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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-6862
DONALDSON, LUFKIN & JENRETTE, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 13-1898818
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
277 Park Avenue, New York, New York 10172
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (212) 892-3000
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
- ------------------- -----------------------------------------
Common Stock, par value $0.10 per share New York Stock Exchange
Series A Fixed/Adjustable Rate Cumulative
Preferred Stock, $50 liquidation
Preference per share New York Stock Exchange
Series B Fixed/Adjustable Rate Cumulative
Preferred Stock, $50 liquidation
Preference per share New York Stock Exchange
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 than the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K [X].
Cover Page 1 of 2
As of March 19, 1998, the latest practicable date, there were 58,458,178
shares of Common Stock, $0.10 par value, outstanding.
At March 19, 1998 the aggregate market value of the voting stock held by non-
affiliates of the registrant was approximately $1,241.1 million. For purposes
of this information, the outstanding shares of Common Stock owned by directors
and executive officers of the registrant were deemed to be shares of Common
Stock held by affiliates.
DOCUMENTS INCORPORATED BY REFERENCE:
The information required to be furnished pursuant to Part III of this Form 10-K
is set forth in, and incorporated by reference from, the registrant's
definitive proxy statement for the annual meeting of stockholders to be held
April 22, 1998, which definitive proxy statement (the "Proxy Statement") was
filed by the registrant with the Securities and Exchange Commission on March
12, 1998 not later than 120 days after the year ended December 31, 1997.
Cover Page 2 of 2
PART I
ITEM 1. BUSINESS
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Donaldson, Lufkin & Jenrette, Inc. (the "Company") is a leading
integrated investment and merchant bank serving institutional, corporate,
governmental and individual clients both domestically and internationally. The
Company is a holding company which conducts its business through various
subsidiaries including its principal broker-dealer subsidiary, Donaldson,
Lufkin & Jenrette Securities Corporation ("DLJSC"). The business of the Company
includes:
o Securities underwriting, sales and trading
o Merchant banking
o Financial advisory services
o Investment research
o Venture capital
o Correspondent brokerage services
o Online interactive brokerage services
o Asset management and other advisory services
Founded in 1959, the Company initially focused on providing in-depth
investment research to institutional investors. In 1970, the Company became the
first member firm of the New York Stock Exchange ("NYSE") to be owned publicly.
Fifteen years later, the Company was purchased by The Equitable Life Assurance
Society of the United States ("Equitable Life"). Prior to the Company's initial
public offering in October 1995, the Company was an independently operated
indirect wholly owned subsidiary of The Equitable Companies Incorporated
("Equitable"). At December 31, 1997 the Equitable owned 76.2% of DLJ's issued
and outstanding common stock. Equitable is a diversified financial services
organization and one of the world's largest investment management
organizations. AXA, a French holding company for an international group of
insurance and related financial services companies, is Equitable's largest
stockholder, beneficially owning, at December 31, 1997, approximately 58.7% of
Equitable's outstanding common stock.
The Company conducts its business through three principal operating
groups:
o Banking Group
o Investment Banking
o Merchant Banking
o Emerging Markets
o Capital Markets Group
o Fixed Income
o Institutional Equities
o Equity Derivatives
o Sprout
o Financial Services Group
o Pershing
o Investment Services
o Asset Management
In 1997, the Company took steps toward achieving the goal of
establishing a strong international presence. The acquisition of the Phoenix
Securities Group, a London-based investment bank provided the opportunity to
enhance the Company's international merger and acquisition and leveraged
financing capabilities. In 1997, the Company also acquired London Global
Securities, a leading international securities financing intermediary. In
addition to these acquisitions, a new high-yield group was established in
London.
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All business groups have planned expansion of their international activities.
An investment banking group is in the process of being established in Paris,
joining the Company's institutional equity sales operation, as well as planned
investment banking and foreign equity trading operations in Russia and Germany.
The Company continued to target selected areas in the emerging markets of
Eastern Europe, Latin America and Asia. The Merchant Banking Group has expanded
its international efforts, with significant investments in the U.K., Italy,
France, Argentina and Brazil. By year-end, the Company's London operation
employed more than 800 individuals. Total assets and total revenues related to
the Company's foreign operations approximated $8.6 billion and $535.2 million,
respectively, at December 31, 1997. The Company's foreign operations were not
significant in 1996.
Banking Group. The Company's Banking Group is a major participant in
the raising of capital and the providing of financial advice to companies
throughout the U.S. and has significantly expanded its activities abroad.
Through the Investment Banking Group, the Company manages and underwrites
public offerings of securities, arranges private placements and provides
advisory and other services in connection with mergers, acquisitions,
restructurings and other financial transactions. The Company's Merchant Banking
Group pursues direct investments in a variety of areas through a number of
investment vehicles funded with capital provided primarily by institutional
investors, the Company and its employees. The Emerging Markets Group
specializes in client advisory services for mergers, acquisitions and financial
restructurings, as well as merchant banking and the underwriting, placement and
trading of equity, debt and derivative securities in Latin America, Asia and
Eastern Europe.
Capital Markets Group. The Capital Markets Group encompasses a broad
range of activities including trading, research, origination and distribution
of equity and fixed-income securities, private equity investments and venture
capital. Its Fixed Income Division provides institutional clients with
research, trading and sales services for a broad range of fixed-income
products, including high-yield corporate, investment-grade corporate, U.S.
government and mortgage-backed securities. The Institutional Equities Division
provides institutional clients with research, trading and sales services in
U.S. listed and over-the counter ("OTC") equity securities. In addition, the
Company's Equity Derivatives Division provides a broad range of equity and
index option products. Autranet is the oldest and most successful distributor
of research and investment material. Sprout is one of the oldest and largest
groups in the private equity investment and venture capital industry.
