declining corporate profits, rising
unemployment and deflation. However, during the quarter there were preliminary
indications that the steps taken by Japan's government to mitigate these
conditions, including bank bailouts, emergency loans and stimulus packages,
were beginning to have a favorable impact on the nation's economic
performance. As a result, market conditions in the Far East began to exhibit
limited signs of improvement during the quarter. Market conditions elsewhere
in the Far East, including Hong Kong, Singapore and Korea, also exhibited
signs of recovery during the quarter. Although much uncertainty still remains,
investor interest in the Far East region has generally increased as a result
of these developments.
Results of the Company for the Quarter and Six Month Period ended May 31,
1999 and 1998
The Company's net income of $1,151 million and $2,188 million in the quarter
and six month period ended May 31, 1999 represented increases of 35% and 53%
from the comparable periods of fiscal 1998. Net income for the six month
period ended May 31, 1998 included a charge of $117 million resulting from the
cumulative effect of an accounting change. Excluding the impact of the
cumulative effect of an accounting change, net income for the six month period
ended May 31, 1999 increased 42% from the comparable prior year period.
Diluted earnings per common share were $1.95 and $3.71 in the quarter and six
month period ended May 31, 1999 as compared to $1.37 and $2.28 in the quarter
and six month period ended May 31, 1998. Excluding the cumulative effect of an
accounting change, diluted earnings per share for the six month period ended
May 31, 1998 was $2.47. The Company's annualized return on common equity was
31.4% and 30.5% for the quarter and six month period ended May 31, 1999, as
compared to 25.2% and 21.0% for the comparable periods of fiscal 1998.
Excluding the cumulative effect of an accounting change, the annualized return
on common equity for the six month period ended May 31, 1998 was 22.6%.
The increase in net income in the quarter and six month periods ended May
31, 1999 from the comparable prior year periods was primarily due to higher
principal trading, principal investment, commission and investment banking
revenues coupled with improved operating results from the Company's Credit
Services business. These increases were partially offset by higher incentive-
based compensation and other non-interest expenses. The Company's income tax
rate for the quarter and six month period ended May 31, 1999 was 38.0%, as
compared to 39.0% for both periods in fiscal 1998. The decrease reflects,
among other things, lower taxes applicable to non-U.S. earnings.
Business Acquisition
During the second quarter of fiscal 1999, the Company completed its
acquisition of AB Asesores, the largest independent financial services firm in
Spain. AB Asesores has strategic positions in personal investment, asset
management, institutional research and brokerage, and investment banking.
Through its approximately 250 financial advisors, it offers its individual
investors proprietary mutual funds and other financial products. At the end of
1998, it had approximately $4.4 billion of mutual fund assets under
management. This acquisition reflects the Company's strategic initiative to
build an international Securities and Asset Management business to serve the
needs of individual investors. The Company's fiscal 1999 results include the
operations of AB Asesores since March 25, 1999, the date of acquisition.
The remainder of Results of Operations is presented on a business segment
basis. Substantially all of the operating revenues and operating expenses of
the Company can be directly attributable to its two business segments:
Securities and Asset Management and Credit Services. Certain reclassifications
have been made to prior period amounts to conform to the current year's
presentation.
The accompanying business segment information includes the operating results
of Discover Brokerage Direct, Inc. ("DBD"), the Company's provider of
electronic brokerage services, within the Securities and Asset Management
segment. Previously, the Company had included DBD's results within its Credit
Services segment. The segment data of prior periods have been restated in
order to reflect this change.
17
<PAGE>
Securities and Asset Management
Statements of Income (dollars in millions)
<TABLE>
<CAPTION>
Three Months
Ended May Six Months
31, Ended May 31,
------------ -------------
1999 1998 1999 1998
------ ----- ------ ------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Investment banking.............................. $1,022 $ 988 $1,979 $1,788
Principal transactions:
Trading....................................... 1,926 1,091 3,617 1,994
Investments................................... 150 101 415 173
Commissions..................................... 789 611 1,454 1,158
Asset management, distribution and
administration fees............................ 765 741 1,479 1,417
Interest and dividends.......................... 3,167 3,542 6,091 6,694
Other........................................... 46 45 85 99
------ ----- ------ ------
Total revenues................................ 7,865 7,119 15,120 13,323
Interest expense................................ 3,080 3,303 5,736 6,155
------ ----- ------ ------
Net revenues.................................. 4,785 3,816 9,384 7,168
------ ----- ------ ------
Non-interest expenses:
Compensation and benefits....................... 2,290 1,873 4,534 3,523
Occupancy and equipment......................... 141 127 275 250
Brokerage, clearing and exchange fees........... 127 135 241 256
Information processing and communications....... 206 164 398 314
Marketing and business development.............. 167 126 316 242
Professional services........................... 160 132 301 237
Other........................................... 167 132 315 255
------ ----- ------ ------
Total non-interest expenses................... 3,258 2,689 6,380 5,077
------ ----- ------ ------
Income before income taxes and cumulative effect
of accounting change............................. 1,527 1,127 3,004 2,091
Income tax expense................................ 587 446 1,151 823
------ ----- ------ ------
Income before cumulative effect of accounting
change........................................... 940 681 1,853 1,268
Cumulative effect of accounting change ........... -- -- -- (117)
------ ----- ------ ------
Net income.................................... $ 940 $ 681 $1,853 $1,151
====== ===== ====== ======
</TABLE>
Securities and Asset Management net revenues of $4,785 million and $9,384
million in the quarter and six month period ended May 31, 1999 represented an
increase of 25% and 31% from the comparable periods of fiscal 1998. Securities
and Asset Management net income of $940 million and $1,853 million in the
quarter and six month period ended May 31, 1999 represented an increase of 38%
and 61% from the comparable periods of fiscal 1998. Net income for the six
month period ended May 31, 1998 included a charge of $117 million representing
a cumulative effect of an accounting change. Excluding the cumulative effect
of an accounting change, net income for the six month period ended May 31,
1999 increased 46% from the comparable prior year period. In both periods, the
increases were primarily attributable to higher principal trading, principal
investment, investment banking and commission revenues, partially offset by
higher incentive-based compensation and other non-interest expenses.
18
<PAGE>
Investment Banking
Investment banking revenues are derived from the underwriting of securities
offerings and fees from advisory services. Investment banking revenues in the
quarter ended May 31, 1999 increased 3% primarily due to higher revenues from
merger, acquisition and restructuring activities.
Revenues from merger, acquisition and restructuring activities increased to
record levels in the quarter ended May 31, 1999. The global market for such
transactions continued to be robust during the quarter, particularly in the
U.S. and Europe. The high level of transaction activity reflected the
continuing trend of consolidation and globalization across many industry
sectors, as well as deregulation and privatization. The generally favorable
market conditions which existed during the quarter and the Company's strong
global market share in many industry sectors, including technology, utilities
and health care, also contributed to the high level of revenues from merger
and acquisition transactions.
Equity underwriting revenues in the quarter ended May 31, 1999 were
comparable to the prior year period. Equity underwriting revenues benefited
from the high volume of equity offerings which occurred during the quarter,
particularly in the technology sector. The Company's strong global market
share also continued to have a favorable impact on equity underwriting
revenues.
Fixed income underwriting revenues in the quarter ended May 31, 1999 were
also comparable to the prior year period. The volume of fixed income
underwriting transactions continued to be strong due to the relatively low
level of interest rates in the U.S., which has allowed issuers to take
advantage of lower borrowing costs. In addition, the EMU has permitted many
corporate issuers to access the euro-denominated credit market, which
continued to have a favorable impact on the volume of fixed income primary
transactions.
Investment banking revenues in the six month period ended May 31, 1999
increased 11% from the comparable period of fiscal 1998. The increase was
primarily attributable to higher revenues from merger, acquisition and
restructuring activities and equity underwritings, reflecting continued strong
transaction volumes.
Principal Transactions
Principal transaction trading revenues, which include revenues from customer
purchases and sales of securities in which the Company acts as principal and
gains and losses on securities held for resale, including derivatives,
increased 77% in the quarter ended May 31, 1999 from the comparable period of
fiscal 1998. The significant increase reflected higher levels of fixed income,
equity and commodity trading revenues, partially offset by a decline in
foreign exchange trading revenues.
Fixed income trading revenues increased in the quarter ended May 31, 1999
from the comparable period of fiscal 1998, primarily reflecting higher
revenues from trading fixed income derivatives and global high yield
securities. Revenues from fixed income derivatives, including options and
swaps, benefited from strong investor demand, which contributed to high
transaction volume, and from volatility in the global fixed income markets.
These conditions resulted in increased trading opportunities during the
quarter. Volatility in the fixed income markets was affected by heightened
fears of accelerating inflation in the U.S., which led to speculation that the
Fed would be raising interest rates in the near future. The interest rate cuts
made by the ECB during the quarter also contributed to the high levels of
volatility. Revenues from global high yield securities also benefited from the
volatile trading environment.
Equity trading revenues increased in the quarter ended May 31, 1999 as
compared to the prior year period, reflecting higher revenues from both cash
and derivative equity products. Higher revenues from trading in equity cash
products were primarily driven by strong customer trading volumes in both
listed and over-the-counter securities and high levels of market volatility,
particularly in the U.S. Revenues from trading equity derivatives benefited
from high levels of volatility in the global equity markets, particularly in
the technology sector in U.S. markets.
