<PAGE>
-------------------------------------------------------------------------------
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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, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-11758
Morgan Stanley Dean Witter & Co.
(Exact Name of Registrant as Specified in its Charter)
----------------
Delaware 36-3145972
(State of Incorporation) (I.R.S. Employer Identification No.)
1585 Broadway 10036
New York, NY (Zip Code)
(Address of Principal Executive
Offices)
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, 2000 there were 1,125,144,508 shares of Registrant's Common
Stock, par value $.01 per share, outstanding.
-------------------------------------------------------------------------------
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<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
Quarter Ended May 31, 2000
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I--Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Financial Condition--May 31, 2000
(unaudited) and November 30, 1999.................................... 1
Condensed Consolidated Statements of Income (unaudited)--Three and Six
Months Ended May 31, 2000 and May 31, 1999........................... 2
Condensed Consolidated Statements of Comprehensive Income
(unaudited)--Three and Six Months Ended May 31, 2000 and May 31,
1999................................................................. 3
Condensed Consolidated Statements of Cash Flows (unaudited)--Six
Months Ended May 31, 2000 and May 31, 1999........................... 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................................ 37
</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,
2000 1999
---------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 15,956 $ 12,325
Cash and securities deposited with clearing
organizations or segregated under federal and other
regulations (including securities at fair value of
$22,660 at May 31, 2000 and $6,925 at November 30,
1999)............................................... 25,970 9,713
Financial instruments owned:
U.S. government and agency securities............... 17,619 25,646
Other sovereign government obligations.............. 21,299 17,522
Corporate and other debt............................ 29,411 30,443
Corporate equities.................................. 21,723 14,843
Derivative contracts................................ 26,833 22,769
Physical commodities................................ 255 819
Securities purchased under agreements to resell...... 60,750 70,366
Receivable for securities provided as collateral..... 3,935 9,007
Securities borrowed.................................. 119,315 85,064
Receivables:
Consumer loans (net of allowances of $773 at May
31, 2000 and $769 at November 30, 1999)............ 21,733 20,229
Customers, net...................................... 29,602 29,299
Brokers, dealers and clearing organizations......... 1,900 2,252
Fees, interest and other............................ 7,535 5,371
Office facilities, at cost (less accumulated
depreciation and amortization of $1,777 at May 31,
2000 and $1,667 at November 30, 1999)............... 2,158 2,204
Aircraft under operating leases (less accumulated
depreciation of $152 at May 31, 2000 and $101 at
November 30, 1999) 3,995 1,884
Other assets......................................... 7,597 7,211
-------- --------
Total assets......................................... $417,586 $366,967
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Commercial paper and other short-term borrowings..... $ 39,876 $ 38,242
Deposits............................................. 11,089 10,397
Financial instruments sold, not yet purchased:
U.S. government and agency securities............... 13,561 12,285
Other sovereign government obligations.............. 8,513 7,812
Corporate and other debt............................ 4,674 2,322
Corporate equities.................................. 25,421 15,402
Derivative contracts................................ 25,328 23,228
Physical commodities................................ 1,226 919
Securities sold under agreements to repurchase....... 83,782 104,450
Obligation to return securities received as
collateral.......................................... 14,243 14,729
Securities loaned.................................... 41,194 30,080
Payables:
Customers........................................... 74,509 45,775
Brokers, dealers and clearing organizations......... 1,995 1,335
Interest and dividends.............................. 3,009 2,951
Other liabilities and accrued expenses............... 12,862 10,439
Long-term borrowings................................. 37,355 28,604
-------- --------
398,637 348,970
-------- --------
Capital Units........................................ 439 583
-------- --------
Preferred Securities Issued by Subsidiaries.......... 400 400
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock..................................... 545 670
Common stock(1) ($0.01 par value, 3,500,000,000
shares authorized, 1,211,685,904 and 1,211,685,904
shares issued, 1,124,979,347 and 1,104,630,098
shares outstanding at May 31, 2000 and November
30, 1999).......................................... 12 12
Paid-in capital(1).................................. 3,245 3,836
Retained earnings................................... 18,813 16,285
Employee stock trust................................ 2,419 2,426
Cumulative translation adjustments.................. (90) (27)
-------- --------
Subtotal.......................................... 24,944 23,202
Note receivable related to ESOP..................... (55) (55)
Common stock held in treasury, at cost(1) ($0.01
par value, 86,706,557 and 107,055,806 shares at
May 31, 2000 and November 30, 1999)................ (4,360) (4,355)
Common stock issued to employee trust............... (2,419) (1,778)
-------- --------
Total shareholders' equity........................ 18,110 17,014
-------- --------
Total liabilities and shareholders' equity........... $417,586 $366,967
======== ========
</TABLE>
-------
(1) Fiscal 1999 amounts have been retroactively adjusted to give effect for a
two-for-one common stock split, effected in the form of a 100% stock
dividend, which became effective on January 26, 2000.
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,
---------------------------- ---------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Investment banking...... $ 1,370 $ 1,021 $ 2,705 $ 1,978
Principal transactions:
Trading................ 2,501 1,890 4,778 3,549
Investments............ (236) 150 195 415
Commissions............. 972 733 1,956 1,352
Fees:
Asset management,
distribution and
administration........ 1,075 825 2,041 1,593
Merchant and
cardmember............ 447 357 890 698
Servicing.............. 349 310 636 563
Interest and dividends.. 5,123 3,426 9,872 7,171
Other................... 91 67 185 118
------------- ------------- ------------- -------------
Total revenues......... 11,692 8,779 23,258 17,437
Interest expense........ 4,420 3,015 8,352 6,157
Provision for consumer
loan losses............ 204 119 427 296
------------- ------------- ------------- -------------
Net revenues........... 7,068 5,645 14,479 10,984
------------- ------------- ------------- -------------
Non-interest expenses:
Compensation and
benefits.............. 3,097 2,413 6,505 4,776
Occupancy and
equipment............. 174 153 349 299
Brokerage, clearing
and exchange fees..... 130 127 251 241
Information processing
and communications.... 381 315 727 624
Marketing and business
development........... 502 381 973 776
Professional
services.............. 217 191 400 353
Other.................. 272 207 547 385
------------- ------------- ------------- -------------
Total non-interest
expenses............ 4,773 3,787 9,752 7,454
------------- ------------- ------------- -------------
Income before income
taxes.................. 2,295 1,858 4,727 3,530
Provision for income
taxes.................. 837 707 1,725 1,342
------------- ------------- ------------- -------------
Net income.............. $ 1,458 $ 1,151 $ 3,002 $ 2,188
============= ============= ============= =============
Preferred stock dividend
requirements........... $ 9 $ 10 $ 18 $ 21
============= ============= ============= =============
Earnings applicable to
common shares(1)....... $ 1,449 $ 1,141 $ 2,984 $ 2,167
============= ============= ============= =============
Earnings per share(2):
Basic.................. $ 1.32 $ 1.03 $ 2.72 $ 1.96
============= ============= ============= =============
Diluted................ $ 1.26 $ 0.97 $ 2.60 $ 1.85
============= ============= ============= =============
Average common shares
outstanding(2):
Basic.................. 1,098,245,490 1,108,293,164 1,096,007,767 1,107,576,394
============= ============= ============= =============
Diluted................ 1,145,401,309 1,173,311,370 1,146,322,769 1,171,016,370
============= ============= ============= =============
</TABLE>
--------
(1) Amounts shown are used to calculate basic earnings per common share.
(2) Fiscal 1999 amounts have been retroactively adjusted to give effect for a
two-for-one common stock split, effected in the form of a 100% stock
dividend, which became effective on January 26, 2000.
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,
-------------- --------------
2000 1999 2000 1999
------ ------ ------ ------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net income....................................... $1,458 $1,151 $3,002 $2,188
Other comprehensive income, net of tax:
Foreign currency translation adjustment......... (51) (5) (63) (24)
------ ------ ------ ------
Comprehensive income............................. $1,407 $1,146 $2,939 $2,164
====== ====== ====== ======
</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,
----------------
2000 1999
------- -------
(unaudited)
<S> <C> <C>
Cash flows from operating activities
Net income................................................... $ 3,002 $ 2,188
Adjustments to reconcile net income to net cash provided by
(used for) operating activities:
Non-cash charges included in net income.................. 882 616
Changes in assets and liabilities:
Cash and securities deposited with clearing organizations
or segregated under federal and other regulations....... (16,257) 1,372
Financial instruments owned, net of financial instruments
sold, not yet purchased................................. 16,037 13,395
Securities borrowed, net of securities loaned............ (23,137) (16,441)
Receivables and other assets............................. (3,075) (11,264)
Payables and other liabilities........................... 31,317 2,518
------- -------
Net cash provided by (used for) operating activities......... 8,769 (7,616)
------- -------
Cash flows from investing activities
Net (payments for) proceeds from:
Office facilities........................................ (121) (454)
Purchase of AB Asesores, net of cash acquired............ -- (223)
Purchase of Ansett Worldwide, net of cash acquired....... (199) --
Net principal disbursed on consumer loans................ (6,234) (1,480)
Sales of consumer loans.................................. 4,313 2,471
------- -------
Net cash (used for) provided by investing activities......... (2,241) 314
------- -------
Cash flows from financing activities
Net proceeds from (payments for) short-term borrowings..... 1,566 (3,866)
Securities sold under agreements to repurchase, net of
securities purchased under agreements to resell........... (11,052) 4,066
Net proceeds from:
Deposits................................................. 692 612
Issuance of common stock................................. 304 188
Issuance of put options.................................. 18 --
Issuance of long-term borrowings......................... 12,622 6,553
Payments for:
Repurchases of common stock.............................. (1,856) (933)
Repayments of long-term borrowings....................... (4,583) (4,943)
Redemption of Capital Units.............................. (144) (352)
Cash dividends........................................... (464) (290)
------- -------
Net cash (used for) provided by financing activities......... (2,897) 1,035
------- -------
Net increase (decrease) in cash and cash equivalents......... 3,631 (6,267)
Cash and cash equivalents, at beginning of period............ 12,325 16,878
------- -------
Cash and cash equivalents, at end of period.................. $15,956 $10,611
======= =======
</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
Morgan Stanley Dean Witter & Co. (the "Company") is a global financial
services firm that maintains leading market positions in each of its three
business segments--Securities, Asset Management and Credit Services. Its
Securities business includes securities underwriting, distribution and
trading; merger, acquisition, restructuring, real estate, project finance and
other corporate finance advisory activities; full-service and online brokerage
services; 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 private equity activities. The Company's
Asset Management business provides global asset management advice and services
to investors through a variety of product lines and brand names, including
Morgan Stanley Dean Witter Advisors, Van Kampen Investments, Morgan Stanley
Dean Witter Investment Management and Miller Anderson & Sherrerd. The
Company's Credit Services business includes the issuance of the Discover(R)
Card and the Morgan Stanley Dean Witter SM Card and the operation of Discover
Business Services (formerly the Discover/NOVUS(R) Network), a proprietary
network of merchant and cash access locations.