Financial Services Group. The Financial Services Group provides a
broad array of services to individual investors and the financial
intermediaries, which represent them. Pershing is a leading provider of
correspondent brokerage services, clearing transactions for over 600 financial
institutions which collectively maintain over 1.75 million client accounts. The
Company's Investment Services Group provides access to the Company's equity and
fixed-income research, trading services and underwriting to a broad mix of
private clients. Through its Asset Management Group the Company provides cash
management, investment advisory and trust services primarily to high-net-worth
individual and institutional investors.
The following table illustrates the Company's revenue breakdown by its
principal operating groups, net of all interest. Net revenues, however, are not
necessarily indicative of the profitability of each group. Certain
reclassifications of prior year amounts have been made to conform to the 1997
presentation.
NET REVENUES BY OPERATING GROUP:
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YEARS ENDED DECEMBER 31,
1993 1994 1995 1996 1997
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(in millions)
Banking Group.......................... $ 491.8 $ 390.0 $ 689.2 $ 935.8 $ 1,311.8
Capital Markets Group.................. 1,058.2 702.3 851.9 1,086.4 1,292.5
Financial Services Group............... 455.3 458.2 619.5 827.6 1,008.9
Offsets and eliminations (101.7) (45.6) (82.6) (92.3) (125.9)
--------- --------- --------- --------- ----------
Net revenues........................... $ 1,903.6 $ 1,504.9 $ 2,078.0 $ 2,757.5 $ 3,487.3
========= ========= ========= ========= ==========
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The Company currently conducts its operations in 14 cities in the
U.S., including Atlanta, Austin, Boston, Chicago, Dallas, Houston, Jersey City,
Los Angeles, Menlo Park, Miami, New York, Oak Brook, Philadelphia and San
Francisco. The Company also has international offices located in 10 cities,
including Bangalore, Buenos Aires, Geneva, Hong Kong, London, Lugano, Mexico
City, Paris, Sao Paulo and Tokyo.
BANKING GROUP
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The Company's Banking Group is a major participant in the raising and
investing of capital, and the providing of financial advice to companies
throughout the U.S. and has significantly expanded its activities abroad,
through its Investment Banking Group, Merchant Banking Group and Emerging
Markets Group.
INVESTMENT BANKING
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The Company's Investment Banking Group provides a full range of
capital raising and financial advisory services to its clients. The Investment
Banking Group underwrites public offerings of securities and arranges private
placements and has a particular focus on capital raising transactions in the
public equity and high-yield debt markets.
The Company's investment banking strategy is to concentrate a major
portion of its business development efforts within those industries in which
the Company has established a leadership position in providing investment
banking services. Industry specialty groups include chemicals, energy,
entertainment, environmental, financial services, forest products, gaming,
health care, industrial, insurance, media/communications, oil and gas, real
estate finance, retailing, satellite, technology and utilities. These groups
are responsible for initiating, developing and maintaining client relationships
and for executing transactions involving these clients. The Investment Banking
Group has focused primarily on those industries in which the Company also has a
strong research capability. In addition to being structured according to
distinct industry groups, the Company has a number of professionals who
specialize in specific types of transactions. These include mergers and
acquisitions ("M&A"), equity offerings, high-yield securities and other
transaction specialties.
MERGERS AND ACQUISITIONS. The Company is active in arranging various
M&A transactions for its clients. The Company participates in a broad range of
domestic and international assignments including acquisitions, divestitures,
strategic restructurings, proxy contests, leveraged buyouts and defenses
against unsolicited takeovers.
EQUITY OFFERINGS. The equity capital markets group focuses on
providing financing for issuers of equity and convertible equity securities in
the public markets. The group assists in the origination, and is responsible
for the structuring and execution of transactions for a broad range of Banking
Group clients.
HIGH-YIELD SECURITIES. The high-yield securities group focuses on
providing financing in the public and private capital markets. The group is
responsible for originating, structuring and executing high-yield transactions
across a wide range of companies and industries, as well as managing client
relationships with both high-yield corporate issuers and financial sponsors of
leveraged transactions. In 1997, for the fifth consecutive year, DLJ was the
number one ranked underwriter of high-yield bonds.
OTHER TRANSACTION SPECIALTIES. The Company is also active in a variety
of other transaction specialties, which provide capital raising and advisory
services for its clients. The private capital placements group raises capital
within the private debt and equity markets. Formed in 1994, the Company's
private fund group raises private capital, primarily from institutional
investors, for direct investment by venture capital, management buyout and
other investment firms, and for certain of the Company's merchant banking
activities. The private fund group raised over $11.0 billion in private capital
in 1997. The project finance group raises non-recourse financing for a diverse
client base of publicly and privately held companies for specific projects.
Additionally, the Company's restructuring group provides advisory services
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to financially distressed companies. The Company also participates in the
structured finance industry through its asset-backed transactions group, and
specializes in securitizing cash flow generating assets through public or
private offerings of debt or pass-through certificates.
In 1997, the Company continued to expand its international investment
banking presence, acquiring a London based investment bank, Phoenix Group
Limited (Phoenix). Phoenix is an international financial advisory and
investment management business with offices in London and Hong Kong. It has two
principal operations, a corporate finance and advisory business and a private
equity fund management business investing in private securities. It also makes
investments as principal.