19
<PAGE>
Commodity trading revenues also increased in the quarter ended May 31, 1999
as compared to the prior year period, primarily driven by higher revenues from
trading in energy products and commodity derivatives. Trading revenues from
energy products benefited from a sharp rise in global energy prices throughout
the quarter. Trading revenues from commodity derivatives also benefited from
the rising energy prices and from continued volatility in the energy markets.
These increases were partially offset by lower trading revenues from precious
metals, as gold and silver prices fell throughout the quarter.
Foreign exchange trading revenues decreased in the quarter ended May 31,
1999 as compared to the prior year period. While the overall level of customer
trading volume remained high, trading revenues were negatively impacted by
lower levels of volatility in the foreign exchange markets. The strong
economic performance of the U.S., coupled with sluggish growth within much of
Europe, led to the steady decline of the euro throughout the quarter. The U.S.
dollar and the Japanese yen traded within a relatively narrow range for much
of the quarter due to continued uncertainty about the prospects of economic
recovery in Japan.
Principal transaction investment gains aggregating $150 million were
recorded in the quarter ended May 31, 1999, as compared to gains of $101
million in the quarter ended May 31, 1998. Fiscal 1999's results primarily
reflect realized and unrealized gains from the Company's investment in
Knight/Trimark Group Inc., the sale of its holdings in Renaissance Media and
increases in the value of certain other private equity investments.
Principal transaction trading revenues increased 81% in the six month period
ended May 31, 1999 from the comparable prior year period, primarily reflecting
higher fixed income, equity and commodity trading revenues. Fixed income
trading revenues increased due to higher revenues from trading investment
grade, high yield and derivative securities, and benefited from improved
conditions in the global financial markets, strong customer transaction volume
and market volatility. The increase in equity trading revenues reflected
higher revenues from trading both cash and derivative equity securities.
Equity trading revenues benefited from high levels of customer trading volume
and market volatility, particularly in the U.S. and in Europe. Commodity
trading revenues also increased, reflecting higher revenues from commodity
derivatives and energy products. Foreign exchange revenues were comparable to
prior year levels and reflected high customer transaction volume and lower
levels of volatility in the foreign exchange markets.
Principal transaction investment gains aggregating $415 million were
recognized in the six month period ended May 31, 1999 as compared to $173
million in the six month period ended May 31, 1998. Fiscal 1999's results
primarily reflect realized and unrealized gains relating to the Company's
investment in Equant N.V., a Netherlands based data communications company,
and Knight/Trimark Group Inc. Net gains from increases in the value of certain
other private equity investments also contributed to fiscal 1999's results.
Commissions
Commission revenues primarily arise from agency transactions in listed and
over-the-counter equity securities, and sales of mutual funds, futures,
insurance products and options. Commission revenues increased 29% in the
quarter ended May 31, 1999 from the comparable period of fiscal 1998. In the
U.S., favorable market conditions and continuing market volatility contributed
to an increased volume of customer securities transactions, including listed
agency and over-the-counter equity products. Revenues from markets in Europe
also benefited from high trading volumes and market volatility, as well as
from the Company's increased sales and research coverage of the region which
began in mid-1997. The continued growth in the number of the Company's
financial advisors also contributed to the increase.
Commission revenues increased 26% in the six month period ended May 31, 1999
from the comparable period of fiscal 1998. The increase primarily reflects a
higher level of customer trading activity in the global equity markets.
20
<PAGE>
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration revenues include fees for
asset management services, including fund management fees which are received
for investment management, and fees received for promoting and distributing
mutual funds ("12b-1 fees"). Fund management fees arise from investment
management services the Company provides to registered investment companies
(the "Funds") pursuant to various contractual arrangements. The Company
receives management fees based upon each Fund's average daily net assets. The
Company receives 12b-1 fees for services it provides in promoting and
distributing certain open-ended Funds. These fees are based on either the
average daily Fund net asset balances or average daily aggregate net Fund
sales and are affected by changes in the overall level and mix of assets under
management and administration. The Company also receives fees for investment
management services provided to segregated customer accounts pursuant to
various contractual arrangements.
Asset management, distribution and administration revenues increased 3% and
4% in the quarter and six month period ended May 31, 1999 from the comparable
periods of fiscal 1998, primarily reflecting higher fund management and 12b-1
fees as well as other revenues resulting from a higher level of assets under
management or supervision. The increases were partially offset by the absence
of revenues from correspondent clearing and global custody activities, which
was attributable to the Company's sale of its correspondent clearing business
in the third quarter of fiscal 1998 and its global custody business in the
fourth quarter of fiscal 1998.
Customer assets under management or supervision increased to $402 billion at
May 31, 1999 from $374 billion at May 31, 1998. The increase in assets under
management or supervision reflected net inflows of customer assets, as well as
appreciation in the value of existing customer portfolios. Customer assets
under management or supervision included products offered primarily to
individual investors of $238 billion at May 31, 1999 and $206 billion at May
31, 1998. Products offered primarily to institutional investors were $164
billion at May 31, 1999 and $168 billion at May 31, 1998.
Net Interest
Interest and dividend revenues and expense are a function of the level and
mix of total assets and liabilities, including financial instruments owned,
reverse repurchase and repurchase agreements, trading strategies associated
with the Company's institutional securities business, customer margin loans,
and the prevailing level, term structure and volatility of interest rates.
Interest and dividend revenues and expense should be viewed in the broader
context of principal trading and investment banking results. Decisions
relating to principal transactions in securities are based on an overall
review of aggregate revenues and costs associated with each transaction or
series of transactions. This review includes an assessment of the potential
gain or loss associated with a trade, the interest income or expense
associated with financing or hedging the Company's positions, and potential
underwriting, commission or other revenues associated with related primary or
secondary market sales. Net interest revenues decreased 64% and 34% in the
quarter and six month period ended May 31, 1999 from the comparable periods of
fiscal 1998, partially reflecting the level and mix of interest bearing assets
and liabilities during the respective periods, as well as certain trading
strategies utilized in the institutional securities business.
Non-Interest Expenses
Total non-interest expenses increased 21% and 26% in the quarter and six
month period ended May 31, 1999 from the comparable periods of fiscal 1998.
Within the non-interest expense category, compensation and benefits expense
increased 22% and 29% in the quarter and six month period ended May 31, 1999,
principally reflecting higher incentive-based compensation due to record
levels of revenues and earnings. Excluding compensation and benefits expense,
non-interest expense increased 19% in the quarter and six month period ended
May 31, 1999 from the comparable periods of fiscal 1998. Occupancy and
equipment expense increased 11% and 10% in the quarter and six month period
ended May 31, 1999, primarily due to increased office space in New York and
certain other locations, and additional rent associated with 30 new branch
locations in the U.S. Brokerage, clearing and exchange fees decreased 6% in
the quarter and six month period ended May 31, 1999,
21
<PAGE>
primarily attributable to lower agent bank costs resulting from the Company's
fiscal 1998 sale of its global custody business. This decrease was partially
offset by higher brokerage expenses due to increased global securities trading
volume. Information processing and communications expense increased 26% and
27% in the quarter and six month period ended May 31, 1999, primarily due to
increased costs associated with the Company's information processing
infrastructure, including server and data center costs. A higher number of
employees utilizing communications systems and certain data services also
contributed to the increase. Marketing and business development expense
increased 33% and 31% in the quarter and six month period ended May 31, 1999,
reflecting higher advertising expenses associated with DBD and the Company's
individual securities business. Increased travel and entertainment costs
associated with the continued high levels of activity in the global financial
markets also contributed to the increase. Professional services expense
increased 21% and 27% in the quarter and six month period ended May 31, 1999,
primarily reflecting higher consulting costs associated with certain
information technology initiatives, including the preparation for the Year
2000, as well as the Company's increased global business activities. Other
expense increased 27% and 24% in the quarter and six month period ended May
31, 1999, which reflects the impact of a higher level of business activity on
various operating expenses. The amortization of goodwill associated with the
Company's acquisition of AB Asesores in March 1999 also contributed to the
increase.