The condensed consolidated financial statements include the accounts of the
Company and its U.S. and international subsidiaries, including Morgan Stanley
& Co. Incorporated ("MS&Co."), Morgan Stanley & Co. International Limited
("MSIL"), Morgan Stanley Dean Witter Japan Limited ("MSDWJL"), Dean Witter
Reynolds Inc. ("DWR"), Morgan Stanley Dean Witter Advisors Inc. and NOVUS
Credit Services Inc.
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 for the fiscal
year ended November 30, 1999 (the "Form 10-K"). 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 contracts are
derived from pricing models which consider current market and contractual
prices for the
5
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. The Company also uses
interest rate swaps to match the repricing characteristics of consumer loans
with those of 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.
On December 20, 1999, the Company's Board of Directors declared a two-for-
one common stock split, effected in the form of a 100% stock dividend, payable
to shareholders of record on January 12, 2000 and distributable on January 26,
2000. All share, per share and shareholders' equity data have been
retroactively restated to reflect this split.
On April 6, 2000, shareholders of the Company approved an increase in the
number of authorized common stock shares to 3.5 billion.
As of May 31, 2000, approximately $1.9 billion of the Company's aircraft
assets were owned by Morgan Stanley Aircraft Finance, a bankruptcy-remote
special purpose business trust. Such aircraft assets are not available to
satisfy claims of potential creditors of the Company.
Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities,"
6
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. In June 2000, the FASB issued SFAS No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities--an
amendment of FASB Statement No. 133". The Company is in the process of
evaluating the impact of adopting SFAS No. 133, as amended by SFAS No. 138.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 is effective for
financial statements for fiscal years beginning after December 15, 1998 and
provides specific guidance as to when certain costs incurred in connection
with an internal-use software project should be capitalized and when they
should be expensed. The Company adopted SOP 98-1 effective December 1, 1999.
The adoption of SOP 98-1 did not have a material impact on the Company's
condensed consolidated financial statements.
2. Consumer Loans
Activity in the allowance for consumer loan losses was as follows (dollars
in millions):
<TABLE>
<CAPTION>
Three Six
Months Months
Ended May Ended May
31, 31,
---------- ----------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Balance, beginning of period............................ $771 $777 $769 $787
Provision for loan losses............................... 204 119 427 296
Less deductions:
Charge-offs........................................... 228 211 485 482
Recoveries............................................ (26) (30) (62) (62)
---- ---- ---- ----
Net charge-offs....................................... 202 181 423 420
---- ---- ---- ----
Other(1)................................................ -- 53 -- 105
---- ---- ---- ----
Balance, end of period.................................. $773 $768 $773 $768
==== ==== ==== ====
</TABLE>
--------
(1) Primarily reflects transfers related to asset securitizations.
Interest accrued on loans subsequently charged off, recorded as a reduction
of interest revenue, was $26 million and $63 million in the quarter and six
month periods ended May 31, 2000 and $28 million and $63 million in the
quarter and six month periods ended May 31, 1999.
The Company received net proceeds from asset securitizations of $2,999
million and $4,313 million in the quarter and six month period ended May 31,
2000 and $1,946 million and $2,471 million in the quarter and six month period
ended May 31, 1999. The uncollected balances of consumer loans sold through
asset securitizations were $21,195 million at May 31, 2000 and $16,977 million
at November 30, 1999.
3. Long-Term Borrowings
Long-term borrowings at May 31, 2000 scheduled to mature within one year
aggregated $9,350 million.
During the six month period ended May 31, 2000 the Company issued senior
notes aggregating $12,597 million, including non-U.S. dollar currency notes
aggregating $1,619 million, primarily pursuant to its public debt shelf
registration statements. The weighted average coupon interest rate of these
notes was 6.37% at May 31, 2000; the Company has entered into certain
transactions to obtain floating interest rates based primarily on
7
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
short-term LIBOR trading levels. Maturities in the aggregate of these notes by
fiscal year are as follows: 2001, $3,192 million; 2002, $2,299 million; 2003,
$4,370 million; 2004, $25 million; 2005, $953 million and thereafter, $1,758
million. In the six month period ended May 31, 2000, $4,583 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,
2000 1999 2000 1999
--------- ------------ ------- ------------
(dollars in millions)
<S> <C> <C> <C> <C>
ESOP Convertible Preferred Stock,
liquidation
preference $35.88............... -- 3,493,477 $ -- $125
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.......................... $545 $670
==== ====
</TABLE>
Each issue of outstanding preferred stock ranks in parity with all other
outstanding preferred stock of the Company.
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.
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 2015 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.
In January 2000, the Company and MS plc called for the redemption of all of
the outstanding 9.00% Capital Units on February 28, 2000. The aggregate
principal amount of the Capital Units redeemed was $144 million.
In January 2000, all shares of the ESOP Convertible Preferred Stock were
converted into shares of common stock of the Company.
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 $4,139 million at May 31, 2000, which exceeded the amount
required by $3,416 million. DWR's net capital totaled $1,379 million at May
31, 2000, which exceeded the amount required by $1,190 million. MSIL, a
London-based broker-dealer subsidiary, is subject to the capital requirements
of the Securities and Futures Authority, and MSDWJL, a Tokyo-based broker-
dealer, is subject to the capital requirements of the Financial Services
Agency. MSIL and MSDWJL have consistently operated in excess of their
respective regulatory capital requirements.
8
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Under regulatory capital requirements adopted by the Federal Deposit
Insurance Corporation ("FDIC") and other bank regulatory agencies, FDIC-
insured financial institutions must maintain (a) 3% to 5% of Tier 1 capital,
as defined, to average assets ("leverage ratio"), (b) 4% of Tier 1 capital, as
defined, to risk-weighted assets ("Tier 1 risk-weighted capital ratio") and
(c) 8% of total capital, as defined, to risk-weighted assets ("total risk-
weighted capital ratio"). At May 31, 2000, the leverage ratio, Tier 1 risk-
weighted capital ratio and total risk-weighted capital ratio of each of the
Company's FDIC-insured financial institutions exceeded these 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 an effort to enhance its ongoing stock repurchase program, the Company
may sell put options on shares of its common stock to third parties. These put
options entitle the holder to sell shares of the Company's common stock to the
Company on certain dates at specified prices. As of May 31, 2000, put options
were outstanding on an aggregate of 2.0 million shares of the Company's common
stock. The maturity dates of these put options range from June 2000 through
October 2000. The Company may elect cash settlement of the put options instead
of purchasing the stock.
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 May 31, Ended May 31,
-------------- --------------
2000 1999 2000 1999
------ ------ ------ ------
<S> <C> <C> <C> <C>
Basic EPS:
Net income................................... $1,458 $1,151 $3,002 $2,188
Preferred stock dividend requirements........ (9) (10) (18) (21)
------ ------ ------ ------
Net income available to common shareholders.. $1,449 $1,141 $2,984 $2,167
====== ====== ====== ======
Weighted-average common shares outstanding... 1,098 1,108 1,096 1,108
====== ====== ====== ======
Basic EPS.................................... $ 1.32 $ 1.03 $ 2.72 $ 1.96
====== ====== ====== ======
Diluted EPS:
Net income................................... $1,458 $1,151 $3,002 $2,188
Preferred stock dividend requirements........ (9) (9) (18) (18)
------ ------ ------ ------
Net income available to common shareholders.. $1,449 $1,142 $2,984 $2,170
====== ====== ====== ======
Weighted-average common shares outstanding... 1,098 1,108 1,096 1,108
Effect of dilutive securities:
Stock options.............................. 47 42 46 40
ESOP convertible preferred stock........... -- 23 4 23
------ ------ ------ ------
Weighted-average common shares outstanding
and common stock equivalents................ 1,145 1,173 1,146 1,171
====== ====== ====== ======
Diluted EPS.................................. $ 1.26 $ 0.97 $ 2.60 $ 1.85
====== ====== ====== ======
</TABLE>
9
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 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 $6.5 billion and $6.3 billion of letters of
credit outstanding at May 31, 2000 and at November 30, 1999, respectively, to
satisfy various collateral requirements.
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, although 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, 1999, 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 less than
or 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.