MERCHANT BANKING
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The Company entered the merchant banking investment business in 1985
and believes that it has one of the most consistently successful records in
this area over the past 12 years. Through the Merchant Banking Group, the
Company has grown to become a major participant in the asset management
business by pursuing direct investments in a variety of industries and managing
capital provided primarily by pension funds, endowments, charitable
organizations, high-net-worth individuals, the Company and its employees. The
Merchant Banking Group is closely integrated with other parts of the Company
drawing upon all of its resources including debt and equity research and
high-yield financing as well as the industry specialty groups within the
Investment Banking Group.
The Merchant Banking Group manages eight distinct capital funds with
total committed capital of approximately $8.0 billion. These funds include DLJ
Merchant Banking Partners, L.P. and DLJ Merchant Banking Partners II, L.P.
which focus primarily on equity investments in leveraged transactions, the DLJ
Bridge Fund (as described below), a leader in domestic bridge financing, DLJ
Investment Partners, L.P., which focuses on opportunities in lower risk
investments in debt or equity mezzanine securities and corporate joint
ventures, DLJ Real Estate Capital Partners, L.P., which makes investments in
public and private debt and equity in the real estate markets, DLJ Global
Retail Partners, L.P., which pursues investment opportunities in early stage
retailers and Phoenix Equity Partners II, which focuses on international
opportunities. Through the Senior Debt Fund, the Company arranges and
syndicates financing primarily to non-investment grade borrowers. The Company
is also considering expanding its fund management in the future to include
additional areas of investment.
LEVERAGED EQUITY INVESTING. In 1992, the Company established DLJ
Merchant Banking Partners, L.P., a dedicated $1 billion fund which includes
commitments of up to $300 million by the Company and its employees. Employee
participation ranges from approximately 30% to 40% of the Company's and its
affiliates' overall investment in each transaction. In 1996, the Company closed
the $3 billion DLJ Merchant Banking Partners II, L.P. fund. Over 25% of the
capital was committed by DLJ and its employees. The funds make investments in
equity and mezzanine securities arising from leveraged acquisitions and
recapitalizations, restructurings of over-leveraged companies and other similar
types of transactions, which generally involve significant financial leverage.
In keeping with the firm's international focus, the DLJ Merchant Banking
Partners II, L.P. fund invested approximately $100 million in companies in
Europe, South America and India.
DLJ BRIDGE FUND. The Company is the sponsor of the $1.25 billion DLJ
Bridge Fund which provides short-term loans in connection with DLJ's merchant
banking and financial advisory businesses. The Bridge Fund has a $750 million
commitment of subordinated debt from Equitable and $500 million of senior
revolving credit by a commercial bank syndicate, certain terms of which are
being renegotiated. Any loans made by the DLJ Bridge Fund would be expected to
be refinanced, and the outstanding amounts repaid, within a short-term period.
The Company has agreed to pay Equitable the first $25 million of aggregate
principal losses incurred by Equitable with respect to all bridge loans. To
the extent such payments by the Company do not fully cover any such losses
incurred by Equitable, Equitable is entitled to receive all other distributions
otherwise payable to the Company with respect to DLJ Bridge Fund activities
until such losses have been recovered. The Company has also agreed to pay
Equitable the amount, if any, by which any principal loss on an individual
loan exceeds $150 million. The DLJ Bridge Fund currently has one
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individual bridge loan outstanding in excess of $150 million. Pursuant to
arrangements between the Company and the commercial bank syndicate, the Company
is at risk for a significant portion of any loans funded by such banks.
However, substantially all of the bridge loans have been made without using the
bank commitment. At December 31, 1997, the DLJ Bridge Fund had extended $565.1
million of short-term bridge loans which are expected to be refinanced in the
first quarter of 1998.
DLJ INVESTMENT PARTNERS. DLJ Investment Partners, L.P. commenced
operation in 1995 to pursue investments primarily in debt or equity mezzanine
securities and corporate joint ventures. The fund has committed capital of $250
million of which the Company and its employees will provide $50 million.
DLJ REAL ESTATE CAPITAL PARTNERS. DLJ Real Estate Capital Partners,
L.P., focuses on debt and equity investments in a broad range of real estate
and real estate-related assets. The fund has committed capital of approximately
$650 million from its general and limited partners, including $100 million from
the Company and its employees.
GLOBAL RETAIL PARTNERS. Global Retail Partners, L.P., which commenced
operation in 1996, focuses on growth retailing and electronic commerce
opportunities. The fund has committed capital of approximately $150 million.
SENIOR DEBT GROUP. In late 1996, the Company established the Senior
Debt Group, which syndicates leveraged loans and uses the Company's funds
to provide financing to investment banking clients. This group provides the
Company's corporate clients with the convenience of a single financing source.
In 1997, the group acted as lead arranger of loans aggregating approximately
$10 billion.
PHOENIX EQUITY PARTNERS II. Phoenix Equity Partners II is a $220
million fund dedicated to investing in mid-market companies in Europe. During
1997, the fund made investments totaling $63 million.
EMERGING MARKETS
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The Emerging Markets Group is a growing participant in the financial
services industry in certain developing economies in Latin America, Asia,
Eastern Europe and South Africa. The group combines specialized market and
geographic knowledge and experience with the traditional strengths and skills
of the Company. The group is responsible for originating and executing
transactions in their respective areas of expertise, maintaining client
relationships and building the Company's presence in targeted markets where the
Company believes it can be a leading financial services provider or investor.
In Latin America, the group has four principal lines of business:
investment banking, which focuses on international capital raising and
financial advisory services; merchant banking, which utilizes the Company's
expertise in this area to target growth companies and other specific investment
opportunities; sales and trading, which is involved primarily in principal
trading of Latin American debt securities, with an emphasis on Brady Bonds,
local debt instruments and Latin American equity securities; and Latin American
derivatives, in particular, the structuring, placement and trading of products,
which are based on Latin American securities, currencies and indices.