22
<PAGE>
Credit Services
Statements of Income (dollars in millions)
<TABLE>
<CAPTION>
Three
Months Six Months
Ended Ended
May 31, May 31,
----------- -----------
1999 1998 1999 1998
----- ----- ----- -----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Fees:
Merchant and cardmember.............................. $ 357 $ 404 $ 698 $ 832
Servicing............................................ 310 232 563 403
Other.................................................. -- 2 -- 3
----- ----- ----- -----
Total non-interest revenues.......................... 667 638 1,261 1,238
----- ----- ----- -----
Interest revenue....................................... 522 671 1,078 1,452
Interest expense....................................... 198 251 419 544
----- ----- ----- -----
Net interest income.................................. 324 420 659 908
Provision for consumer loan losses..................... 119 275 296 680
----- ----- ----- -----
Net credit income.................................... 205 145 363 228
----- ----- ----- -----
Net revenues......................................... 872 783 1,624 1,466
----- ----- ----- -----
Compensation and benefits.............................. 123 144 242 282
Occupancy and equipment................................ 12 16 24 33
Information processing and communications.............. 109 111 226 228
Marketing and business development..................... 214 160 460 338
Professional services.................................. 31 24 52 47
Other.................................................. 52 58 94 100
----- ----- ----- -----
Total non-interest expenses.......................... 541 513 1,098 1,028
----- ----- ----- -----
Income before income taxes............................. 331 270 526 438
Provision for income taxes............................. 120 99 191 163
----- ----- ----- -----
Net income........................................... $ 211 $ 171 $ 335 $ 275
===== ===== ===== =====
</TABLE>
Credit Services net income of $211 million and $335 million in the quarter
and six month period ended May 31, 1999 represented an increase of 23% and 22%
from the comparable periods of fiscal 1998. The increases in net income in
both periods were primarily attributable to a lower provision for loan losses
and increased servicing fees, partially offset by lower net interest income
and merchant and cardmember fees and higher non-interest expenses.
The quarter and six month period ended May 31, 1999 does not include the
results from operations of SPS Transaction Services, Inc. ("SPS"), the Prime
Option SM MasterCard(R) portfolio ("POS") and the receivables associated with
the discontinued BRAVO(R) Card, all of which were sold during fiscal 1998. The
Company sold its interest in the operations of SPS, which was a 73%-owned,
publicly held subsidiary of the Company, in the fourth quarter of fiscal 1998.
POS, a business the Company operated with NationsBank of Delaware, N.A., was
sold during the second quarter of fiscal 1998. The Company discontinued its
BRAVO Card in fiscal 1998. The Company sold certain credit card receivables
associated with the BRAVO Card in the fourth quarter of fiscal 1998.
Non-Interest Revenues
Total non-interest revenues increased 5% and 2% in the quarter and six month
period ended May 31, 1999 from the comparable periods of fiscal 1998.
23
<PAGE>
Merchant and cardmember fees include revenues from fees charged to merchants
on credit card sales, late payment fees, overlimit fees, insurance fees and
cash advance fees. Merchant and cardmember fees decreased 12% and 16% in the
quarter and six month period ended May 31, 1999 from the comparable periods of
fiscal 1998. In both periods, the decreases were primarily due to a lower
level of merchant and cardmember fees resulting from the Company's sale of the
operations of SPS and the sale of POS. Both periods were also impacted by
higher merchant discount revenue offset by lower levels of late payment fees
and cash advance fees associated with the Discover Card. The increases in
Discover Card merchant discount revenue in both periods were associated with
higher sales volume. Late payment fees decreased due to a lower level of owned
consumer loans. Cash advance fees decreased as a result of decreased cash
advance transaction volume, primarily attributable to the Company's actions to
limit cash advances in an effort to improve credit quality.
Servicing fees are revenues derived from consumer loans which have been sold
to investors through asset securitizations. Cash flows from the interest yield
and cardmember fees generated by securitized loans are used to pay investors
in these loans a predetermined fixed or floating rate of return on their
investment, to reimburse investors for losses of principal through charged off
loans and to pay the Company a fee for servicing the loans. Any excess cash
flows remaining are paid to the Company. The servicing fees and excess net
cash flows paid to the Company are reported as servicing fees in the condensed
consolidated statements of income. The sale of consumer loans through asset
securitizations, therefore, has the effect of converting portions of net
credit income and fee income to servicing fees. The Company completed asset
securitizations of $1,947 million in the quarter ended May 31, 1999 and $2,474
million in the six month period ended May 31, 1999. During the comparable
periods of fiscal 1998, the Company completed asset securitizations of $1,842
million and $2,211 million. The asset securitizations completed in the second
quarter of fiscal 1999 have expected maturities of 3 years from the date of
issuance.
The table below presents the components of servicing fees (dollars in
millions):
<TABLE>
<CAPTION>
Three
Months Six Months
Ended Ended
May 31, May 31,
---------- ------------
1999 1998 1999 1998
---- ---- ----- -----
<S> <C> <C> <C> <C>
Merchant and cardmember fees.......................... $138 $115 $ 269 $ 220
Interest revenue...................................... 699 648 1,324 1,227
Interest expense...................................... (251) (251) (481) (485)
Provision for consumer loan losses.................... (276) (280) (549) (559)
---- ---- ----- -----
Servicing fees........................................ $310 $232 $ 563 $ 403
==== ==== ===== =====
</TABLE>
Servicing fees increased 34% and 40% in the quarter and six month period
ended May 31, 1999 from the comparable periods of fiscal 1998. The increase in
both periods was due to higher levels of net interest cash flows, increased
fee revenue, and decreased credit losses from securitized consumer loans. The
increases in net interest and fee revenue were primarily a result of higher
levels of average securitized loans. The decrease in credit losses was the
result of a lower net charge-off rate, partially offset by an increase in the
level of securitized consumer loans.
Net Interest Income
Net interest income represents the difference between interest revenue
derived from Credit Services consumer loans and short-term investment assets
and interest expense incurred to finance those assets. Credit Services assets,
consisting primarily of consumer loans, currently earn interest revenue at
both fixed rates and market-indexed variable rates. The Company incurs
interest expense at fixed and floating rates. Interest expense also includes
the effects of interest rate contracts entered into by the Company as part of
its interest rate risk management program. This program is designed to reduce
the volatility of earnings resulting from changes in
24
<PAGE>
interest rates and is accomplished primarily through matched financing, which
entails matching the repricing schedules of consumer loans and related
financing. Net interest income decreased 23% and 27% in the quarter and six
month period ended May 31, 1999 from the comparable periods of fiscal 1998.
The decreases in both periods were predominately due to lower average levels
of owned consumer loans and a lower yield on these loans. The decrease in
owned consumer loans in both periods was due to the sale of the operations of
SPS, the sale of POS, and the discontinuance of the BRAVO Card in fiscal 1998,
and a higher level of securitized Discover Card loans. The lower yield during
both periods was due to a lower yield on Discover Card loans coupled with the
exclusion of SPS and POS loans from the Company's portfolio. The lower yield
on Discover Card loans was due to the effect of changes in the interest rates
on the Company's variable loan portfolio, primarily associated with a decrease
in the prime rate in the fourth quarter of fiscal 1998.
The Company repriced a substantial portion of its existing credit card
receivables to a range of fixed interest rates beginning with cardmembers'
March 1999 billing cycle. The Company believes that the repricing will not
have a material impact on net interest income, or its interest rate risk
exposure, because of the Company's matched financing objectives and because
the Company has the ability to exercise its rights, with notice to
cardmembers, to adjust the interest rate the cardmember pays at the Company's
discretion. Given this strategic decision, the Company's interest rate
sensitivity analysis now incorporates a pricing strategy that assumes an
appropriate repricing of fixed rate credit card receivables to reflect the
market interest rate environment, the Company's liability management policy
and competitive factors.