10
<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,
2000 and November 30, 1999 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 comparable 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, 2000
Interest rate and
currency swaps and
options (including
caps, floors and swap
options) and other
fixed income securities
contracts.............. $ 2,537 $ 4,423 $ 2,660 $ 900 $ 117 $ 146 $10,783
Foreign exchange forward
contracts and options.. 138 1,070 907 122 -- 206 2,443
Equity securities
contracts (including
equity swaps, warrants
and options)........... 1,657 2,663 1,044 100 2,174 554 8,192
Commodity forwards,
options and swaps...... 228 1,091 1,306 1,600 179 913 5,317
Mortgage-backed
securities forward
contracts, swaps and
options................ 48 29 20 1 -- -- 98
------- ------- ------- ------ ------ ------ -------
Total.................. $ 4,608 $ 9,276 $ 5,937 $2,723 $2,470 $1,819 $26,833
======= ======= ======= ====== ====== ====== =======
Percent of total........ 17% 35% 22% 10% 9% 7% 100%
======= ======= ======= ====== ====== ====== =======
At November 30, 1999
Interest rate and
currency swaps and
options (including
caps, floors and swap
options) and other
fixed income securities
contracts.............. $ 1,569 $ 3,842 $ 2,896 $ 884 $ 117 $ 174 $ 9,482
Foreign exchange forward
contracts and options.. 556 1,551 1,285 170 -- 140 3,702
Equity securities
contracts (including
equity swaps, warrants
and options)........... 1,742 2,310 1,109 260 1,308 320 7,049
Commodity forwards,
options and swaps...... 164 571 660 469 52 508 2,424
Mortgage-backed
securities forward
contracts, swaps and
options ............... 41 33 35 1 1 1 112
------- ------- ------- ------ ------ ------ -------
Total.................. $ 4,072 $ 8,307 $ 5,985 $1,784 $1,478 $1,143 $22,769
======= ======= ======= ====== ====== ====== =======
Percent of total........ 18% 37% 26% 8% 6% 5% 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 control structure for its securities businesses.
11
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Segment Information
The Company structures its segments primarily based upon the nature of the
financial products and services provided to customers and the Company's
management organization. The Company operates in three business segments:
Securities, Asset Management and Credit Services, through which it provides a
wide range of financial products and services to its customers. Revenues and
expenses directly associated with each respective segment are included in
determining their operating results. Other revenues and expenses that are not
directly attributable to a particular segment are allocated based upon the
Company's allocation methodologies, generally based on each segment's
respective revenues or other relevant measures. Selected financial information
for the Company's segments is presented in the tables below.
<TABLE>
<CAPTION>
Three Months Ended May 31,
2000 Securities Asset Management Credit Services Total
-------------------------- ---------- ---------------- --------------- ------
<S> <C> <C> <C> <C>
(dollars in millions)
All other revenues......... $5,160 $613 $592 $6,365
Net interest............... 290 16 397 703
------ ---- ---- ------
Net revenues............... $5,450 $629 $989 $7,068
====== ==== ==== ======
Income before taxes........ $1,687 $263 $345 $2,295
Provision for income
taxes..................... 597 107 133 837
------ ---- ---- ------
Net income................. $1,090 $156 $212 $1,458
====== ==== ==== ======
<CAPTION>
Three Months Ended May 31,
1999 Securities Asset Management Credit Services Total
-------------------------- ---------- ---------------- --------------- ------
<S> <C> <C> <C> <C>
(dollars in millions)
All other revenues......... $4,177 $509 $548 $5,234
Net interest............... 83 4 324 411
------ ---- ---- ------
Net revenues............... $4,260 $513 $872 $5,645
====== ==== ==== ======
Income before taxes........ $1,346 $181 $331 $1,858
Provision for income
taxes..................... 511 76 120 707
------ ---- ---- ------
Net income................. $ 835 $105 $211 $1,151
====== ==== ==== ======
</TABLE>
12
<PAGE>
MORGAN STANLEY DEAN WITTER & CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
Six Months Ended May 31,
2000 Securities Asset Management Credit Services Total
------------------------ ---------- ---------------- --------------- --------
<S> <C> <C> <C> <C>
(dollars in millions)
All other revenues....... $ 10,660 $1,200 $ 1,099 $ 12,959
Net interest............. 712 29 779 1,520
-------- ------ ------- --------
Net revenues............. $ 11,372 $1,229 $ 1,878 $ 14,479
======== ====== ======= ========
Income before taxes...... $ 3,619 $ 531 $ 577 $ 4,727
Provision for income
taxes................... 1,285 217 223 1,725
-------- ------ ------- --------
Net income............... $ 2,334 $ 314 $ 354 $ 3,002
======== ====== ======= ========
<CAPTION>
Six Months Ended May 31,
1999 Securities Asset Management Credit Services Total
------------------------ ---------- ---------------- --------------- --------
<S> <C> <C> <C> <C>
(dollars in millions)
All other revenues....... $ 8,012 $ 993 $ 965 $ 9,970
Net interest............. 326 29 659 1,014
-------- ------ ------- --------
Net revenues............. $ 8,338 $1,022 $ 1,624 $ 10,984
======== ====== ======= ========
Income before taxes...... $ 2,639 $ 365 $ 526 $ 3,530
Provision for income
taxes................... 998 153 191 1,342
-------- ------ ------- --------
Net income............... $ 1,641 $ 212 $ 335 $ 2,188
======== ====== ======= ========
<CAPTION>
Total Assets Securities Asset Management Credit Services Total
------------ ---------- ---------------- --------------- --------
<S> <C> <C> <C> <C>
(dollars in millions)
May 31, 2000(1).......... $385,031 $5,126 $27,429 $417,586
======== ====== ======= ========
November 30, 1999(1)..... $336,890 $4,927 $25,150 $366,967
======== ====== ======= ========
</TABLE>
--------
(1) Corporate assets have been fully allocated to the Company's business
segments.
10. Business Acquisition
During the second quarter of fiscal 2000, the Company completed its
acquisition of Ansett Worldwide Aviation Services ("Ansett Worldwide"). Ansett
Worldwide is one of the world's leading aircraft leasing groups, supplying new
and used commercial jet aircraft to airlines around the world. The Company's
fiscal 2000 results include the operations of Ansett Worldwide since April 27,
2000, the date of acquisition.
13
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of 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, 2000, and the related condensed consolidated statements of income and
comprehensive income for the three and six month periods ended May 31, 2000
and 1999, and condensed consolidated statements of cash flows for the six
month periods ended May 31, 2000 and 1999. 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 auditing standards generally accepted in the
United States of America, 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 auditing standards generally accepted in the United
States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated statement of
financial condition of Morgan Stanley Dean Witter & Co. and subsidiaries as of
November 30, 1999, and the related consolidated statements of income,
comprehensive 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, 1999; and, in our report dated January 21, 2000, we expressed an
unqualified opinion on those consolidated financial statements (which report
includes an explanatory paragraph for a change in the method of accounting for
certain offering costs of closed-end funds). In our opinion, the information
set forth in the accompanying condensed consolidated statement of financial
condition as of November 30, 1999 is fairly stated, in all material respects,
in relation to the consolidated statement of financial condition from which it
has been derived.
/s/ Deloitte & Touche LLP
New York, New York
July 10, 2000
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
Morgan Stanley Dean Witter & Co. (the "Company") is a global financial
services firm that maintains leading market positions in each of its three
business segments--Securities, Asset Management and Credit Services. The
Company combines global strength in investment banking and institutional sales
and trading with strength in providing full-service and online brokerage
services, investment and global asset management services and, primarily
through its Discover(R) Card brand, quality consumer credit products. The
Company provides its products and services to a large and diversified group of
clients and customers, including corporations, governments, financial
institutions and individuals.
Results of Operations*
Certain Factors Affecting Results of Operations
The Company's results of operations may be materially affected by market
fluctuations and by 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 and cost 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 to
conduct electronic commerce and the emergence of electronic communication
trading networks); the availability and cost of credit; inflation; investor
sentiment; and legislative, legal and regulatory developments. Such factors
also may 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 expansion of its Credit Services business.
The results of the Company's Securities 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 global market activity,
which, among other things, affects the size, number and timing of investment
banking client assignments and transactions and the realization of returns
from the Company's private equity and other principal investments. The level
of global market activity also could impact the flow of investment capital
into mutual funds and the way in which such capital is allocated among money
market, equity, fixed income or other investment alternatives, which could
impact the results of the Company's Asset Management business. In the
Company's Credit Services business, changes in economic variables, such as the
number and size of personal bankruptcy filings, the rate of unemployment and
the level of consumer debt, may substantially affect consumer loan levels and
credit quality, which, in turn, could impact overall Credit Services results.
The Company's results of operations also may be materially affected by
competitive factors. Among the principal competitive factors affecting the
Securities business are the Company's reputation, the quality of its
professionals and other personnel, its products and services, relative pricing
and innovation. Competition in the Company's Asset Management business is
affected by a number of factors, including investment objectives and
performance; advertising and sales promotion efforts; and the level of fees,
distribution channels and types and quality of services offered. In the Credit
Services business, competition centers on merchant acceptance of credit cards,
credit card acquisition and customer utilization of credit cards, all of which
are impacted by the type of fees, interest rates and other features offered.
--------
* 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>
In addition to competition from firms traditionally engaged in the financial
services business, competition has increased in recent years from other
sources, such as commercial banks, insurance companies, online service
providers, sponsors of mutual funds and other companies offering financial
services both in the U.S. and globally. The financial services industry also
has experienced consolidation and convergence in recent years, as financial
institutions involved in a broad range of financial services industries have
merged. This convergence trend is expected to continue and could result in the
Company's competitors gaining greater capital and other resources, such as a
broader range of products and services and geographic diversity. In November
1999, the Gramm-Leach-Bliley Act was passed in the U.S., effectively repealing
certain sections of the 1933 Glass-Steagall Act. Its passage allows commercial
banks, securities firms and insurance firms to affiliate, which may accelerate
consolidation and lead to increasing competition in markets which
traditionally have been dominated by investment banks and retail securities
firms.
The Company also has experienced increased competition for qualified
employees in recent years, including from companies engaged in Internet-
related businesses and private equity funds, in addition to the traditional
competition for employees from the financial services, insurance and
management consulting industries. The Company's ability to sustain or improve
its competitive position will substantially depend on its ability to continue
to attract and retain qualified employees.
For a detailed discussion of the competitive factors in the Company's
Securities, Asset Management and Credit Services businesses, see the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 1999.
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 business for the long term and to
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, evaluating credit product pricing,
managing risks in the Securities, Asset Management and Credit Services
businesses, 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.