In Europe, the group is also involved in sales and trading of Eastern
European debt securities with emphasis on local debt instruments in Turkey and
Russia In addition, they are involved with the structuring, placement and
trading of products based on Russian loans.
The group is also active in the Asia-Pacific region, focusing
exclusively on the sale of Latin American and Emerging European products. In
addition, investment banking services are offered through the Company's Hong
Kong office which is dedicated to building the Company's capital raising,
financial advisory and merchant banking presence in this region.
CAPITAL MARKETS GROUP
- ---------------------
The Capital Markets Group encompasses a broad range of activities
including trading, research, origination and distribution of equity and
fixed-income securities, private equity investments and venture capital through
its Fixed Income Division, Institutional Equities Division, Equity Derivatives
Division and Sprout. The Company's focus is primarily client-driven, in
contrast to that of many other securities firms, which emphasize proprietary
trading. The Capital Markets Group has approximately 1,600 employees.
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FIXED INCOME
- ------------
The Fixed Income Division provides institutional clients with
research, trading and sales services for a broad range of fixed-income
products, and distributes fixed-income securities in connection with offerings
underwritten by the Company. Its core businesses are in high-yield bonds and
bank debt, U.S. government and investment-grade corporate bonds and real estate
finance. The Fixed Income Division's research professionals include credit
analysis teams knowledgeable in high-yield corporate, investment-grade
corporate and mortgage-backed securities as well as quantitative and economic
research.
HIGH-YIELD SECURITIES. The High-Yield Securities department provides
institutional clients with research, trading and sales services and distributes
non-investment-grade securities in connection with offerings underwritten by
the Company. In 1997, the high-yield franchise expanded into the international
markets, creating a London-based unit. Further expansion will also include Hong
Kong.
INVESTMENT-GRADE CORPORATE BONDS. The Company has been a major
participant in the secondary trading and distribution of investment-grade
corporate debt instruments and has consistently ranked as one of the top
providers of credit research on those securities. While its emphasis has
traditionally been on trading and distributing secondary issues, the Corporate
Bond department has played an increasing role in new issue underwriting and
origination and new issue structuring.
GOVERNMENT BONDS. The Company is a primary dealer in U.S. government
securities designated by the Federal Reserve Bank of New York. The Government
Bond department's activities include making secondary markets in, and
participating in the underwriting of U.S. Treasury bills, notes and bonds, and
securities of Federal agencies. The Company is a member of every major agency
underwriting group, including Federal National Mortgage Association ("Fannie
Mae"), Federal Farm Credit, Federal Home Loan Bank and Student Loan Mortgage
Association ("Sallie Mae"). The Company also engages in the "stripping" of
government and government-guaranteed bonds to create zero-coupon securities. It
also trades treasury futures and options and develops hedging programs for its
clients. The Government Bond department also maintains a money desk which
provides financing for its daily trading inventory positions, and to a lesser
extent those of other fixed-income departments through the use of repurchase
agreements and also acts as an intermediary between borrowers and lenders of
short-term funds utilizing repurchase and reverse repurchase agreements. The
department's economic research group provides analyses and forecasts of
macroeconomic and government policy trends, together with advice on
interest-rate fluctuations, for the benefit of institutional clients and the
Company's trading operations.
MORTGAGE-AND ASSET-BACKED SECURITIES. The Company trades and makes
markets in Government National Mortgage Association securities, Federal Home
Loan Mortgage Corporation participation certificates, Fannie Mae obligations,
non-agency mortgage-backed securities, and various asset-backed securities. The
Mortgage Securities department also issues, trades and makes markets in
Collateralized Mortgage Obligations ("CMOs"), which are debt obligations
secured by the cash flow from a pool of mortgages or mortgage securities, as
well as in other mortgage-related derivative products.
REAL ESTATE FINANCE GROUP. The group provides capital and financial
advisory services for major participants in the commercial real estate market.
In 1997, more than $8 billion was raised for clients. The Real Estate Finance
department also originates loans secured by multifamily and commercial
properties and, acting as agent, places mortgage-backed debt for clients.
Column Financial originates, acquires and enhances mortgage loans for
securitization and sale to investors in the form of Collateralized Mortgage
Obligations. Previously, Column Financial was jointly owned by the Company and
Equitable. During 1997, DLJ increased its ownership in Column Financial from 50
percent to 100 percent by purchasing Equitable's 50 percent interest in Column.
SENIOR DEBT GROUP. In 1997, the Company established the Senior
Debt Group, which syndicates leveraged loans and enters into commitments to
extend credit primarily to non-investment grade borrowers. This Group provides
the Company's corporate clients with the convenience of a single financing
source. In 1997, this Group arranged loans aggregating approximately
$10 billion.
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INSTITUTIONAL EQUITIES
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The Institutional Equities Division provides domestic and
international institutional clients with research, trading and sales services
in U.S. listed and OTC equities, and foreign equities trading and distributes
equity securities in connection with offerings underwritten by the Banking
Group.
DOMESTIC INSTITUTIONAL SALES AND LISTED EQUITY TRADING. The Company's
equity trading operations and sales coverage of major U.S. institutions are
conducted by traders and institutional equity salespeople from nine of the
Company's domestic offices. Smaller U.S. institutions are covered by account
executives in the regional offices of the Investment Services Group, which is
part of the Company's Financial Services Group.
In listed equity securities, the Company acts as both an agent and
principal in executing trades in the secondary market. Much of the Company's
institutional business consists of large block trades of 10,000 or more shares.
In such transactions, the Company frequently provides its clients with
liquidity by taking a long or short position as a principal to facilitate the
client's purchase or sale of stock in the event that a counterparty buyer or
seller is not immediately available.