25
<PAGE>
The following tables present analyses of Credit Services average balance
sheets and interest rates for the quarters and six month periods ended May 31,
1999 and 1998 and changes in net interest income during those periods:
Average Balance Sheet Analysis (dollars in millions)
<TABLE>
<CAPTION>
Three Months Ended May 31,
-------------------------------------------------
1999 1998
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
General purpose credit card
loans....................... $14,660 13.31% $492 $16,732 13.59% $574
Other consumer loans......... 4 9.02 -- 1,561 16.24 64
Investment securities........ 661 4.91 8 597 7.95 12
Other........................ 1,664 5.27 22 1,460 5.88 21
------- ---- ------- ----
Total interest earning
assets.................. 16,989 12.19 522 20,350 13.08 671
Allowance for loan losses.... (775) (845)
Non-interest earning assets.. 1,641 1,630
------- -------
Total assets............. $17,855 $21,135
======= =======
LIABILITIES AND SHAREHOLDER'S
EQUITY
Interest bearing liabilities:
Interest bearing deposits
Savings.................... $ 1,418 4.36% $ 16 $ 975 4.83% $ 12
Brokered................... 5,224 6.41 85 6,075 6.65 102
Other time................. 1,996 5.40 27 2,208 6.14 35
------- ---- ------- ----
Total interest bearing
deposits................ 8,638 5.84 128 9,258 6.34 149
Other borrowings............. 5,075 5.54 70 6,928 5.90 102
------- ---- ------- ----
Total interest bearing
liabilities............. 13,713 5.73 198 16,186 6.15 251
Shareholder's equity/other
liabilities................. 4,142 4,949
------- -------
Total liabilities and
shareholder's equity.... $17,855 $21,135
======= =======
Net interest income.......... $324 $420
==== ====
Net interest margin.......... 7.57% 8.18%
Interest rate spread......... 6.46% 6.93%
</TABLE>
26
<PAGE>
Average Balance Sheet Analysis (dollars in millions)
<TABLE>
<CAPTION>
Six Months Ended May 31,
-------------------------------------------------
1999 1998
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
General purpose credit card
loans....................... $15,528 13.09% $1,014 $18,391 13.77% $1,263
Other consumer loans......... 5 8.99 -- 1,612 16.57 133
Investment securities........ 793 5.11 20 422 7.33 15
Other........................ 1,629 5.36 44 1,379 5.96 41
------- ------ ------- ------
Total interest earning
assets.................. 17,955 12.04 1,078 21,804 13.36 1,452
Allowance for loan losses.... (777) (866)
Non-interest earning assets.. 1,654 1,658
------- -------
Total assets............. $18,832 $22,596
======= =======
LIABILITIES & SHAREHOLDER'S
EQUITY
Interest bearing liabilities:
Interest bearing deposits
Savings.................... $ 1,461 4.37% $ 32 $ 916 4.75% $ 22
Brokered................... 5,051 6.46 163 5,995 6.63 198
Other time................. 2,001 5.44 54 2,282 6.12 70
------- ------ ------- ------
Total interest bearing
deposits................ 8,513 5.86 249 9,193 6.32 290
Other borrowings............. 6,165 5.53 170 8,421 6.05 254
------- ------ ------- ------
Total interest bearing
liabilities............. 14,678 5.72 419 17,614 6.19 544
Shareholder's equity/other
liabilities................. 4,154 4,982
------- -------
Total liabilities &
shareholder's equity.... $18,832 $22,596
======= =======
Net interest income.......... $ 659 $ 908
====== ======
Net interest margin.......... 7.36% 8.35%
Interest rate spread......... 6.32% 7.17%
</TABLE>
27
<PAGE>
Rate/Volume Analysis (dollars in millions)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31, 1999 vs. 1998 May 31, 1999 vs. 1998
-------------------------- -------------------------
Increase/(Decrease) Increase/(Decrease)
Due to Changes in Due to Changes in
-------------------------- -------------------------
Volume Rate Total Volume Rate Total
-------- ------- ------- -------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
INTEREST REVENUE
General purpose credit
card loans............. $ (72) $ (10) $ (82) $ (196) $ (53) $ (249)
Other consumer loans.... (64) -- (64) (133) -- (133)
Investment securities... 1 (5) (4) 14 (9) 5
Other................... 3 (2) 1 8 (5) 3
------- -------
Total interest
revenue.............. (111) (38) (149) (256) (118) (374)
------- -------
INTEREST EXPENSE
Interest bearing
deposits
Savings................. 6 (2) 4 13 (3) 10
Brokered................ (14) (3) (17) (31) (4) (35)
Other time.............. (4) (4) (8) (9) (7) (16)
------- -------
Total interest bearing
deposits............. (10) (11) (21) (21) (20) (41)
Other borrowings........ (27) (5) (32) (68) (16) (84)
------- -------
Total interest
expense.............. (38) (15) (53) (91) (34) (125)
------- -------
Net interest income..... $ (72) $ (24) $ (96) $ (165) $ (84) $ (249)
======= ======= ======= ======= ====== =======
</TABLE>
The supplemental table below provides average managed loan balance and rate
information which takes into account both owned and securitized loans:
Supplemental Average Managed Loan Balance Sheet Information (dollars in
millions)
<TABLE>
<CAPTION>
Three Months Ended May 31,
---------------------------------------------------
1999 1998
------------------------- -------------------------
Avg. Bal. Rate % Interest Avg. Bal. Rate % Interest
--------- ------ -------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans............ $32,258 14.39 $1,171 $34,479 14.79 $1,286
General purpose credit
card loans............... 32,253 14.39 1,170 32,249 14.64 1,190
Total interest earning
assets................... 34,583 13.77 1,201 36,537 14.32 1,319
Total interest bearing
liabilities.............. 31,306 5.58 440 32,373 6.15 502
Consumer loan interest
rate spread.............. 8.81 8.64
Interest rate spread...... 8.19 8.17
Net interest margin....... 8.72 8.87
<CAPTION>
Six Months Ended May 31,
---------------------------------------------------
1999 1998
------------------------- -------------------------
Avg. Bal. Rate % Interest Avg. Bal. Rate % Interest
--------- ------ -------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans............ $32,575 14.23 $2,311 $35,641 14.76 $2,623
General purpose credit
card loans............... 32,571 14.23 2,311 33,359 14.60 2,429
Total interest earning
assets................... 34,997 13.61 2,375 37,441 14.35 2,679
Total interest bearing
liabilities.............. 31,721 5.62 888 33,251 6.21 1,029
Consumer loan interest
rate spread.............. 8.61 8.55
Interest rate spread...... 7.99 8.14
Net interest margin....... 8.52 8.84
</TABLE>
28
<PAGE>
Provision for Consumer Loan Losses
The provision for consumer loan losses is the amount necessary to establish
the allowance for loan losses at a level the Company believes is adequate to
absorb estimated losses in its consumer loan portfolio at the balance sheet
date. The Company's allowance for loan losses is regularly evaluated by
management for adequacy on a portfolio-by-portfolio basis and was $768 million
and $824 million at May 31, 1999 and 1998. The provision for consumer loan
losses, which is affected by net charge-offs, loan volume and changes in the
amount of consumer loans estimated to be uncollectable, decreased 57% and 56%
in the quarter and six month period ended May 31, 1999 from the comparable
periods of fiscal 1998. The decreases in both periods were primarily due to a
lower level of charge-offs related to the Discover Card portfolio and the
positive impact of the sale of the operations of SPS, the sale of POS and the
discontinuance of the BRAVO Card. These decreases were reflective of the
Company's continuing efforts to improve the credit quality of its portfolio.
The provision for consumer loan losses was also positively impacted by a
decline in the loan loss allowance in connection with securitization
transactions entered into prior to the third quarter of 1996. The Company
expects this loan loss allowance will be fully amortized over fiscal 1999. The
Company's future charge-off rates and credit quality are subject to
uncertainties that could cause actual results to differ materially from what
has been discussed above. Factors that influence the provision for consumer
loan losses include the level and direction of consumer loan delinquencies and
charge-offs, changes in consumer spending and payment behaviors, bankruptcy
trends, the seasoning of the Company's loan portfolio, interest rate movements
and their impact on consumer behavior, and the rate and magnitude of changes
in the Company's consumer loan portfolio, including the overall mix of
accounts, products and loan balances within the portfolio.
Consumer loans are considered delinquent when interest or principal payments
become 30 days past due. Consumer loans are charged off during the month in
which they become 180 days past due, except in the case of bankruptcies and
fraudulent transactions, where loans are charged off earlier. Loan
delinquencies and charge-offs are primarily affected by changes in economic
conditions and may vary throughout the year due to seasonal consumer spending
and payment behaviors.
From time to time, the Company has offered, and may continue to offer,
cardmembers with accounts in good standing the opportunity to skip a minimum
monthly payment, while continuing to accrue periodic finance charges, without
being considered to be past due ("skip-a-payment"). The comparability of
delinquency rates at any particular point in time may be affected depending on
the timing of the skip-a-payment program.
The following table presents delinquency and net charge-off rates with
supplemental managed loan information.
Asset Quality (dollars in millions)
<TABLE>
<CAPTION>
May 31, November 30,
---------------------------------- ----------------
1999 1998 1998
---------------- ---------------- ----------------
Owned Managed Owned Managed Owned Managed
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans at period-
end..................... $14,588 $32,805 $17,913 $34,091 $15,996 $32,502
Consumer loans
contractually past due
as a
Percentage of period-
end consumer loans:
30 to 89 days.......... 3.13% 3.52% 4.26% 4.33% 3.54% 3.69%
90 to 179 days......... 2.11% 2.42% 2.71% 2.73% 2.67% 2.84%
Net charge-offs as a
percentage of average
consumer loans (year-to-
date)................... 5.42% 5.91% 6.96% 7.05% 6.75% 6.90%
</TABLE>
Non-Interest Expenses
Non-interest expenses increased 5% and 7% in the quarter and six month
period ended May 31, 1999 from the comparable periods of fiscal 1998.
29
<PAGE>
Compensation and benefits expense decreased 15% and 14% in the quarter and
six month period ended May 31, 1999 from the comparable periods of fiscal 1998
due to a lower level of compensation costs resulting from the sale of the
operations of SPS and the sale of POS, partially offset by higher employment
costs at Discover Financial Services associated with increased employment
levels. Occupancy and equipment expense decreased 25% and 27%, primarily due
to the exclusion of the results of SPS and POS in fiscal 1999's results.
Information processing and communications expense decreased 2% and 1% due to
the exclusion of SPS and POS results in fiscal 1999, partially offset by
increased external data processing costs at Discover Financial Services.
Marketing and business development expense increased 34% and 36% due to
increased direct mail and other promotional activities related to the launch
and continued promotion of the Discover Platinum Card and higher cardmember
rewards expense. Higher cardmember rewards expense in both periods was due to
increased sales volume. Cardmember rewards expense includes the Cashback
Bonus(R) award, pursuant to which the Company annually pays Discover
cardmembers and Private Issue(R) cardmembers electing this feature a
percentage of their purchase amounts. The Company expects to continue to
invest in the growth of its credit card business. Professional services
expense increased 29% and 11% due to increased costs associated with account
collections and consumer credit counseling, partially offset by a decrease in
expenses associated with the sale of the operations of SPS and the sale of
POS. Other expenses decreased 10% and 6%. The decreases in both periods were
due to the exclusion of SPS and POS results in fiscal 1999 and a decrease in
fraud losses, partially offset by higher expenses related to the Discover
Platinum Card.