The Company believes that technological advancements in the Internet and the
growth of electronic commerce will continue to present both challenges and
opportunities to the Company and could lead to significant changes and
innovations in financial markets and the financial services industry as a
whole. The Company's initiatives in this area have included Web-enabling
existing businesses, enhancing client communication and access to information
and services and making investments, or otherwise participating, in
alternative trading systems, electronic communication networks and related
businesses or technologies. The Company expects to continue to augment these
initiatives in the future.
Global Market and Economic Conditions in the Quarter Ended May 31, 2000
Global market and economic conditions during the second quarter of fiscal
2000 were generally favorable, although the rising interest rate environment
in the U.S. and Europe and a correction in the NASDAQ market led to periods of
increased volatility, particularly during the latter half of the quarter.
In the U.S., the economy continued to exhibit positive fundamentals and a
high rate of economic growth. Favorable economic trends, such as historically
low levels of unemployment, high levels of consumer confidence and spending, a
high demand for imports and increased productivity continued to persist.
During the first half of fiscal 2000, there were few indications that the
interest rate actions initiated by the Federal Reserve Board (the "Fed") in
fiscal 1999 and the first quarter of fiscal 2000 had sufficiently slowed the
rate of U.S. economic
16
<PAGE>
growth, and, as a result, the Fed remained concerned with the potential for
increased inflation. The Fed's aggressive efforts to slow the U.S. economy
continued during the second quarter of fiscal 2000, as the overnight lending
rate was increased by 0.25% in March 2000 and an additional 0.50% in May 2000.
Although the Fed has raised the overnight lending rate six times since June
1999 aggregating 1.75%, there continues to be uncertainty in the financial
markets as to future Fed actions.
Market conditions in Europe were also volatile during the quarter ended May
31, 2000. In May 2000, the euro fell to a record low against the U.S. dollar,
as the growth rate of the U.S. economy continued to outpace the growth rate in
the European Union ("EU"). Economic growth across much of the region remained
positive. However, the region's economic performance, coupled with the sharp
rise in global energy and commodity prices and the continued weakness of the
euro, gave rise to fears of increasing inflationary pressures within the U.K.
and the EU. In an effort to mitigate such conditions, during the second
quarter of fiscal 2000, the European Central Bank (the "ECB") raised interest
rates by 0.25% in March 2000 and an additional 0.25% in April 2000, while the
Bank of England decided to leave rates unchanged.
During the second quarter of fiscal 2000, economies and financial markets in
the Far East continued to recover from the difficult conditions that have
existed in the region since the latter half of fiscal 1997. In Japan, there
have been indications that the steps taken by the nation's government to
stimulate economic activity, such as bank bailouts, emergency loans, a zero
interest rate policy, stimulus packages and tax cuts for both individuals and
corporations, were beginning to have a favorable impact. However, Japan's rate
of economic growth continues to be sluggish amid a growing budget deficit.
While financial markets throughout the Far East have benefited from increased
investor interest in fiscal 2000, major market indices in the region decreased
during the second quarter and were affected by the decline in the U.S. equity
markets. Although uncertainty remains, investor confidence in the recovery
prospects of the Far East region, particularly in Japan, Hong Kong and Korea,
remained generally strong.
Results of the Company for the Quarter and Six Month Period ended May 31,
2000
The Company's net income in the quarter and six month period ended May 31,
2000 was $1,458 million and $3,002 million, an increase of 27% and 37% from
the comparable periods of fiscal 1999. Diluted earnings per common share were
$1.26 and $2.60 in the quarter and six month period ended May 31, 2000, as
compared to $0.97 and $1.85 in the comparable periods of fiscal 1999. The
Company's annualized return on common equity for the quarter and six month
period ended May 31, 2000 were 33.0% and 34.7%, as compared to 31.4% and 30.5%
in the comparable prior year periods.
The increase in net income in the quarter and six month period ended May 31,
2000 was primarily attributable to the Company's Securities business,
reflecting higher investment banking, principal trading and commission
revenues, partially offset by a decline in principal investment revenues.
Improved results in the Company's Asset Management business also contributed
to the increase. The Company's net income for the quarter and six month period
ended May 31, 2000 also reflected higher levels of incentive-based
compensation and other non-interest expenses.
Business Acquisition
During the second quarter of fiscal 2000, the Company completed its
acquisition of Ansett Worldwide Aviation Services ("Ansett Worldwide"). Ansett
Worldwide is one of the world's leading aircraft leasing groups, supplying new
and used commercial jet aircraft to airlines around the world. The Company's
fiscal 2000 results include the operations of Ansett Worldwide since April 27,
2000, the date of acquisition.
Business Segments
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 attributed to its three business segments:
Securities; Asset Management; and Credit Services. Certain revenues and
expenses have been
17
<PAGE>
allocated to each business segment, generally in proportion to their
respective revenues or other relevant measures. The accompanying business
segment information includes the operating results of Morgan Stanley Dean
Witter Online ("MSDW Online"), the Company's provider of electronic brokerage
services, within the Securities segment. Prior to the second quarter of fiscal
1999, the Company had included MSDW Online's results within its Credit
Services segment. In addition, the following segment data reflects the
Company's fiscal 1999 adoption of Statement of Financial Accounting Standards
("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related
Information." Prior to the adoption of SFAS No. 131, the Company had presented
the results of its Securities and Asset Management segments on a combined
basis. The segment data of all periods presented have been restated to reflect
these changes. Certain reclassifications have been made to prior-period
amounts to conform to the current year's presentation.
Securities
Statements of Income (dollars in millions)
<TABLE>
<CAPTION>
Three Months
Ended May Six Months
31, Ended May 31,
------------- ---------------
2000 1999 2000 1999
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Investment banking............................. $1,337 $ 994 $ 2,628 $ 1,928
Principal transactions:
Trading...................................... 2,501 1,890 4,778 3,549
Investments.................................. (242) 145 181 406
Commissions.................................... 968 733 1,947 1,352
Asset management, distribution and
administration fees........................... 505 348 941 659
Interest and dividends......................... 4,354 2,897 8,357 6,059
Other.......................................... 91 67 185 118
------ ----- ------- -------
Total revenues............................... 9,514 7,074 19,017 14,071
Interest expense............................... 4,064 2,814 7,645 5,733
------ ----- ------- -------
Net revenues................................. 5,450 4,260 11,372 8,338
------ ----- ------- -------
Non-interest expenses:
Compensation and benefits...................... 2,764 2,132 5,831 4,220
Occupancy and equipment........................ 137 118 277 228
Brokerage, clearing and exchange fees.......... 110 97 212 181
Information processing and communications...... 244 185 458 356
Marketing and business development............. 184 134 341 250
Professional services.......................... 166 130 302 241
Other.......................................... 158 118 332 223
------ ----- ------- -------
Total non-interest expenses.................. 3,763 2,914 7,753 5,699
------ ----- ------- -------
Income before income taxes....................... 1,687 1,346 3,619 2,639
Provision for income taxes....................... 597 511 1,285 998
------ ----- ------- -------
Net income..................................... $1,090 $ 835 $ 2,334 $ 1,641
====== ===== ======= =======
</TABLE>
Securities achieved net revenues of $5,450 million and $11,372 million in
the quarter and six month period ended May 31, 2000, an increase of 28% and
36% from the comparable periods of fiscal 1999. Securities net income for the
quarter and six month period ended May 31, 2000 was $1,090 million and $2,334
million, an increase of 31% and 42% from the comparable periods of fiscal
1999. The increases in net revenues and net income in both periods were
primarily attributable to higher revenues from investment banking, sales and
trading and asset management activities, partially offset by lower principal
investment revenues and higher levels of 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, 2000 increased 35% from the comparable period of fiscal
1999, reflecting higher revenues from merger, acquisition and restructuring
activities and equity underwriting transactions, partially offset by a decline
in fixed income underwriting revenues.
Revenues from merger, acquisition and restructuring activities increased in
the quarter ended May 31, 2000 as compared to the prior year period, as the
global market for such transactions continued to be robust, particularly in
the U.S. and Europe. The high level of transaction activity reflected the
continuing trends of convergence, consolidation and globalization, as
companies continued to expand into new markets and businesses in order to
increase earnings growth. Transaction activity was strong across many
industries, particularly in the technology, telecommunication, energy and
pharmaceutical sectors. The Company's strong global market share in many
industry sectors also contributed to the high level of revenues from merger
and acquisition transactions.
Equity underwriting revenues also increased in the quarter ended May 31,
2000 as compared to the prior year period, benefiting from a high volume of
equity offerings, particularly during the first half of the quarter.
Transaction volume in the latter half of the period was negatively impacted by
volatile market conditions in the U.S., reflecting the correction in the
NASDAQ market and uncertainty regarding the Fed's interest rate policy. The
quarter's equity underwriting revenues reflected a high level of new issue
volume in the telecommunications and technology sectors, and 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, 2000 were
lower than those recorded during the quarter ended May 31, 1999. The volume of
fixed income underwriting transactions was adversely affected by the rising
interest rate environment in the U.S. and Europe, resulting in increased
market volatility and higher borrowing costs. The market for global high yield
issues was particularly slow during the quarter. However, fixed income
underwriting revenues continued to benefit from the need for strategic
financing in light of the robust global market for merger and acquisition
transactions, and from the ongoing development of the euro-denominated credit
market.
Investment banking revenues in the six month period ended May 31, 2000,
increased 36% from the comparable period of fiscal 1999. The increase was
attributable to higher revenues from merger, acquisition and restructuring
activities and equity underwritings, reflecting continued strong levels of
transaction volumes.
Principal Transactions
Principal transaction trading revenues, which include revenues from customer
purchases and sales of securities, including derivatives, in which the Company
acts as principal and gains and losses on securities held for resale,
increased 32% in the quarter ended May 31, 2000 from the comparable period of
fiscal 1999. The increase reflected higher levels of equity and commodity
trading revenues, partially offset by declines in fixed income and foreign
exchange trading revenues.