INTERNATIONAL SALES AND TRADING. The Company's international equity
sales organization operates from five of the Company's international offices
and one domestic office. Consistent with the Company's focus on international
expansion, start-up operations are planned for Western Europe, Russia and the
Far East. These will include integrated research, distribution and trading
capabilities based in Hong Kong and London. International equities expansion
plans include the trading of non-dollar based securities. The division is
scheduled to have a sales and trading operation in Moscow by the end of 1998.
OTC TRADING. The Company makes markets in approximately 400 securities
traded on the National Association of Securities Dealers ("NASD") Automated
Quotation System ("Nasdaq"). The Company conducts these activities as a dealer,
buying and selling the securities as a principal. The Company's market-making
is concentrated in stocks that are followed by the equity research department
or underwritten by the Company. The Company's market-making strengths are in
the communications, consumer, entertainment, financial services, health care
and technology sectors.
EQUITY RESEARCH. The Company's equity research department consists of
professional investment research analysts and associates who are engaged in the
analysis of economic trends and a broad range of industries and companies. The
department produces publications, studies and forecasts on economic conditions,
financial markets, portfolio strategy, quantitative analysis, industry
developments and individual companies. Consistent with DLJ's expansion in
international markets, the firm now has coverage in four global sectors: power,
energy, communications and transportation. Substantial growth of global
coverage is planned for 1998, with a particular focus in Latin America, Europe
and the Far East.
The Company's equity research analysts are also utilized as important
resources in obtaining investment banking business and assessing merchant
banking transactions, as well as developing and maintaining banking
relationships with clients through continued involvement after the execution of
specific transactions.
AUTRANET. Autranet Inc., a registered broker-dealer and member firm of
the NYSE is active in the distribution of investment research products
purchased from approximately 450 sources known as "independent originators."
Independent originators are research specialists, not primarily employed by
securities firms, and range in size and scope from large economic consulting
firms to individual freelance analysts.
CONVERTIBLE SECURITIES. The Company is a market-maker in convertible
securities, dealing primarily with an expanding base of institutional clients.
While its emphasis has been in trading and distributing secondary issues, the
Company has also been effective in the primary distribution of convertible
securities underwritten by the Company.
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EQUITY DERIVATIVES
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The Equity Derivatives Division provides institutional clients with
research, trading and sales services in a broad range of equity options
products and in convertible securities.
EQUITY OPTIONS. The Company's activities in equity derivative products
have focused primarily on product innovations in the design and origination of
custom-tailored OTC options to meet the specific needs of customers rather than
on hedging against the firm's own positions. The Company offers options based
on U.S. equities and equity indices; foreign currencies; equities from European
and Asian countries; commodities and precious metals; and various fixed-income
instruments in both domestic and international markets. The Company has
expanded its sales effort for its proprietary options and futures products into
Europe in recent years.
SPROUT
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Founded in 1969, Sprout is one of the oldest and largest groups in the
private equity investment and venture capital industry. Since the
capitalization of Sprout's first fund at $11.5 million, ten major investment
partnerships have been formed primarily for large institutional investors.
Present funds under management have original capital of approximately $1.6
billion, and include, among others, Sprout VII, a multi-stage venture fund,
Sprout Growth II, a late-stage equity fund and Sprout VIII, which had an
initial closing of $612 million in 1998 and will have a final closing in the
near future.
Sprout's investors are major public and corporate pension funds,
endowments, insurance companies and wealthy individuals. To accommodate their
growing interest, Sprout has committed to significant leadership positions in
the industries in which it concentrates: health care, technology, retail and
other services.
FINANCIAL SERVICES GROUP
- ------------------------
The Financial Services Group is comprised of Pershing, a leading
provider of correspondent brokerage services, the Investment Services Group,
which provides the full range of the Company's investment products and services
to high-net-worth individuals and medium to smaller sized institutions, and the
Asset Management Group which acts as a cash manager and investment counselor
primarily to high-net-worth individuals and institutions.
PERSHING DIVISION
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Pershing is one of the leading providers of correspondent brokerage
services to the world's financial institutions. Founded in 1939 and acquired by
the Company in 1977, Pershing operates out of seven of the Company's domestic
offices and London. Pershing provides execution and clearance services to
approximately 600 correspondents, ranging from small investment boutiques to
large financial institutions, which collectively maintain over 1.75 million
client accounts holding more than $175 billion of assets at December 31, 1997.
During 1997, Pershing participated in over 10% of the trading volume on the
NYSE. Pershing maintains broad execution coverage of all U.S. securities
exchanges, supported by extensive in-house trading desks for institutional
block and retail orders, as well as OTC securities, all fixed-income products,
mutual funds and money market funds. As a wholesaler of trading, execution,
clearing and information management activities, Pershing offers its service on
a fee-for-services basis.
Through their affiliation with Pershing, correspondent firms also have
access to a broad selection of investment products for their customers,
including investment related insurance products, retirement plans, a precious
metals storage program, central asset accounts, and managed wrap accounts. In
addition, Pershing makes available to its correspondents information and
recommendations provided through its own research analysts' action-oriented
opinions and advice.
Sophisticated communications and information management are a
cornerstone of Pershing's service. Pershing's computer-directed communications
system provides Pershing's correspondents with a link to major financial
markets around the world. Pershing's proprietary software systems allow online
order entry and reporting. Pershing also maintains extensive operational and
informational systems for its correspondents.
8
LONDON GLOBAL SECURITIES
- ------------------------
In 1997, the Company acquired London Global Securities, a leading
international securities financing intermediary, with operations in London and
Australia. London Global offers institutional investors financing services for
a full range of securities through a variety of transaction structures.