Liquidity and Capital Resources
The Company's total assets increased from $317.6 billion at November 30,
1998 to $342.3 billion at May 31, 1999 primarily reflecting higher securities
borrowed and customer receivables. A substantial portion of the Company's
total assets consists of highly liquid marketable securities and short-term
receivables arising principally from securities transactions. The highly
liquid nature of these assets provides the Company with flexibility in
financing and managing its business.
The Company's senior management establishes the overall funding and capital
policies of the Company, reviews the Company's performance relative to these
policies, monitors the availability of sources of financing, reviews the
foreign exchange risk of the Company and oversees the liquidity and interest
rate sensitivity of the Company's asset and liability position. The primary
goal of the Company's funding and liquidity activities is to ensure adequate
financing over a wide range of potential credit ratings and market
environments.
The Company views return on equity to be an important measure of its
performance, in the context of both the particular business environment in
which the Company is operating and its peer group's results. In this regard,
the Company actively manages its consolidated capital position based upon,
among other things, business opportunities, capital availability and rates of
return together with internal capital policies, regulatory requirements and
rating agency guidelines and therefore may, in the future, expand or contract
its capital base to address the changing needs of its businesses. The Company
returns internally generated equity capital which is in excess of the needs of
its businesses to its shareholders through common stock repurchases and
dividends.
The Company funds its balance sheet on a global basis. The Company's funding
for its Securities and Asset Management business is raised through diverse
sources. These sources include the Company's capital, including equity and
long-term debt; repurchase agreements; U.S., Canadian, Euro and Japanese
commercial paper; letters of credit; unsecured bond borrows; securities
lending; buy/sell agreements; municipal re-investments; master notes; and
committed and uncommitted lines of credit. Repurchase agreement transactions,
securities lending and a portion of the Company's bank borrowings are made on
a collateralized basis and therefore provide a more stable source of funding
than short-term unsecured borrowings.
The funding sources utilized for the Company's Credit Services business
include the Company's capital, including equity and long-term debt; asset
securitizations; commercial paper; deposits; asset-backed commercial paper;
Federal Funds; and short-term bank notes. The Company sells consumer loans
through asset securitizations using several transaction structures. Riverwoods
Funding Corporation ("RFC"), an entity included in the Company's condensed
consolidated financial statements, issues asset-backed commercial paper.
30
<PAGE>
The Company's bank subsidiaries solicit deposits from consumers, purchase
Federal Funds and issue short-term bank notes. Interest bearing deposits are
classified by type as savings, brokered and other time deposits. Savings
deposits consist primarily of money market deposits and certificates of
deposit accounts sold directly to cardmembers and savings deposits from
individual securities clients. Brokered deposits consist primarily of
certificates of deposits issued by the Company's bank subsidiaries. Other time
deposits include institutional certificates of deposits. The Company, through
Greenwood Trust Company, an indirect subsidiary of the Company, sells notes
under a short-term bank note program.
The Company maintains borrowing relationships with a broad range of banks,
financial institutions, counterparties and others from which it draws funds in
a variety of currencies. The volume of the Company's borrowings generally
fluctuates in response to changes in the amount of repurchase transactions
outstanding, the level of the Company's securities inventories and consumer
loans receivable, and overall market conditions. Availability and cost of
financing to the Company can vary depending upon market conditions, the volume
of certain trading activities, the Company's credit ratings and the overall
availability of credit.
The Company's reliance on external sources to finance a significant portion
of its day-to-day operations makes access to global sources of financing
important. The cost and availability of unsecured financing generally are
dependent on the Company's short-term and long-term debt ratings. In addition,
the Company's debt ratings have a significant impact on certain trading
revenues, particularly in those businesses where longer term counterparty
performance is critical, such as over-the-counter derivative transactions.
As of June 30, 1999 the Company's credit ratings were as follows:
<TABLE>
<CAPTION>
Commercial Senior
Paper Debt
----------- ------
<S> <C> <C>
Dominion Bond Rating Service Limited.................. R-1 (middle) n/a
Duff & Phelps Credit Rating Co. ...................... D-1+ AA
Fitch IBCA Inc. ...................................... F1+ AA-
Japan Rating & Investment Information, Inc. .......... a-1+ AA-
Moody's Investors Service............................. P-1 Aa3
Standard & Poor's (1)................................. A-1 A+
Thomson BankWatch, Inc. .............................. TBW-1 AA
</TABLE>
- --------
(1) As of April 16, 1999 Standard & Poor's has placed the Company's senior
debt ratings on Positive Outlook.
As part of its Year 2000 preparations, the Company's Treasury Department, in
conjunction with the Company's business areas, has developed a Year 2000
Funding Plan that addresses the issue of maintaining adequate liquidity over
the fourth calendar quarter of 1999 and the first calendar quarter of 2000.
The Company's Year 2000 liquidity strategy is the culmination of a global
effort on the part of the Treasury Department and the Company's business areas
to determine potential funding needs, assess Year 2000 opportunities and extra
liquidity needs, determine the precise timing and size of these needs and
evaluate appropriate currencies for funding.
In developing this plan, the Company has attempted to identify potential
levels of disruption and has determined that, while it may well turn out that
the level of disruption is negligible or easily manageable, it is prudent to
establish a reasonable, but not extreme, amount of liquidity over the course
of the remainder of 1999 in order to avoid the potential for an illiquidity
problem late in the year.
In connection with this plan, the Company intends to extend the maturity of
a portion of its existing short-term unsecured funding. The Company is also in
the process of executing its core 1999 long-term financing plan, and has
renewed its committed credit facilities. With respect to funding liquidity,
the Company's preparation for the Year 2000 will continue throughout the
remainder of 1999.
31
<PAGE>
As the Company continues to expand globally and as revenues are increasingly
derived from various currencies, foreign currency management is a key element
of the Company's financial policies. The Company benefits from operating in
several different currencies because weakness in any particular currency is
often offset by strength in another currency. The Company closely monitors its
exposure to fluctuations in currencies and, where cost-justified, adopts
strategies to reduce the impact of these fluctuations on the Company's
financial performance. These strategies include engaging in various hedging
activities to manage income and cash flows denominated in foreign currencies
and using foreign currency borrowings, when appropriate, to finance
investments outside the U.S.
During the six month period ended May 31, 1999, the Company issued senior
notes aggregating $6,540 million, including non-U.S. dollar currency notes
aggregating $2,009 million, primarily pursuant to its public debt shelf
registration statements. These notes have maturities from 2000 to 2020 and a
weighted average coupon interest rate of 4.2% at May 31, 1999; the Company has
entered into certain transactions to obtain floating interest rates based
primarily on short-term LIBOR trading levels. At May 31, 1999 the aggregate
outstanding principal amount of the Company's Senior Indebtedness (as defined
in the Company's public debt shelf registration statements) was approximately
$42.2 billion.
Effective March 1, 1999, the Company and Morgan Stanley Finance, plc ("MS
plc"), a U.K. subsidiary, redeemed all of the outstanding 7.82% Capital Units
and 7.80% Capital Units. The aggregate principal amount of the Capital Units
redeemed was $352 million. During the quarter ended May 31, 1999, the Company
and MS plc repurchased in a series of transactions in the open market
approximately $69 million of the $134 million outstanding 8.03% Capital Units.
The Company and MS plc intend to retire these repurchased Capital Units in the
Company's third fiscal quarter.
On May 5, 1999, the Company's shelf registration statement for the issuance
of an additional $12 billion of debt securities, units, warrants or purchase
contracts or any combination thereof in the form of units or preferred stock,
became effective.
During the six month period ended May 31, 1999, the Company purchased $933
million of its common stock. Subsequent to May 31, 1999 and through June 30,
1999, the Company purchased an additional $151 million of its common stock.
In June 1999, in an effort to enhance the Company's ongoing stock repurchase
program, the Company sold put options on an aggregate of 768,500 shares of its
common stock to a third party. These put options entitle the holder to sell
shares of the Company's common stock to the Company on certain dates at
specified prices. The maturity dates of the put options range from July 1999
through November 1999. The Company may elect cash settlement of the put
options instead of taking delivery of the stock.
On April 28, 1999, the Company renewed its senior revolving credit agreement
with a group of banks to support general liquidity needs, including the
issuance of commercial paper (the "MSDW Facility"). Under the terms of the
MSDW Facility, the banks are committed to provide up to $5.5 billion. The MSDW
Facility contains restrictive covenants which require, among other things,
that the Company maintain shareholders' equity of at least $9.1 billion at all
times. The Company believes that the covenant restrictions will not impair the
Company's ability to pay its current level of dividends. At May 31, 1999, no
borrowings were outstanding under the MSDW Facility.
The Company maintains a master collateral facility that enables Morgan
Stanley & Co. Incorporated ("MS&Co."), one of the Company's U.S. broker-dealer
subsidiaries, to pledge certain collateral to secure loan arrangements,
letters of credit and other financial accommodations (the "MS&Co. Facility").