Equity trading revenues increased to record levels in the quarter ended May
31, 2000, reflecting higher trading revenues from virtually all equity
products. Higher revenues from trading in equity cash products were primarily
driven by significantly increased levels of customer trading volumes in both
listed and over-the-counter securities, particularly in the U.S. and in
Europe. Revenues from equity derivative products benefited from increased
customer flows, strong trading volumes and the high level of volatility in the
equity markets that existed during much of the quarter. The level of market
volatility was impacted by a correction in the NASDAQ market, as investors
became concerned about the valuations of certain Internet and technology-
related issues. Higher revenues from certain proprietary trading activities
also contributed to the increase in equity trading revenues.
Fixed income trading revenues decreased in the quarter ended May 31, 2000
from the comparable period of fiscal 1999, primarily due to lower revenues
from trading global high-yield and investment grade fixed income
19
<PAGE>
securities. Trading revenues from global high-yield fixed income securities
decreased due to lighter trading activity as investors remained concerned
about rising interest rates throughout the quarter. Volatile equity markets
also had an adverse effect on the value of global high-yield fixed income
securities, particularly in the media and telecommunications sectors. Revenues
from investment grade fixed income securities were also adversely affected by
the volatile market conditions which resulted in reduced liquidity and
widening credit spreads.
Commodity trading revenues increased to record levels in the quarter ended
May 31, 2000, primarily driven by higher revenues from trading energy
products, including natural gas and electricity. The quarter's trading
revenues from energy-related products benefited from periods of rising prices
and increased volatility across the entire energy sector. Natural gas prices
were particularly volatile due to increased demand at a time when inventory
levels and production capabilities were low.
Foreign exchange trading revenues decreased modestly in the quarter ended
May 31, 2000 as compared to the prior year period. Trading volumes were
negatively affected by the exit of certain hedge funds from the market and
periods of increased volatility in the global securities markets. The euro
continued to depreciate relative to the U.S. dollar and reached an all time
low during the quarter, reflecting the strong economic performance of the U.S.
economy and higher interest rates in the U.S. The U.S. dollar weakened against
the Japanese yen during the quarter, as growing business confidence and
increasing industrial production in Japan bolstered the demand for yen-
denominated assets.
Principal transaction investment losses aggregating $242 million were
recorded in the quarter ended May 31, 2000, as compared to gains of $145
million in the quarter ended May 31, 1999. Fiscal 2000's results primarily
consist of unrealized losses from certain private equity and venture capital
investments, including Allegiance Telecom, Inc. and InterNAP Network Services
Corporation, reflecting difficult conditions in the technology and
telecommunications sectors. Fiscal 1999's results primarily reflect realized
and unrealized gains from the Company's investment in Knight/Trimark Group,
Inc. and increases in the value of certain other principal equity investments.
Principal transaction trading revenues increased 35% in the six month period
ended May 31, 2000 from the comparable period of fiscal 1999, primarily
reflecting higher equity and commodity trading revenues, partially offset by a
decline in fixed income and foreign exchange trading revenues. The increase in
equity trading revenues reflected higher revenues from both cash and
derivative equity products, due to higher levels of customer trading volumes
and market volatility. Fixed income trading revenues decreased, reflecting
less favorable market conditions and a rising global interest rate
environment. Commodity trading revenues increased due to the sharp rise in
global energy prices in fiscal 2000. Foreign exchange trading revenues
decreased moderately due to industry-wide decreases in market activity.
Principal transaction investment gains aggregating $181 million were
recognized in the six month period ended May 31, 2000 as compared to $406
million in the six month period ended May 31, 1999. The decrease in fiscal
2000's results primarily reflect unrealized losses from certain of the
Company's private equity and venture capital investments and the inclusion of
gains from the Company's investment in Knight/Trimark Group, Inc. in 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. Commissions also include revenues from
customer securities transactions associated with MSDW Online. Commission
revenues increased 32% in the quarter ended May 31, 2000 from the comparable
period of fiscal 1999. In the U.S., commission revenues benefited from
significantly increased levels of customer securities transactions, including
listed agency and over-the-counter equity products, as volumes on the New York
Stock Exchange and the NASDAQ increased significantly from the prior year.
Revenues from markets in Europe also benefited from higher trading volumes.
Commission revenues from securities markets in Japan and Hong Kong also
increased, generally reflecting increased investor interest in the region.
Commission revenues also benefited from higher sales of mutual funds and the
continued growth in the number of the Company's financial advisors.
20
<PAGE>
Commission revenues increased 44% in the six month period ended May 31, 2000
from the comparable period of fiscal 1999. The increase primarily reflected
higher levels of customer trading activity in the global equity markets, as
trading volumes on the New York Stock Exchange and NASDAQ increased to record
levels, and trading volumes increased on major European exchanges.
In October 1999, the Company launched ichoiceSM, a new service and
technology platform available to individual investors. ichoice provides each
of the Company's individual investor clients with the choice of self-directed
investing online; a traditional full-service brokerage relationship through a
financial advisor; or some combination of both. ichoice provides a range of
pricing options, including fee-based pricing. In future periods, the amount of
revenues recorded within the "Commissions" and "Asset management, distribution
and administration fees" income statement categories will be affected by the
number of the Company's clients electing a fee-based pricing arrangement.
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 are integral components of trading
activity. In assessing the profitability of trading activities, the Company
views net interest and principal trading revenues in the aggregate. In
addition, 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 and the interest income or
expense associated with financing or hedging the Company's positions. Net
interest revenues increased 249% and 118% in both the quarter and six month
period ended May 31, 2000 from the comparable periods of fiscal 1999,
partially reflecting the level and mix of interest bearing assets and
liabilities (including liabilities associated with the Company's aircraft
financing activities) during the respective periods, as well as certain
trading strategies utilized in the Company's institutional securities
business. Higher net revenues from brokerage services provided to
institutional and individual customers, including an increase in the level of
customer margin loans, also contributed to the increase in net interest
revenues.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration revenues include fees for
asset management services, including fees for promoting and distributing
mutual funds ("12b-1 fees") and fees for investment management services
provided to segregated customer accounts pursuant to various contractual
arrangements in connection with the Company's Investment Consulting Services
("ICS") business. The Company receives 12b-1 fees for services it provides in
promoting and distributing certain open-ended mutual 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 or supervision. Asset management, distribution
and administration fees also include revenues from individual investors
electing a fee-based pricing arrangement under the Company's ichoice service
and technology platform.
Asset management, distribution and administration revenues increased 45% and
43% in the quarter and six month period ended May 31, 2000 from the comparable
periods of fiscal 1999. The increase reflects higher 12b-1 fees from promoting
and distributing mutual funds to individual investors through the Company's
financial advisors, higher revenues from investment management services
associated with ICS, and higher revenues from individual investors electing
fee-based pricing.
Non-Interest Expenses
Total non-interest expenses increased 29% and 36% in the quarter and six
month period ended May 31, 2000 from the comparable periods of fiscal 1999.
Within the non-interest expense category, compensation and benefits expense
increased 30% and 38% in the quarter and six month period ended May 31, 2000
from the
21
<PAGE>
comparable periods of fiscal 1999, principally reflecting higher incentive-
based compensation due to higher levels of revenues and earnings. Excluding
compensation and benefits expense, non-interest expense increased 28% and 30%
in the quarter and six month period ended May 31, 2000 from the comparable
periods of fiscal 1999. Occupancy and equipment expense increased 16% and 21%
in the quarter and six month period ended May 31, 2000 from the comparable
periods of fiscal 1999, primarily due to additional rent associated with new
U.S. branch locations, as well as increased office space in New York and
certain other locations. Brokerage, clearing and exchange fees increased 13%
and 17% in the quarter and six month period ended May 31, 2000 from the
comparable periods of fiscal 1999, primarily reflecting higher brokerage
expenses due to increased global trading volume, particularly in North America
and Europe. Brokerage costs associated with the business activities of AB
Asesores, which the Company acquired in March 1999, also contributed to the
increase. Information processing and communications expense increased 32% and
29% in the quarter and six month period ended May 31, 2000 from the comparable
periods of fiscal 1999, primarily due to increased costs associated with the
Company's information processing infrastructure, including data processing,
market data services, and telecommunications. A higher number of employees
utilizing communications systems and certain data services also contributed to
the increase. Marketing and business development expense increased 37% and 36%
in the quarter and six month period ended May 31, 2000 from the comparable
periods of fiscal 1999, primarily reflecting increased travel and
entertainment costs associated with the high levels of business activity in
the global financial markets. Higher advertising and promotional expenses
associated with the Company's individual securities business also contributed
to the increase. Professional services expense increased 28% and 25% in the
quarter and six month period ended May 31, 2000 from the comparable periods of
fiscal 1999, primarily reflecting higher consulting costs associated with
certain strategic initiatives in the Company's securities business, including
e-commerce. The increase also reflected higher costs for employment fees and
temporary staffing due to the increased level of overall business activity.
Other expense increased 34% and 49% in the quarter and six month period ended
May 31, 2000 from the comparable periods of fiscal 1999, reflecting 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 and certain costs associated with the Company's aircraft leasing
business also contributed to the increase.
22
<PAGE>
Asset Management
Statements of Income (dollars in millions)
<TABLE>
<CAPTION>
Three
Months
Ended May Six Months
31, Ended May 31,
----------- -------------
2000 1999 2000 1999
----- ----- ------ ------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Investment banking................................. $ 33 $ 27 $ 77 $ 50
Principal transactions:
Investments...................................... 6 5 14 9
Commissions........................................ 4 -- 9 --
Asset management, distribution and administration
fees.............................................. 570 477 1,100 934
Interest and dividends............................. 19 7 32 34
----- ----- ------ ------
Total revenues................................... 632 516 1,232 1,027
Interest expense................................... 3 3 3 5
----- ----- ------ ------
Net revenues..................................... 629 513 1,229 1,022
----- ----- ------ ------
Non-interest expenses:
Compensation and benefits.......................... 198 158 384 314
Occupancy and equipment............................ 22 23 43 47
Brokerage, clearing and exchange fees.............. 20 30 39 60
Information processing and communications.......... 19 21 37 42
Marketing and business development................. 38 33 74 66
Professional services.............................. 24 30 45 60
Other.............................................. 45 37 76 68
----- ----- ------ ------
Total non-interest expenses...................... 366 332 698 657
----- ----- ------ ------
Income before income taxes........................... 263 181 531 365
Provision for income taxes........................... 107 76 217 153
----- ----- ------ ------
Net income....................................... $ 156 $ 105 $ 314 $ 212
===== ===== ====== ======
</TABLE>
Asset Management achieved net revenues of $629 million and $1,229 million in
the quarter and six month period ended May 31, 2000, an increase of 23% and
20% from the comparable periods of fiscal 1999. Asset Management's net income
for the quarter and six month period ended May 31, 2000 was $156 million and
$314 million, an increase of 49% and 48% from the comparable periods of fiscal
1999. The increases primarily reflect higher asset management, distribution
and administration fees resulting from the continued accumulation and
management of customer assets, partially offset by higher incentive-based
compensation expenses.