DLJDIRECT
- ---------
DLJdirect, established in 1988 as PC Financial Network, provides
securities transaction services to the subscribers of major online services,
including America Online, Prodigy, CompuServe and the Internet
(www.DLJdirect.com). DLJdirect offers trading, real-time quotes, news, and for
qualified investors an opportunity to invest in Company lead-managed, initial
public offerings, as well as limited access to the Company's equity research.
DLJdirect has opened more than 400,000 online accounts and conducted more than
$30 billion in transactions.
iNautix Technologies, a subsidiary of DLJdirect, develops financial
transaction solutions and Internet Web-sites for DLJdirect, Pershing
correspondents and other Company affiliates.
INVESTMENT SERVICES GROUP
- -------------------------
The Investment Services Group offers a full range of investment and
portfolio services to high-net-worth individual investors and medium to smaller
size financial institutions, corporations and professional investors. In 1997,
the group expanded overseas and opened its first offshore office in London, as
part of the Company's principal London broker-dealer subsidiary.
Due to the close working relationships between account executives and
the Company's research analysts and traders, the group's clients are provided
with the same comprehensive coverage that characterizes the Company's
traditional institutional businesses. The group also offers the "Portfolio
Advisory Service" to its clients, a wrap fee account based solely on the
Company's research, which has over $1 billion in assets under management at
December 31, 1997.
ASSET MANAGEMENT GROUP
- ----------------------
The Asset Management Group consists of DLJ Investment Management
Corporation and Wood, Struthers & Winthrop. The group specializes in individual
and institutional investment management and has a total of $12 billion of
assets under management.
DLJ Investment Management Corp. was established in 1996 to manage
funds for institutional clients. In its first full year of operation, the
company increased assets under management from $1 billion to $5 billion.
Wood, Struthers & Winthrop Management Corp., founded in 1871 and
acquired by the Company in 1977, is a money management firm, managing over $7
billion in assets at December 31, 1997. Wood, Struthers & Winthrop targets
sophisticated individual investors, as well as charitable endowments,
foundations and trusts, corporations and Employee Retirement Income Security
Act of 1974 ("ERISA") plans. Wood, Struthers & Winthrop manages portfolios of
both stocks and bonds, balancing risk and return to meet a client's objectives
for growth and capital preservation. The professional staff of Wood, Struthers
& Winthrop is experienced in portfolio management, investment research, tax
advice, financial planning and in providing personalized service to all of its
clients. Through its WSW Capital Inc. subsidiary, the firm manages a $2.9
billion portfolio of private placements which it originated.
Wood, Struthers & Winthrop is the investment advisor to the Company's
Winthrop Focus Funds, a domestic family of five diversified open-end mutual
funds. The Focus Funds consist of three U.S. equity funds and two fixed-income
funds which aggregate approximately $680 million. In addition, Wood, Struthers
& Winthrop and DLJ Investment Management Corp., are the advisors to the
Winthrop Opportunity Funds, a family of diversified open-end mutual funds.
These funds consist of an international developing markets fund, an established
markets equity fund, and two money market funds which were launched in 1997.
The Winthrop Opportunity Funds aggregate $170 million at December 31,1997.
9
Wood, Struthers & Winthrop has a limited purpose trust company
subsidiary, Winthrop Trust Company, which provides tax, financial planning,
custody and personal fiduciary services to its high-net-worth individual and
family clients. At December 31, 1997, Winthrop Trust Company had received
fiduciary appointments aggregating in excess of $800 million.
COMPETITION
- -----------
The Company encounters significant competition in all aspects of the
securities business and competes worldwide directly with other domestic and
foreign securities firms, a number of which have greater capital, financial and
other resources than the Company. In addition to competition from firms
currently in the securities business, there has been increasing competition
from other sources, such as commercial banks and investment boutiques. As a
result of pending legislative and regulatory initiatives in the U.S. to remove
or relieve certain restrictions on commercial banks, it is anticipated that
competition in some markets currently dominated by investment banks may
increase in the near future. Such competition could also affect the Company's
ability to attract and retain highly skilled individuals to conduct its various
businesses. The principal competitive factors influencing the Company's
business are its professional staff, the firm's reputation in the marketplace,
its existing client relationships, the ability to commit capital to client
transactions and its mix of market capabilities. The Company's ability to
compete effectively in securities brokerage and investment banking activities
will also be influenced by the adequacy of its capital levels.
EMPLOYEES
- ---------
At December 31, 1997, the Company had approximately 7,000 employees.
Professional personnel receive salary as well as incentive compensation in the
form of bonus and, in certain instances, through long-term incentive and/or
other compensation plans. Most of the Company's securities sales force
personnel receive a percentage of their gross revenues or a percentage of a
specified revenue pool as compensation. Other employees receive a salary and,
in certain cases, overtime compensation and compensation in the form of profit
sharing. None of the Company's employees is represented by a labor union.
REGULATION
- ----------
The Company's business and the securities industry in general are
subject to extensive regulation in the U.S. at both the Federal and state
level, as well as by industry Self Regulatory Organizations ("SROs"). A number
of Federal regulatory agencies are charged with safeguarding the integrity of
the securities and other financial markets and with protecting the interests of
customers participating in those markets. The Securities and Exchange
Commission (the "Commission") is the Federal agency that is primarily
responsible for the regulation of broker-dealers and investment advisors doing
business in the U.S., and the Commodity Futures Trading Commission ("CFTC") is
primarily responsible for the regulation of futures commission merchants. In
addition, the Department of the Treasury and the Municipal Securities
Rulemaking Board have the authority to promulgate regulations relating to U.S.
government and agency securities and to municipal securities, respectively, and
the Board of Governors of the Federal Reserve System promulgates regulations
applicable to certain securities credit transactions. Broker-dealers and
investment advisers are subject to registration and regulation by state
securities regulators in those states in which they conduct business. Industry
SROs, each of which has authority over the firms that are its members, include
the NASD, the NYSE, and other securities exchanges, the National Futures
Association ("NFA") and the commodities exchanges. Certain of the Company's
international broker-dealer subsidiaries are subject to the regulatory
requirements of the non-U.S. securities financial regulatory authorities.