As part of the MS&Co. Facility, MS&Co. also maintains a secured committed
credit agreement with a group of banks that are parties to the master
collateral facility under which such banks are committed to provide up to
$1.875 billion. At May 31, 1999 no borrowings were outstanding under the
MS&Co. Facility. Both the master collateral facility and the secured committed
credit agreement were renewed on June 8, 1999.
32
<PAGE>
On May 25, 1999 the Company renewed its revolving committed financing
facility that enables Morgan Stanley & Co. International Limited ("MSIL"), the
Company's London-based broker-dealer subsidiary, to secure committed funding
from a syndicate of banks by providing a broad range of collateral under
repurchase agreements (the "MSIL Facility"). Such banks are committed to
provide up to an aggregate of $1.91 billion available in 6 currencies. At May
31, 1999 no borrowings were outstanding under the MSIL Facility.
On June 7, 1999, Morgan Stanley Japan Limited ("MSJL"), the Company's Tokyo-
based broker-dealer subsidiary, entered into a committed revolving credit
facility guaranteed by the Company, that provides funding to support general
liquidity needs, including support of MSJL's unsecured borrowings (the "MSJL
Facility"). Under the terms of the MSJL Facility, a syndicate of banks is
committed to provide up to 60 billion Japanese yen.
RFC also maintains a $2.6 billion senior bank credit facility which supports
the issuance of asset-backed commercial paper. RFC has never borrowed from its
senior bank credit facility.
The Company anticipates that it will utilize the MSDW Facility, the MS&Co.
Facility, the MSIL Facility or the MSJL Facility for short-term funding from
time to time.
At May 31, 1999 certain assets of the Company, such as real property,
equipment and leasehold improvements of $2.1 billion, and goodwill and other
intangible assets of $1.4 billion, were illiquid. In addition, certain equity
investments made in connection with the Company's private equity and other
principal investment activities, high-yield debt securities, emerging market
debt, certain collateralized mortgage obligations and mortgage-related loan
products, bridge financings, and certain senior secured loans and positions
are not highly liquid.
In connection with its private equity, real estate and certain other
principal investment activities, the Company has equity investments (directly
or indirectly through funds managed by the Company) in privately and publicly
held companies. At May 31, 1999, the aggregate carrying value of the Company's
equity investments in privately held companies (including direct investments
and partnership interests) was $189 million, and its aggregate investment in
publicly held companies was $395 million. The Company also has commitments of
$436 million at May 31, 1999 in connection with its private equity and other
principal investment activities.
In addition, at May 31, 1999 the aggregate value of high-yield debt
securities and emerging market loans and securitized instruments held in
inventory was $1,971 million (a substantial portion of which was subordinated
debt). These securities, loans and instruments were not attributable to more
than 3% to any one issuer, 19% to any one industry or 14% to any one
geographic region. Non-investment grade securities generally involve greater
risk than investment grade securities due to the lower credit ratings of the
issuers, which typically have relatively high levels of indebtedness and are,
therefore, more sensitive to adverse economic conditions. In addition, the
market for non-investment grade securities and emerging market loans and
securitized instruments has been, and may continue to be, characterized by
periods of volatility and illiquidity. The Company has in place credit and
other risk policies and procedures to control total inventory positions and
risk concentrations for non-investment grade securities and emerging market
loans and securitized instruments that are administered in a manner consistent
with the Company's overall risk management policies and procedures (see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Risk Management" and Note 9 to the consolidated financial
statements for the fiscal year ended November 30, 1998, included in the
Company's Annual Report on Form 10-K).
The Company acts as an underwriter of and as a market-maker in mortgage-
backed pass-through securities, collateralized mortgage obligations and
related instruments, and as a market-maker in commercial, residential and real
estate loan products. In this capacity, the Company takes positions in market
segments where liquidity can vary greatly from time to time. The carrying
value of the portion of the Company's mortgage-related portfolio at May 31,
1999 traded in markets that the Company believed were experiencing lower
levels of liquidity than traditional mortgage-backed pass-through securities
approximated $1,211 million.
33
<PAGE>
In connection with certain of its business activities, the Company provides
financing or financing commitments (on a secured and unsecured basis) to
companies in the form of senior and subordinated debt, including bridge
financing on a selective basis. The borrowers may be rated investment grade or
non-investment grade and the loans have varying maturities. As part of these
activities, the Company may syndicate and trade certain of these loans. At May
31, 1999, the aggregate value of loans and positions were $2,145 million. The
Company has also provided additional commitments associated with these
activities aggregating $1,992 million at May 31, 1999. At June 30, 1999, the
Company had loans and positions outstanding of $2,210 million and aggregate
commitments of $2,180 million.
The Company has entered into an agreement that will result in the
development of an office tower in New York City. Pursuant to this agreement,
the Company has entered into a 99-year lease for the land at the proposed
development site.
At May 31, 1999 the Company had an investment of $300 million in the Long-
Term Capital Portfolio, L.P. ("LTCP"). The Company is a member of a consortium
of 14 financial institutions participating in an equity recapitalization of
LTCP. The objectives of this investment are to continue active management of
its positions and, over time, reduce excessive risk exposures and leverage,
return capital to the participants and ultimately realize the potential value
of the LTCP portfolio. In July 1999, LTCP announced that it would make a
distribution to members of the consortium.
At May 31, 1999 financial instruments owned by the Company included
derivative products (generally in the form of futures, forwards, swaps, caps,
collars, floors, swap options and similar instruments which derive their value
from underlying interest rates, foreign exchange rates or commodity or equity
instruments and indices) related to financial instruments and commodities with
an aggregate net replacement cost of $21.6 billion. The net replacement cost
of all derivative products in a gain position represents the Company's maximum
exposure to derivatives related credit risk. Derivative products may have both
on- and off-balance sheet risk implications, depending on the nature of the
contract. It should be noted, however, that in many cases derivatives serve to
reduce, rather than increase, the Company's exposure to losses from market,
credit and other risks. The risks associated with the Company's derivative
activities, including market and credit risks, are managed on an integrated
basis with associated cash instruments in a manner consistent with the
Company's overall risk management policies and procedures. The Company manages
its credit exposure to derivative products through various means, which
include reviewing counterparty financial soundness periodically; entering into
master netting agreements and collateral arrangements with counterparties in
appropriate circumstances; and limiting the duration of exposure.
Year 2000 Readiness Disclosure
Many of the world's computer systems (including those in non-information
technology equipment and systems) currently record years in a two-digit
format. If not addressed, such computer systems may be unable to properly
interpret dates beyond the year 1999, which could lead to business disruptions
in the U.S. and internationally (the "Year 2000" issue). The potential costs
and uncertainties associated with the Year 2000 issue may depend on a number
of factors, including software, hardware and the nature of the industry in
which a company operates. Additionally, companies must coordinate with other
entities with which they electronically interact.
The Company has established a firm-wide initiative to address issues
associated with the Year 2000. Each of the Company's business areas has taken
responsibility for the identification and remediation of Year 2000 issues
within its own areas of operations and for addressing all interdependencies. A
corporate team of internal and external professionals supports the business
teams by providing direction and company-wide coordination as needed. The Year
2000 project has been designated as the highest priority activity of the
Company. To ensure
34
<PAGE>
that the Company's computer systems are Year 2000 compliant, a team of
Information Technology professionals began preparing for the Year 2000 issue
in 1995. Since then, the Company has reviewed its systems and programs to
identify those that contain two-digit year codes and has upgraded its global
infrastructure and corporate facilities. In addition, the Company is actively
working with its major external counterparties and suppliers to assess their
compliance and remediation efforts and the Company's exposure to them.
In addressing the Year 2000 issue, the Company has identified the following
phases. In the Awareness phase, the Company defined the Year 2000 issue and
obtained executive level support and funding. In the Inventory phase, the
Company collected a comprehensive list of items that may be affected by Year
2000 compliance issues. Such items include facilities and related non-
information technology systems (embedded technology), computer systems,
hardware, and services and products provided by third parties. In the
Assessment phase, the Company evaluated the items identified in the Inventory
phase to determine which will function properly with the change to the new
century, and ranked items which will need to be remediated based on their
potential impact to the Company. The Remediation phase included an analysis of
the items that are affected by Year 2000, the identification of problem areas
and the repair of non-compliant items. The Testing phase included a thorough
testing of all proposed repairs, including present and forward date testing
which simulates dates in the Year 2000. The Implementation phase consisted of
placing all items that were remediated and successfully tested into
production. Finally, the Integration and External Testing phase includes
exercising business critical production systems in a future time environment
and testing with external entities.
The Company has completed the Awareness, Inventory, Assessment, Remediation,
Testing and Implementation phases pursuant to plan. The Integration and
External Testing phase commenced in the second quarter of 1998 and will
continue through 1999.
The Company continues to survey and communicate with counterparties,
intermediaries, and vendors with whom it has important financial and
operational relationships to determine the extent to which they are vulnerable
to Year 2000 issues. In addition, the major operational relationships with
vendors of the Company have been identified, and the most critical of them
have been or are scheduled to be tested. The Company is closely monitoring the
status of non-compliant vendors. In some cases, the Company has implemented
risk reduction steps or created specific contingency plans to mitigate the
risk associated with the non-compliant vendor.