Investment Banking
Asset Management primarily generates investment banking revenues from the
underwriting of Unit Investment Trust products. Investment banking revenues
increased 22% and 54% in the quarter and six month periods ended May 31, 2000
from the comparable periods of fiscal 1999, primarily reflecting a higher
volume of Unit Investment Trust underwriting transactions. Unit Investment
Trust sales volumes rose to $4.5 billion and $10.6 billion in the quarter and
six month periods ended May 31, 2000, an increase of 32% and 63% from the
comparable periods of fiscal 1999.
Principal Transactions
Asset Management primarily generates principal transaction revenues from net
gains resulting from the Company's capital investments in certain of its funds
and other investments.
23
<PAGE>
In both the quarter and the six month period ended May 31, 2000 and the
comparable periods of fiscal 1999, principal transaction investment revenues
primarily consisted of net gains from the Company's capital investments in
certain of its funds.
Commissions
Asset Management primarily generates commission revenues from dealer and
distribution concessions on sales of certain funds, as well as certain
allocated commission revenues.
Commission revenues increased in both the quarter and six month period ended
May 31, 2000 from the comparable periods of fiscal 1999, primarily reflecting
higher levels of transaction volume and allocated commission revenues.
Net Interest
Asset Management generates net interest revenues from certain investment
positions, as well as from certain allocated interest revenues and expenses.
Net interest revenues increased in the quarter ended May 31, 2000 from the
comparable period of fiscal 1999, primarily reflecting higher net revenues
from certain investment positions. Net interest revenues for the six month
period ended May 31, 2000 were unchanged from the comparable period of fiscal
1999.
Asset Management, Distribution and Administration Fees
Asset management, distribution and administration fees primarily include
revenues from the management and administration of assets. These fees arise
from investment management services the Company provides to investment
vehicles (the "Funds") pursuant to various contractual arrangements.
Generally, the Company receives fees based upon the Fund's average net assets.
In the quarter and six month period ended May 31, 2000, asset management,
distribution and administration fees increased 19% and 18% from the comparable
periods of fiscal 1999. The increases in revenues primarily reflect higher
fund management fees as well as other revenues resulting from a higher level
of assets under management or supervision. The increases also reflect a more
favorable asset mix, primarily reflecting a shift in asset mix to a greater
percentage of equity products.
Customer assets under management or supervision increased to $445 billion at
May 31, 2000 from $405 billion at May 31, 1999. The increase in assets under
management or supervision reflected appreciation in the value of customer
portfolios and net inflows of new customer assets. Customer assets under
management or supervision included products offered primarily to individual
investors of $278 billion at May 31, 2000 and $241 billion at May 31, 1999.
Products offered primarily to institutional investors were $167 billion at May
31, 2000 and $164 billion at May 31, 1999.
Non-Interest Expenses
Asset Management's non-interest expenses increased 10% and 6% in the quarter
and six month period ended May 31, 2000 from the comparable periods of fiscal
1999. Within the non-interest expense category, employee compensation and
benefits expense increased 25% and 22% in the quarter and six month period
ended May 31, 2000 from the comparable periods of fiscal 1999, primarily
reflecting higher incentive-based compensation costs due to Asset Management's
higher level of net revenues. Excluding compensation and benefits expense,
non-interest expenses decreased 3% and 8% in the quarter and six month period
ended May 31, 2000 from the comparable periods of fiscal 1999. Occupancy and
equipment expense decreased 4% and 9% in the quarter and six month period
ended May 31, 2000 from the comparable periods of fiscal 1999, as lower levels
of depreciation expense on certain data processing equipment were partially
offset by higher occupancy
24
<PAGE>
costs at certain office locations. Brokerage, clearing and exchange fees
decreased 33% and 35% in the quarter and six month period ended May 31, 2000
from the comparable periods of fiscal 1999, primarily attributable to lower
sales of closed-end funds through the non-proprietary distribution channel.
Information processing and communications costs decreased 10% and 12% in the
quarter and six month period ended May 31, 2000 from the comparable periods of
fiscal 1999, primarily reflecting lower data processing servicing costs and
computer software costs. Marketing and business development expense increased
15% and 12% in the quarter and six month period ended May 31, 2000 from the
comparable periods of fiscal 1999, primarily related to higher promotional and
distribution costs for certain mutual funds. Professional services expense
decreased 20% and 25% in the quarter and six month period ended May 31, 2000
from the comparable periods of fiscal 1999, primarily reflecting the inclusion
of consulting costs related to the Company's preparations for the Year 2000
within fiscal 1999's results. Other expenses increased 22% and 12% in the
quarter and six month period ended May 31, 2000 from the comparable periods of
fiscal 1999. The increase was primarily associated with new and increased
business activity, including the Company's new strategic business venture,
Morgan Stanley Dean Witter Alternative Investment Partners that was announced
in March 2000.
Credit Services
Statements of Income (dollars in millions)
<TABLE>
<CAPTION>
Three
Months
Ended May Six Months
31, Ended May 31,
----------- -------------
2000 1999 2000 1999
----- ----- ------ ------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Fees:
Merchant and cardmember............................ $ 447 $ 357 $ 890 $ 698
Servicing.......................................... 349 310 636 563
----- ----- ------ ------
Total non-interest revenues...................... 796 667 1,526 1,261
----- ----- ------ ------
Interest revenue..................................... 750 522 1,483 1,078
Interest expense..................................... 353 198 704 419
----- ----- ------ ------
Net interest income................................ 397 324 779 659
Provision for consumer loan losses................... 204 119 427 296
----- ----- ------ ------
Net credit income.................................. 193 205 352 363
----- ----- ------ ------
Net revenues....................................... 989 872 1,878 1,624
----- ----- ------ ------
Non-interest expenses:
Compensation and benefits.......................... 135 123 290 242
Occupancy and equipment............................ 15 12 29 24
Information processing and communications.......... 118 109 232 226
Marketing and business development................. 280 214 558 460
Professional services.............................. 27 31 53 52
Other.............................................. 69 52 139 94
----- ----- ------ ------
Total non-interest expenses...................... 644 541 1,301 1,098
----- ----- ------ ------
Income before income taxes........................... 345 331 577 526
Provision for income taxes........................... 133 120 223 191
----- ----- ------ ------
Net income....................................... $ 212 $ 211 $ 354 $ 335
===== ===== ====== ======
</TABLE>
Credit Services achieved record net income of $212 million in the quarter
ended May 31, 2000. Credit Services net income of $354 million for the six
month period ended May 31, 2000 was approximately 6% higher than the
comparable period of fiscal 1999. The increases in net income for both periods
were primarily attributable to increased merchant and cardmember fees,
servicing fees and net interest income, partially offset
25
<PAGE>
by a higher provision for loan losses and non-interest expenses. Credit
Services' results for the quarter and six month period ended May 31, 2000 also
reflected higher levels of transaction volume from the comparable periods of
fiscal 1999, as well as a record level of period-end managed consumer loans.
Non-Interest Revenues
Total non-interest revenues increased 19% and 21% in the quarter and six
month period ended May 31, 2000 from the comparable periods of fiscal 1999.
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 increased 25% and 28% in the
quarter and six month period ended May 31, 2000 from the comparable periods of
fiscal 1999. The increases in both periods were primarily due to higher
merchant discount revenue and late payment fees associated with the Discover
Card. The increases in Discover Card merchant discount revenues were due to a
higher level of sales volume. Late payment fees increased primarily due to a
fee increase introduced during April 1999, coupled with an increase in the
number of late fee occurrences.
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 resulting
from 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 $3.0 billion and $4.3 billion in the
quarter and six month period ended May 31, 2000. During the comparable periods
of fiscal 1999, the Company completed asset securitizations of $1.9 billion
and $2.5 billion. The asset securitization transactions completed in the
second quarter of fiscal 2000 have an expected maturity of approximately 3 to
7 years from the date of issuance.
The table below presents the components of servicing fees (dollars in
millions):
<TABLE>
<CAPTION>
Three
Months
Ended May Six Months
31, Ended May 31,
------------ --------------
2000 1999 2000 1999
----- ----- ------ ------
<S> <C> <C> <C> <C>
Merchant and cardmember fees...................... $ 143 $ 138 $ 285 $ 269
Interest revenue.................................. 808 699 1,515 1,324
Interest expense.................................. (335) (251) (630) (481)
Provision for consumer loan losses................ (267) (276) (534) (549)
----- ----- ------ ------
Servicing fees.................................... $ 349 $ 310 $ 636 $ 563
===== ===== ====== ======
</TABLE>
Servicing fees increased 13% in both the quarter and six month period ended
May 31, 2000 from the comparable periods of fiscal 1999. The increases in both
periods were due to higher levels of net interest cash flows, increased fee
revenue and lower credit losses from securitized consumer loans. The increases
in net interest and fee revenue were primarily due to higher levels of average
securitized loans. The decrease in credit losses was due to a lower rate of
charge-offs related to the Discover Card portfolio, partially offset by an
increase in the level of average 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, earn interest revenue at both fixed
rates and market-
26
<PAGE>
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 interest rates and is accomplished
primarily through matched financing, which entails matching the repricing
schedules of consumer loans and related financing. Net interest income
increased 23% and 18% in the quarter and six month period ended May 31, 2000
from the comparable periods of fiscal 1999. In both periods, the increase was
primarily due to higher average levels of consumer loans, partially offset by
a lower yield on these loans and increased interest expense. In addition, net
interest income in the quarter ended May 31, 2000 benefited from the Company's
repricing of certain credit card receivables discussed below. The increase in
average consumer loans was due to higher levels of sales and balance transfer
volume. The lower yield on Discover Card loans was primarily due to the lower
interest rates offered to both existing and new cardmembers. The lower yield
also reflected an increase in consumer loans from balance transfers, which are
generally offered at lower interest rates for an introductory period. The
increase in interest expense was due to a higher level of interest bearing
liabilities coupled with an increase in the Company's average cost of
borrowings, reflecting a series of interest rate increases made by the Fed in
fiscal 1999 and the first half of fiscal 2000.