10
Each of DLJSC, Pershing Trading Company, L.P. ("Pershing Trading"),
DLJdirect and Autranet (collectively, the "U.S. Broker-Dealers") is registered
as a broker-dealer with the Commission and is a member of, and subject to
regulation by, a number of securities industry SROs, including the NYSE and the
NASD. Both DLJSC and Pershing Trading are, in addition to being NYSE members,
members of most other major U.S. securities exchanges. DLJSC is also registered
as a broker-dealer in all 50 states and the District of Columbia, as a futures
commission merchant with the CFTC, as an investment adviser with the Commission
and in certain states, is also designated a primary dealer in U.S. government
securities by the Federal Reserve Bank of New York. In connection with its
business as a futures commission merchant, DLJSC is also a member of, and
subject to regulation by, the NFA and the Chicago Board of Trade ("CBOT").
Pershing Trading, Autranet and DLJdirect are registered as broker-dealers in a
number of states. Wood, Struthers & Winthrop Management Corp. and DLJ
Investment Partners, Inc. are registered with the Commission and, in certain
states as an investment adviser. The Company also has certain other direct and
indirect subsidiaries that are registered with the Commission and certain
states or with other regulatory authorities as broker-dealers or investment
advisers. Winthrop Trust Company is regulated by the New York State Banking
Department.
As a result of registration and SRO memberships, the U.S.
Broker-Dealers are subject to overlapping schemes of regulation, which cover
all aspects of their securities business. Such regulations cover matters
including capital requirements, the use and safekeeping of customers' funds and
securities, recordkeeping and reporting requirements, supervisory and
organizational procedures intended to assure compliance with securities laws
and rules of the SRO's and to prevent the improper trading on " material
nonpublic" information, employee-related matters, limitations on extensions of
credit in securities transactions, and clearance and settlement procedures. A
particular focus of the applicable regulations concerns the relationship
between broker-dealers and their customers. As a result, the U.S.
Broker-Dealers in some instances may be required to make "suitability"
determinations as to certain customer transactions, are limited in the amounts
that they may charge customers, cannot trade ahead of their customers and must
make certain required disclosures to their customers.
As investment advisers registered with the Commission, Wood, Struthers
& Winthrop Management Corp. and DLJSC are subject to the requirements of the
Investment Advisers Act of 1940 and the Commission's regulations thereunder.
Such requirements relate to, among other things, limitations on the ability of
investment advisers to charge performance-based or non-refundable fees to
clients, recordkeeping and reporting requirements, disclosure requirements,
limitations on principal transactions between an adviser or its affiliates and
advisory clients, as well as general anti-fraud prohibitions. The state
securities law requirements applicable to registered investment advisers are in
certain cases more comprehensive than those imposed under the Federal
securities laws.
DLJSC, as a registered futures commission merchant, is subject to the
capital and other requirements of the CFTC under the Commodity Exchange Act.
These requirements include the provision of certain disclosure documents,
prohibitions against trading ahead of customers and other fraudulent trading
practices, provisions as to the handling of customer funds and reporting and
recordkeeping requirements.
11
In addition to being regulated in the U.S., the Company's business is
subject to regulation by various foreign governments and regulatory bodies. The
Company does business in the international equity and fixed income markets and
undertakes investment banking activities through several of its London
subsidiaries. These broker-dealer subsidiaries are subject to regulation by the
SFA, which governs all aspects of a United Kingdom investment business,
including regulatory capital, sales and trading practices, use and safekeeping
of customer funds and securities, recordkeeping, margin practices and
procedures, registration standards for individuals, periodic reporting and
settlement procedures. In addition, the Company has broker-dealer subsidiaries
which are subject to regulation, including capital requirements, imposed by the
SFC of Hong Kong and the Ontario Securities Commission.
Additional legislation and regulations, including those relating to
the activities of affiliates of broker-dealers, changes in rules promulgated by
the Commission, the CFTC or other U.S. or foreign governmental regulatory
authorities and SRO's or changes in the interpretation or enforcement of
existing laws and rules may adversely affect the manner of operation and
profitability of the Company.
The Company's businesses may be materially affected not only by
regulations applicable to it as a financial market intermediary, but also by
regulations of general application. For example, the volume of the Company's
underwriting, merger and acquisition and merchant banking businesses in any
year could be affected by, among other things, existing and proposed tax
legislation, antitrust policy and other governmental regulations and policies
(including the interest rate policies of the Federal Reserve Board) and changes
in interpretation or enforcement of existing laws and rules that affect the
business and financial communities. From time to time, various forms of
anti-takeover legislation and legislation that could affect the benefits
associated with financing leveraged transactions with high-yield securities
have been proposed that, if enacted, could adversely affect the volume of
merger and acquisition and merchant banking business, which in turn could
adversely affect the Company's underwriting, advisory and trading revenues
related thereto.
The Company believes that it is in material compliance with the
regulations described herein.
In addition, several states, including New York, which is Equitable
Life's state of domicile, regulate transactions between an insurer and its
affiliates under insurance holding company acts. Under such laws and an
undertaking submitted by Equitable Life to the New York State Insurance
Department, certain transactions between the Company, on the one hand, and
Equitable Life and its subsidiaries on the other, may be subject to prior
notice or approval of the New York State Insurance Department depending on the
size of such transactions.