The Company has participated in the planning and execution of the Year 2000
Industrywide Tests organized by the membership of the Securities Industry
Association (the "SIA"). Such testing involved the participation of hundreds
of firms and a significant number of simulated transactions and conditions.
Additionally, the Company has participated in a variety of external tests in
the U.K., Japan, Hong Kong and selected European countries. The Company has
achieved successful results in each of the tests in which it participated. The
Company will continue to participate in industry-wide and vendor-specific
tests throughout the remainder of 1999.
There are many risks associated with the Year 2000 issue, including the
possibility of a failure of the Company's computer and non-information
technology systems. Such failures could have a material adverse effect on the
Company and may cause systems malfunctions; incorrect or incomplete
transaction processing resulting in failed trade settlements; the inability to
reconcile accounting books and records; the inability to reconcile credit card
transactions and balances; the inability to reconcile trading positions and
balances with counterparties; and inaccurate information to manage the
Company's exposure to trading risks and disruptions of funding requirements.
In addition, even if the Company successfully remediates its Year 2000 issues,
it can be materially and adversely affected by failures of third parties to
remediate their own Year 2000 issues. The Company recognizes the uncertainty
of such external dependencies since it can not directly control the
remediation efforts of third parties. The failure of third parties with which
the Company has financial or operational relationships such as securities
exchanges, clearing organizations, depositories, regulatory agencies, banks,
clients, counterparties, vendors (including data center, data network and
voice service providers) and utilities, to remediate their computer and non-
information technology systems issues in a timely manner could result in a
material financial risk to the Company.
35
<PAGE>
If the above mentioned risks are not remedied, the Company may experience
business interruption or shutdown, financial loss, regulatory actions, damage
to the Company's global franchise and legal liability. In addition, the
Company is monitoring the extent to which the impact of either potential or
actual Year 2000 problems in the financial services industry, such as a
reduction in the general level of trading activity by market participants, may
affect its business and operations.
The Company has business continuity plans in place for its critical business
functions on a worldwide basis. To help mitigate the impact of potential Year
2000-related issues, the Company is continuing to review the status of its
major external counterparties and suppliers with respect to their Year 2000
preparation. Where necessary, contingency plans have been expanded or
developed to address specific Year 2000 risk scenarios. In addition, the
Company is developing command, control and communication functions to assist
in event management and provide for a timely response to Year 2000 induced
failures. This preparation includes the development of analytical tools to
monitor critical business functions over the event horizon. The Company has
begun and will continue to test Year 2000 specific contingency plans during
the remainder of calendar year 1999 as part of its Year 2000 mitigation
efforts. The Company notes that no contingency plan can guarantee that mission
critical systems will not be impacted by the Year 2000 issue, particularly
with respect to systems that interact with third party products or services
outside the Company's control. The Company also has in place a Year 2000
Funding Plan (see "Liquidity & Capital Resources").
Based upon current information, the Company estimates that the total cost of
implementing its Year 2000 initiative will be between $200 million and $225
million. The Year 2000 costs include all activities undertaken on Year 2000
related matters across the Company, including, but not limited to,
remediation, testing (internal and external), third party review, risk
mitigation and contingency planning. Through May 31, 1999, the Company has
expended approximately $160 million on the Year 2000 project. The majority of
the remaining costs are expected to be directed primarily towards testing and
contingency planning activities. These costs have been and will continue to be
funded through operating cash flow and are expensed in the period in which
they are incurred.
The Company's expectations about future costs and the timely completion of
its Year 2000 activities are subject to uncertainties that could cause actual
results to differ materially from what has been discussed above. Factors that
could influence the amount of future costs and the effectiveness of the Year
2000 project include the success of the Company in identifying computer
programs and non-information technology systems that contain two-digit year
codes; the nature and amount of programming and testing required to upgrade or
replace any newly discovered Year 2000 issues; the nature and amount of
testing, verification and reporting required by the Company's regulators
around the world, including securities exchanges, central banks and various
governmental regulatory bodies; the rate and magnitude of related labor and
consulting costs; and the success of the Company's external counterparties and
suppliers, as well as worldwide exchanges, clearing organizations and
depositories, in addressing the Year 2000 issue.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Pursuant to Item 305 of Regulation S-K, there were no material changes for
the quarter ended May 31, 1999.
36
<PAGE>
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings.
The following developments have occurred with respect to certain matters
previously reported in the Company's Annual Report on Form 10-K for the fiscal
year ended November 30, 1998 and in the Company's Quarterly Report on Form 10-
Q for the fiscal quarter ended February 28, 1999.
Global Opportunity Fund Litigation. The matter has been settled.
Penalty Bid Litigation. In Myers v. Merrill Lynch & Co., Inc., et al., the
court held a hearing on March 25, 1999 on defendants' motion to dismiss the
complaint and plaintiffs' motion to remand the action. In Friedman, et al. v.
Salomon Smith Barney, Inc., et al., on May 7, 1999, defendants filed a motion
to dismiss the amended complaint.
IPO Fee Litigation. On April 29, 1999, defendants filed a motion to dismiss
the amended complaint.
Nenni, et al. v. Dean Witter Reynolds Inc. Plaintiffs filed an amended
complaint on April 30, 1999. Defendants filed a motion to dismiss the amended
complaint on July 9, 1999.
Item 2. Changes in Securities and Use of Proceeds.
(a) On June 15, 1999, the Company entered into the Second Amendment (the
"Second Amendment") to its Rights Agreement, dated as of April 25, 1995 (the
"Rights Agreement"), with Chase Manhattan Bank, as Rights Agent, which deleted
the provison that redemption of the rights following a change in the majority
of the Company's Board of Directors required the concurrence of a majority of
those directors (i) who were members of the Company's Board of Directors
before the adoption of the Rights Agreement (or directors who were nominated
or approved by such persons) and (ii) who are not affiliated with, or
representatives of, a holder of 15% or more of the common stock, par value
$0.01 per share, of the Company. The foregoing description of the Second
Amendment does not purport to be complete and is qualified in its entirety by
reference to the Second Amendment which has been filed with the Securities and
Exchange Commission as an exhibit to the Company's Current Report on Form 8-K
dated June 15, 1999.
(c) To enhance its ongoing stock repurchase program, the Company sold
European-style put options on an aggregate of 768,500 shares of its common
stock subsequent to May 31, 1999. The put options expire on various dates
through November 1999. They entitle the holder to sell common stock to the
Company at prices ranging from $87.8230 to $72.0149 per share, although the
Company may elect cash settlement of the put options instead of taking
delivery of the stock. The sale of the put options, which was made as a
private placement to a third party, generated proceeds to the Company of
approximately $4 million.
Item 4. Submission of Matters to a Vote of Security Holders.
The annual meeting of stockholders of the Company was held on April 9, 1999.
The stockholders voted on proposals to (1) elect one class of directors for
a three-year term, (2) amend the Company's Employee Stock Purchase Plan
("ESPP") to increase the number of shares of the Company's Common Stock
reserved for issuance thereunder by 25,000,000 shares and (3) ratify the
appointment of Deloitte & Touche LLP as independent auditors.
The stockholders also took action on three stockholder proposals seeking to
(1) declassify the Board of Directors ("First Proposal"), (2) tie executive
compensation to the amount of dividends paid ("Second Proposal") and (3)
request that the Board of Directors issue a report by October 1999 reviewing
the Company's
37
<PAGE>
underwriting, investing and lending criteria with the view to incorporating
criteria related to a transaction's impact on the environment, human rights
and risk to the Company's reputation ("Third Proposal").
The vote of the stockholders resulted in the approval of the amendment to
the ESPP and the ratification of the appointment of the independent auditors.
In addition, all nominees for election to the board were elected to the terms
of office set forth in the Proxy Statement dated February 19, 1999. The three
stockholder proposals
were defeated. The number of votes cast for, against or withheld, and the
number of abstentions and broker non-votes with respect to each proposal, is
set forth below.
<TABLE>
<CAPTION>
Against/ Broker
For Withheld Abstain Non-vote
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Election of Directors:
Nominee:
Charles F. Knight ............ 484,510,286 3,278,004 * *
Miles L. Marsh................ 484,525,221 3,263,069 * *
Laura D'Andrea Tyson.......... 481,931,697 5,856,592 * *
Approval of the Amendment to the
Employee Stock Purchase Plan .. 464,241,772 20,645,660 2,906,990 *
Ratification of Independent
Auditors....................... 484,574,614 1,453,294 1,722,912 *
First Proposal.................. 181,346,277 254,182,650 6,048,634 36,304,996
Second Proposal................. 20,838,493 400,722,389 20,096,932 36,224,743
Third Proposal.................. 22,983,413 382,455,152 36,202,311 36,241,681
</TABLE>
- --------
* Not Applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
An exhibit index has been filed as part of this Report on Page E-1.
(b) Reports on Form 8-K
Form 8-K dated March 25, 1999 reporting Items 5 and 7.
Form 8-K dated May 6, 1999 reporting Items 5 and 7.
Form 8-K/A dated May 6, 1999 reporting Items 5 and 7.
38
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Morgan Stanley Dean Witter & Co.
(Registrant)
/s/ Joanne Pace
By:
----------------------------------
Joanne Pace, Controller and
Principal Accounting Officer
Date: July 14, 1999
39
<PAGE>
EXHIBIT INDEX
MORGAN STANLEY DEAN WITTER & CO.