In response to the rising interest rate environment in the U.S., the Company
is repricing a substantial portion of its existing credit card receivables to
a market-indexed variable interest rate. During the quarter ended May 31,
2000, certain of such credit card receivables were repriced beginning with the
April 2000 billing cycle. The Company believes that its repricing actions will
continue to have a positive impact on net interest income.
27
<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,
2000 and 1999 and changes in net interest income during those periods:
Average Balance Sheet Analysis (dollars in millions)
<TABLE>
<CAPTION>
Three Months Ended May 31,
-------------------------------------------------
2000 1999(3)
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
General purpose credit card
and other consumer loans... $23,459 12.10% $714 $14,664 13.31% $492
Investment securities....... 574 6.12 9 661 4.91 8
Other....................... 1,872 5.89 27 1,664 5.27 22
------- ---- ------- ----
Total interest earning
assets................. 25,905 11.52 750 16,989 12.19 522
Allowance for loan losses... (773) (775)
Non-interest earning
assets..................... 1,593 1,641
------- -------
Total assets............ $26,725 $17,855
======= =======
LIABILITIES AND
SHAREHOLDER'S EQUITY
Interest bearing
liabilities:
Interest bearing deposits
Savings................... $ 1,492 5.44% $ 20 $ 1,418 4.36% $ 16
Brokered.................. 7,618 6.55 126 5,224 6.41 85
Other time................ 3,018 6.11 46 1,996 5.40 27
------- ---- ------- ----
Total interest bearing
deposits............... 12,128 6.31 192 8,638 5.84 128
Other borrowings............ 9,997 6.37 161 5,075 5.54 70
------- ---- ------- ----
Total interest bearing
liabilities............ 22,125 6.33 353 13,713 5.73 198
Shareholder's equity/other
liabilities................ 4,600 4,142
------- -------
Total liabilities and
shareholder's equity... $26,725 $17,855
======= =======
Net interest income......... $397 $324
==== ====
Net interest margin(1)...... 6.11% 7.57%
Interest rate spread(2)..... 5.19% 6.46%
</TABLE>
--------
(1) Net interest margin represents net interest income annualized as a
percentage of total interest earning assets.
(2) Interest rate spread represents the difference between the rate on total
interest earning assets and the rate on total interest bearing
liabilities.
(3) Certain prior-year information has been reclassified to conform to the
current year's presentation.
28
<PAGE>
Average Balance Sheet Analysis (dollars in millions)
<TABLE>
<CAPTION>
Six Months Ended May 31,
-------------------------------------------------
2000 1999(3)
------------------------ ------------------------
Average Average
Balance Rate Interest Balance Rate Interest
------- ----- -------- ------- ----- --------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets:
General purpose credit card
and other consumer loans... $23,326 12.04% $1,404 $15,533 13.09% $1,014
Investment securities....... 628 6.13 19 793 5.11 20
Other....................... 1,845 6.55 60 1,629 5.36 44
------- ------ ------- ------
Total interest earning
assets................. 25,799 11.50 1,483 17,955 12.04 1,078
Allowance for loan losses... (774) (777)
Non-interest earning
assets..................... 1,605 1,654
------- -------
Total assets............ $26,630 $18,832
======= =======
LIABILITIES & SHAREHOLDER'S
EQUITY
Interest bearing
liabilities:
Interest bearing deposits
Savings................... $ 1,531 5.25% $ 40 $ 1,461 4.37% $ 32
Brokered.................. 7,447 6.52 243 5,051 6.46 163
Other time................ 3,030 6.07 92 2,001 5.44 54
------- ------ ------- ------
Total interest bearing
deposits............... 12,008 6.25 375 8,513 5.86 249
Other borrowings............ 10,193 6.45 329 6,165 5.53 170
------- ------ ------- ------
Total interest bearing
liabilities............ 22,201 6.34 704 14,678 5.72 419
Shareholder's equity/other
liabilities................ 4,429 4,154
------- -------
Total liabilities &
shareholder's equity .. $26,630 $18,832
======= =======
Net interest income......... $ 779 $ 659
====== ======
Net interest margin(1)...... 6.04% 7.36%
Interest rate spread(2)..... 5.16% 6.32%
</TABLE>
--------
(1) Net interest margin represents net interest income annualized as a
percentage of total interest earning assets.
(2) Interest rate spread represents the difference between the rate on total
interest earning assets and the rate on total interest bearing
liabilities.
(3) Certain prior-year information has been reclassified to conform to the
current year's presentation.
29
<PAGE>
Rate/Volume Analysis (dollars in millions)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
May 31, 2000 vs. 1999 May 31, 2000 vs. 1999
--------------------- ---------------------
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> <C>
INTEREST REVENUE
General purpose credit
card and other consumer
loans.................. $ 294 $ (72) $ 222 $ 512 $ (122) $ 390
Investment securities... (1) 2 1 (4) 3 (1)
Other................... 3 2 5 6 10 16
------- ------
Total interest
revenue............ 274 (46) 228 474 (69) 405
------- ------
INTEREST EXPENSE
Interest bearing
deposits
Savings................ 1 3 4 1 7 8
Brokered............... 38 3 41 78 2 80
Other time............. 14 5 19 28 10 38
------- ------
Total interest
bearing deposits... 50 14 64 103 23 126
Other borrowings........ 70 21 91 112 47 159
------- ------
Total interest
expense............ 122 33 155 216 69 285
------- ------
Net interest income..... $ 152 $ (79) $ 73 $ 258 $ (138) $ 120
======= ======= ======= ====== ======= ======
</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,
-------------------------------------------------
2000 1999
------ ------
Avg. Avg.
Bal. Rate % Interest Bal Rate % Interest
------- ------ -------- ------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
General purpose credit card
and other consumer loans... $42,961 13.69% $1,479 $32,258 14.39% $1,171
Total interest earning
assets..................... 45,406 13.65 1,558 34,583 14.01 1,221
Total interest bearing
liabilities................ 42,927 6.38 688 31,906 5.58 449
Consumer loan interest rate
spread..................... 7.31 8.81
Interest rate spread........ 7.27 8.43
Net interest margin......... 7.62 8.86
<CAPTION>
Six Months Ended May 31,
-------------------------------------------------
2000 1999
------ ------
Avg. Avg.
Bal. Rate % Interest Bal Rate % Interest
------- ------ -------- ------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
General purpose credit card
and other consumer loans... $41,997 13.52% $2,840 $32,575 14.23% $2,311
Total interest earning
assets..................... 44,470 13.48 2,998 34,997 13.76 2,402
Total interest bearing
liabilities................ 41,997 6.35 1,334 32,061 5.62 900
Consumer loan interest rate
spread..................... 7.17 8.61
Interest rate spread........ 7.13 8.14
Net interest margin......... 7.48 8.61
</TABLE>
30
<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 and was $773 million at May 31, 2000. At November 30,
1999, the Company's allowance for loan losses was $769 million.
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, increased 71% and 44% in the quarter and six month period ended
May 31, 2000 from the comparable periods of fiscal 1999. The increases were
primarily due to higher levels of average consumer loans, partially offset by
a lower level of net charge-offs. In addition, the provision for consumer loan
losses in fiscal 1999 benefited from a decline in the loan loss allowance in
connection with securitization transactions entered into prior to the third
quarter of 1996. This loan loss allowance was fully amortized by the end of
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 on the last day of the
month in which they become 180 days delinquent, 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.
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,
---------------------------------- ----------------
2000 1999 1999
---------------- ---------------- ----------------
Owned Managed Owned Managed Owned Managed
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Consumer loans at
period-end............. $22,506 $43,701 $14,588 $32,805 $20,998 $37,975
Consumer loans
contractually past due
as a percentage of
period-end consumer
loans:
30 to 89 days......... 2.51% 3.10% 3.21% 3.52% 3.35% 3.79%
90 to 179 days........ 1.61% 2.01% 2.18% 2.42% 2.20% 2.53%
Net charge-offs as a
percentage of average
consumer loans (year-
to-date)............... 3.60% 4.43% 5.42% 5.91% 4.78% 5.42%
</TABLE>
Non-Interest Expenses
Non-interest expenses increased 19% and 18% in the quarter and six month
period ended May 31, 2000 from the comparable periods of fiscal 1999.
Compensation and benefits expense increased 10% and 20% in the quarter and
six month period ended May 31, 2000 from the comparable periods of fiscal
1999, primarily reflecting higher employment costs associated with increased
employment levels resulting from higher levels of transaction volume.
Occupancy and equipment expense increased 25% and 21% in the quarter and six
month period ended May 31, 2000 from the
31
<PAGE>
comparable periods of fiscal 1999, primarily due to increased rent expense at
both domestic and international locations. Information processing and
communications expense increased 8% and 3% in the quarter and six month period
ended May 31, 2000 from the comparable periods of fiscal 1999, primarily due
to an increase in volume-related external data processing costs at both
domestic and international operations. The increase in the six month period
was partially offset by the termination of an external transaction processing
contract. Marketing and business development expense increased 31% and 21% in
the quarter and six month period ended May 31, 2000 from the comparable
periods of fiscal 1999, primarily due to higher cardmember rewards expense
associated with increased sales volume, as well as increased advertising and
direct mailing costs at both domestic and international operations.