Quarter Ended May 31, 1999
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
4.1 Second Amendment, dated as of June 15, 1999 to the Company's Rights Agreement, dated
as of April 25, 1995, with Chase Manhattan Bank, as Rights Agent (incorporated by
reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated June 15,
1999 and filed June 29, 1999).
11 Computation of earnings per share.
12 Computation of ratio of earnings to fixed charges.
15.1 Letter of awareness from Deloitte & Touche LLP, dated July 14, 1999
concerning unaudited interim financial information.
27 Financial Data Schedule.
</TABLE>
E-1
<PAGE>
Exhibit 11
Morgan Stanley Dean Witter & Co.
Computation of Earnings Per Share
(In millions, except share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------------------- --------------------------------
May 31 May 31 May 31 May 31
1999 1998 1999 1998
---------------- ----------------- ---------------- --------------
<S> <C> <C> <C> <C>
Basic:
Weighted-average shares outstanding 554,146,582 581,326,618 553,788,197 583,502,306
================ ================= ================ ==============
Earnings:
Income before cumulative effect
of accounting change $1,151 $852 $2,188 $1,543
Cumulative effect of accounting
change - - - (117)
Less: Preferred stock dividend
requirements (10) (14) (21) (29)
---------------- ----------------- ---------------- --------------
Earnings applicable to common shares $1,141 $838 $2,167 $1,397
================ ================= ================ ==============
Basic EPS before cumulative effect
of accounting change $2.06 $1.44 $3.91 $2.59
Cumulative effect of accounting
change - - - (0.20)
================ ================= ================ ==============
Basic earnings per share $2.06 $1.44 $3.91 $2.39
================ ================= ================ ==============
Diluted:
Weighted-average shares outstanding 554,146,582 581,326,618 553,788,197 583,502,306
Average common shares issuable
under employee benefit plans 20,795,026 19,341,537 19,964,374 18,689,467
Average common shares issuable upon
conversion of ESOP preferred stock 11,714,077 11,957,199 11,755,614 11,987,642
---------------- ----------------- ---------------- --------------
Total weighted-average diluted shares 586,655,685 612,625,354 585,508,185 614,179,415
================ ================= ================ ==============
Earnings:
Income before cumulative effect
of accounting change $1,151 $852 $2,188 $1,543
Cumulative effect of accounting
change - - - $(117)
Less: Preferred stock dividend
requirements (9) (13) (18) (26)
---------------- ----------------- ---------------- --------------
Earnings applicable to common shares $1,142 $839 $2,170 $1,400
================ ================= ================ ==============
Diluted EPS before cumulative effect
of accounting change $1.95 $1.37 $3.71 $2.47
Cumulative effect of accounting - - - (0.19)
change
================ ================= ================ ==============
Diluted earnings per share $1.95 $1.37 $3.71 $2.28
================ ================= ================ ==============
</TABLE>
<PAGE>
EXHIBIT 12
Ratio of Earnings to Fixed Charges
and Ratio of Earnings to Fixed Charges and Preferred Stock Dividends
(Dollars in millions)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended Fiscal Year
------------------ ----------------- ---------------------------
May 31, May 31, May 31, May 31,
1999 1998 1999 1998 1998 1997 1996
------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Ratio of Earnings to Fixed Charges
Earnings:
Income before income taxes $ 1,858 $ 1,397 $ 3,530 $ 2,529 $ 5,385 $ 4,274 $ 3,117
Add: Fixed charges, net 3,307 3,579 6,212 6,748 13,614 10,898 9,026
------- ------- ------- ------- ------- ------- -------
Income before income taxes and
fixed charges, net $ 5,165 $ 4,976 $ 9,742 $ 9,277 $18,999 $15,172 $12,143
======= ======= ======= ======= ======= ======= =======
Fixed charges:
Total interest expense $ 3,278 $ 3,554 $ 6,155 $ 6,699 $13,514 $10,806 $ 8,934
Interest factor in rents 29 25 57 49 100 92 92
------- ------- ------- ------- ------- ------- -------
Total fixed charges $ 3,307 $ 3,579 $ 6,212 $ 6,748 $13,614 $10,898 $ 9,026
======= ======= ======= ======= ======= ======= =======
Ratio of earnings to fixed charges 1.6 1.4 1.6 1.4 1.4 1.4 1.3
Ratio of Earnings to Fixed Charges and
Preferred Stock Dividends
Earnings:
Income before income taxes $ 1,858 $ 1,397 $ 3,530 $ 2,529 $ 5,385 $ 4,274 $ 3,117
Add: Fixed charges, net 3,307 3,579 6,212 6,748 13,614 10,898 9,026
------- ------- ------- ------- ------- ------- -------
Income before income taxes and
fixed charges, net $ 5,165 $ 4,976 $ 9,742 $ 9,277 $18,999 $15,172 $12,143
======= ======= ======= ======= ======= ======= =======
Fixed charges:
Total interest expense $ 3,278 $ 3,554 $ 6,155 $ 6,699 $13,514 $10,806 $ 8,934
Interest factor in rents 29 25 57 49 100 92 92
Preferred stock dividends 18 24 35 48 87 110 101
------- ------- ------- ------- ------- ------- -------
Total fixed charges and preferred
stock dividends $ 3,325 $ 3,603 $ 6,247 $ 6,796 $13,701 $11,008 $ 9,127
======= ======= ======= ======= ======= ======= =======
Ratio of earnings to fixed charges and
preferred stock dividends 1.6 1.4 1.6 1.4 1.4 1.4 1.3
</TABLE>
(1) 1998 income before income taxes does not include a cumulative effect of
accounting change.
"Earnings" consist of income before income taxes and fixed charges. "Fixed
charges" consist of interest costs, including interest on deposits, and
that portion of rent expense estimated to be representative of the interest
factor. The preferred stock dividend amounts represent pre-tax earnings
required to cover dividends on preferred stock.
<PAGE>
EXHIBIT 15.1
To the Directors and Shareholders of Morgan Stanley Dean Witter & Co.:
We have made a review, in accordance with standards established by the American
Institute of Certified Public Accountants, of the unaudited interim condensed
consolidated financial information of Morgan Stanley Dean Witter & Co. and
subsidiaries as of May 31, 1999 and for the three and six month periods ended
May 31, 1999 and 1998, as indicated in our report dated July 14, 1999; because
we did not perform an audit, we expressed no opinion on that information.
We are aware that our report, which is included in your Quarterly Report on Form
10-Q for the quarter ended May 31, 1999, is incorporated by reference in the
following Registration Statements:
Filed on Form S-3:
Registration Statement No. 33-57202
Registration Statement No. 33-60734
Registration Statement No. 33-89748
Registration Statement No. 33-92172
Registration Statement No. 333-07947
Registration Statement No. 333-22409
Registration Statement No. 333-27881
Registration Statement No. 333-27893
Registration Statement No. 333-27919
Registration Statement No. 333-46403
Registration Statement No. 333-46935
Registration Statement No. 333-76111
Registration Statement No. 333-75289
Filed on Form S-4:
Registration Statement No. 333-25003
Filed on Form S-8:
Registration Statement No. 33-62374
Registration Statement No. 33-63024
Registration Statement No. 33-63026
Registration Statement No. 33-78038
Registration Statement No. 33-79516
Registration Statement No. 33-82240
Registration Statement No. 33-82242
Registration Statement No. 33-82244
Registration Statement No. 333-04212
Registration Statement No. 333-28141
Registration Statement No. 333-25003
Registration Statement No. 333-28263
Registration Statement No. 333-62869
Registration Statement No. 333-78081
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
July 14, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> BD
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION AT MAY 31, 1999 AND THE
CONDENSED CONSOLIDATED STATEMENTS OF INCOME FOR THE SIX MONTHS ENDED MAY 31,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> NOV-30-1999
<PERIOD-START> DEC-01-1998
<PERIOD-END> MAY-31-1999
<CASH> 19,791
<RECEIVABLES> 59,322
<SECURITIES-RESALE> 85,138
<SECURITIES-BORROWED> 88,009
<INSTRUMENTS-OWNED> 79,664
<PP&E> 2,121
<TOTAL-ASSETS> 342,345
<SHORT-TERM> 33,131
<PAYABLES> 59,145
<REPOS-SOLD> 101,961
<SECURITIES-LOANED> 25,382
<INSTRUMENTS-SOLD> 67,806
<LONG-TERM> 28,782
0
672
<COMMON> 6
<OTHER-SE> 14,671
<TOTAL-LIABILITY-AND-EQUITY> 342,345
<TRADING-REVENUE> 3,617
<INTEREST-DIVIDENDS> 7,169
<COMMISSIONS> 1,454
<INVESTMENT-BANKING-REVENUES> 1,979
<FEE-REVENUE> 2,740
<INTEREST-EXPENSE> 6,155
<COMPENSATION> 4,776
<INCOME-PRETAX> 3,530
<INCOME-PRE-EXTRAORDINARY> 3,530
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,188
<EPS-BASIC> 3.91
<EPS-DILUTED> 3.71
</TABLE>