Professional services expense decreased 13% and increased 2% in the quarter
and six month period ended May 31, 2000 from the comparable periods of fiscal
1999. The decrease in the quarter was due to the inclusion of certain costs
related to the Company's preparation for the Year 2000 within fiscal 1999's
results. The increase in the six month period was due to higher costs
associated with account collections and consumer credit counseling and the
outsourcing of certain call center operations, partially offset by the
exclusion of Year 2000 costs in fiscal 2000's results. Other expenses
increased 33% and 48% in the quarter and six month period ended May 31, 2000
from the comparable periods of fiscal 1999. These increases were primarily due
to increases in certain operating expenses due to higher levels of transaction
volume and business activity, including higher fraud losses associated with an
increased volume of new account mailings.
Liquidity and Capital Resources
The Company's total assets increased to $417.6 billion at May 31, 2000 from
$367.0 billion at November 30, 1999, primarily attributable to increases in
securities borrowed and cash and securities deposited with clearing
organizations associated with increased levels of customer activity. Aircraft
under operating leases increased due to the purchase of Ansett Worldwide.
These increases were partially offset by a decrease in securities purchased
under agreements to resell. 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 businesses 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 reinvestments; 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
32
<PAGE>
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.
During the quarter ended May 31, 2000, an extendible asset-backed certificate
program (the "Certificates Program") was launched.
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, including 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, a
wholly-owned 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 can 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, 2000, 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) AA (low)
Fitch (1).............................................. F1+ AA
Japan Rating & Investment Information, Inc. ........... a-1+ AA
Moody's Investors Service.............................. P-1 Aa3
Standard & Poor's (2).................................. A-1+ AA-
Thomson Financial BankWatch............................ TBW-1 AA+
</TABLE>
--------
(1) Fitch IBCA, Inc. and Duff & Phelps Credit Rating Co. merged on June 1,
2000. The merged company will use the former Fitch IBCA, Inc. rating
scale.
(2) On May 17, 2000, Standard & Poor's upgraded the Company's commercial paper
rating from A-1 to A-1+ and upgraded the Company's senior debt rating from
A+ to AA-.
As the Company continues to expand globally and derives revenues
increasingly in 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, 2000, the Company issued senior
notes aggregating $12,597 million, including non-U.S. dollar currency notes
aggregating $1,619 million, primarily pursuant to its public debt shelf
registration statements. These notes have maturities from 2001 to 2030 and a
weighted average coupon interest rate of 6.37% at May 31, 2000; the Company
has entered into certain transactions to obtain floating
33
<PAGE>
interest rates based primarily on short-term LIBOR trading levels. At May 31,
2000 the aggregate outstanding principal amount of the Company's Senior
Indebtedness (as defined in the Company's public debt shelf registration
statements) was approximately $57 billion (not including approximately $10.3
billion of additional senior indebtedness consisting of guaranteed obligations
of the indebtedness of subsidiaries).
In January 2000, the Company and Morgan Stanley Finance, plc, a U.K.
subsidiary, called for the redemption of all of the outstanding 9.00% Capital
Units on February 28, 2000. The aggregate principal amount of the Capital
Units redeemed was $144 million.
During the six month period ended May 31, 2000, the Company purchased $1,856
million of its common stock. Subsequent to May 31, 2000 and through June 30,
2000, the Company purchased an additional $111 million of its common stock.
Effective June 22, 2000, the Company's Board of Directors authorized the
repurchase, subject to market conditions and certain other factors, of an
additional $1.5 billion of the Company's common stock for capital management
purposes.
In an effort to enhance its ongoing stock repurchase program, the Company
may sell put options on shares of its common stock to third parties. These put
options entitle the holder to sell shares of the Company's common stock to the
Company on certain dates at specified prices. As of May 31, 2000, put options
were outstanding on an aggregate of 2.0 million shares of the Company's common
stock. The expiration dates of these put options range from June 2000 through
October 2000. The Company may elect cash settlement of the put options instead
of purchasing the stock.
The Company maintains a 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 $11.0 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, 2000, 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. The credit agreement contains restrictive covenants, which
require among other things, that MS&Co. maintain specified levels of
consolidated shareholder's equity and Net Capital, as defined. At May 31,
2000, no borrowings were outstanding under the MS&Co. Facility.
Morgan Stanley & Co. International Limited ("MSIL"), the Company's London-
based broker-dealer subsidiary, maintains a revolving committed financing
facility 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 $1.785 billion
available in six major currencies. The facility agreement contains restrictive
covenants which require, among other things, that MSIL maintain specified
levels of Shareholder's Equity and Financial Resources, each as defined. At
May 31, 2000, no borrowings were outstanding under the MSIL Facility.
Morgan Stanley Dean Witter Japan Limited ("MSDWJL"), the Company's Tokyo-
based broker-dealer subsidiary, maintains a committed revolving credit
facility guaranteed by the Company that provides funding to support general
liquidity needs, including support of MSDWJL's unsecured borrowings (the
"MSDWJL Facility"). Under the terms of the MSDWJL Facility, a syndicate of
banks is committed to provide up to 60 billion Japanese yen. At May 31, 2000,
no borrowings were outstanding under the MSDWJL Facility. In June 2000, the
amount available under the MSDWJL Facility increased to 70 billion Japanese
yen.
34
<PAGE>
RFC currently maintains a senior bank credit facility to support the
issuance of asset-backed commercial paper in the amount of $1.0 billion. Under
the terms of the asset-backed commercial paper program, certain assets of RFC
are subject to a lien in the amount of $1.0 billion. RFC has never borrowed
from its senior bank credit facility. As a result of the Certificates Program,
the RFC senior bank credit facility is in the process of being eliminated.
The Company anticipates that it will utilize the MSDW Facility, the MS&Co.
Facility, the MSIL Facility or the MSDWJL Facility for short-term funding from
time to time.
At May 31, 2000, certain assets of the Company, such as real property,
equipment and leasehold improvements of $2.2 billion, aircraft assets of $4.0
billion, and goodwill and other intangible assets of $1.4 billion, were
illiquid. 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 financing, and certain senior
secured loans and positions are not highly liquid. The Company also has
commitments of $641 million at May 31, 2000 in connection with its private
equity and other principal investment activities.
At May 31, 2000, the aggregate value of high-yield debt securities and
emerging market loans and securitized instruments held in inventory was $1,966
million (a substantial portion of which was subordinated debt). These
securities, loans and instruments were not attributable to more than 5% to any
one issuer, 20% 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 "Risk
Management" and Note 9 to the consolidated financial statements for the fiscal
year ended November 30, 1999, included in the Company's Annual Report on Form
10-K).
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 may have varying maturities. As part of
these activities, the Company may syndicate and trade certain positions of
these loans. At May 31, 2000, the aggregate value of such loans and positions
was $5.5 billion. The Company has also provided additional commitments
associated with these activities aggregating $14.8 billion at May 31, 2000. At
June 30, 2000, the Company had loans and positions outstanding of $4.4 billion
and aggregate commitments of $13.1 billion. The higher level of the Company's
loans, positions and commitments as compared with prior periods continues to
be primarily attributable to increased merger and acquisition activities,
particularly in Europe. However, there can be no assurance that the level of
such activities will continue in future periods.
The Company has contracted to develop a one million-square-foot office tower
in New York City. Pursuant to this agreement, the Company will own the
building and has entered into a 99-year lease for the land at the development
site. Construction began in 1999 and the Company intends to occupy the
building upon project completion, which is anticipated in 2002. The total
investment in this project (which will be incurred over the next several
years) is estimated to be approximately $650 million.
At May 31, 2000, 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 $26.8 billion.
35
<PAGE>
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. However, 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of May 31, 2000, Aggregate Value-at-Risk ("VaR") for the Company's
trading and related activities, measured at a 99% confidence level with a one-
day time horizon, was $39 million. Aggregate VaR declined from $47 million as
of February 29, 2000, primarily as the result of a decrease in the VaR
associated with various equity risk positions, including certain private
equity positions.
The Company uses VaR as one of various risk management tools and notes that
VaR values should be interpreted in light of the method's strengths and
limitations. For a further discussion of the Company's risk management policy
and control structure, refer to the "Risk Management" section of the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 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, 1999 and in the Company's Quarterly Report on Form 10-
Q for the fiscal quarter ended February 29, 2000.
Term Trust Class Actions. Defendants' motion to dismiss the New York action
was granted on May 3, 2000. The time to appeal the dismissal of both the New
Jersey and the New York actions has expired.
Morgan Stanley Dean Witter North American Government Income Trust
Litigation. The court approved the class action settlement at the fairness
hearing held on April 26, 2000.
In re Merrill Lynch, et al. Securities Litigation. The U.S. Court of Appeals
for the Third Circuit agreed to hear plaintiffs' appeal of the denial of class
certification by order dated May 12, 2000.
Item 2. Changes in Securities and Use of Proceeds.
(c) To enhance its ongoing stock repurchase program, during the quarter
ended May 31, 2000, the Company sold European-style put options on an
aggregate of 500,000 shares of its common stock. These put options mature in
July and August 2000. They entitle the holders to sell common stock to the
Company at prices ranging from $69.96 to $70.18 per share. The sale of these
put options, which were made as private placements to third parties, generated
proceeds to the Company of approximately $2.2 million.
Item 4. Submission of Matters to a Vote of Security Holders.
The annual meeting of stockholders of the Company was held on April 6, 2000.
Further details concerning matters submitted to a vote of stockholders can be
found in the Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended February 29, 2000.
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 23, 2000 reporting Item 5 and Item 7.
Form 8-K dated May 18, 2000 reporting Item 5 and Item 7.
37
<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, 2000
38
<PAGE>
EXHIBIT INDEX
MORGAN STANLEY DEAN WITTER & CO.
Quarter Ended May 31, 2000
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
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 10, 2000,
concerning unaudited interim financial information.
27 Financial Data Schedule.
</TABLE>
E-1