CAPITAL REQUIREMENTS
- --------------------
As broker-dealers registered with the Commission and member firms of
the NYSE and/or NASD, each of DLJSC, Pershing Trading, DLJdirect and Autranet
is subject to the capital requirements of the Commission and of the NYSE. These
capital requirements specify minimum levels of capital, computed in accordance
with regulatory requirements ("net capital"), that the U.S. Broker-Dealers are
required to maintain and also limit the amount of leverage that the U.S.
Broker-Dealers are able to obtain in their businesses. As a futures commission
merchant, DLJSC is also subject to the capital requirements of the CFTC and the
CBOT. Compliance with regulatory capital requirements could limit those
operations of the U.S. Broker-Dealers that require the intensive use of
capital, such as DLJSC's underwriting and trading activities, and the financing
of customer account balances, and also restrict the Company's ability to pay
dividends, pay interest, repay debt, and redeem or purchase shares of its
outstanding capital stock. A change in such rules, or the imposition of new
rules, affecting the scope, coverage, calculation or amount of capital
requirements, or a significant operating loss or any usually large charge
against capital, would adversely affect the ability of the Company to pay
dividends or to expand or even maintain present levels of business. The Company
believes that at all times the U.S. Broker-Dealers have been in compliance in
all material respects with the applicable minimum capital rules of the
Commission, the NYSE, the CFTC and the CBOT. As of December 31, 1997, DLJSC was
required to maintain a minimum "net capital," in accordance with commission and
CFTC rules, of approximately $107.3 million and had total net capital of
approximately $762.2 million (including $482.5 million of subordinated debt
borrowed under various agreements), or approximately $654.9 million in excess
of 2% of aggregate debit items and approximately $507.9 million in excess of 5%
of aggregate debit items.
12
The Company's non-U.S. broker-dealer subsidiaries may be subject to the
net capital requirements imposed by foreign financial regulatory authorities.
At December 31, 1997 and 1996, the Company believes that its foreign
broker-dealer subsidiaries were in compliance with all applicable regulatory
capital adequacy requirements.
ITEM 2. PROPERTIES
----------
The Company's principal executive offices are presently located at 277
Park Avenue, New York, New York and occupy approximately 881,000 square feet
under a lease expiring in 2016. The Company also leases space at 120 Broadway,
New York, New York, aggregating approximately 94,000 square feet. This lease
expires in 2006.
The Company's principal London-based broker-dealer subsidiary is
located at 99 Bishopsgate and occupies approximately 76,000 square feet under a
lease expiring in 2008. The Company is in the process of negotiating for an
additional 100,000 square feet in London.
Pershing also leases approximately 460,000 square feet in Jersey City,
New Jersey, under leases which expire at various dates through 2009. The
Company also owns land and a building with approximately 133,000 square feet in
Florham Park, New Jersey.
The Company leases an aggregate of approximately 650,000 square feet
for its domestic and international regional offices, the leases for which
expire at various dates through 2014. Other domestic offices are located in
Atlanta, Austin, Boston, Chicago, Dallas, Houston, Jersey City, Los Angeles,
Menlo Park, Miami, Oak Brook, Philadelphia and San Francisco. Its foreign
office locations are Bangalore, Buenos Aires, Geneva, Hong Kong, London,
Lugano, Mexico City, Paris, Sao Paulo and Tokyo.
The Company believes that its present facilities are adequate for its
current needs.
ITEM 3. LEGAL PROCEEDINGS
-----------------
Beginning on March 25, 1991, Dayton Monetary Associates and Charles
Davison, along with more than 200 other plaintiffs, filed several complaints
against DLJSC and a number of other financial institutions and several
individuals in the U.S. District Court for the Southern District of New York.
The plaintiffs allege that DLJSC and other defendants violated civil provisions
of RICO by inducing plaintiffs to invest over $40 million during the years 1978
through 1982 in The Securities Groups, a number of tax shelter limited
partnerships. The plaintiffs seek recovery of the loss of their entire
investment and an approximately equivalent amount of tax-related damages.
Judgments for damages under RICO are subject to trebling. Discovery is complete
and motions for summary judgment are pending. No trial date has been set by the
court. DLJSC believes that it has meritorious defenses to the complaints and is
contesting the suits vigorously. Although there can be no assurance, the
Company does not believe that the ultimate outcome of this litigation will have
a material adverse effect on its consolidated financial condition and/or the
Company's results of operations in any particular period.
In October 1995, DLJSC was named as a defendant in a purported class
action filed in a Texas State Court on behalf of the holders of $550 million
principal amount of subordinated redeemable discount debentures of National
Gypsum Corporation ("NGC") canceled in connection with a Chapter 11 plan of
reorganization for NGC consummated in July 1993. The State Court named
plaintiff also filed an adversary proceeding in the U.S. Bankruptcy Court for
the Northern District of Texas seeking a declaratory judgment that the
confirmed NGC plan of reorganization does not bar the class action claims.
Subsequent to the consummation of NGC's plan of reorganization, NGC's shares
traded for values substantially in excess of, and in 1995 NGC was acquired for
a value substantially in excess of, the values upon which NGC's plan of
reorganization was based. The two actions arise out of DLJSC's activities as
financial advisor to NGC in the course of NGC's Chapter 11 reorganization
proceedings. The class action complaint alleges that the plan of reorganization
submitted by NGC was based upon projections by NGC and DLJSC which
intentionally understated forecasts, and provided misleading and incorrect
information in order to hide NGC's true value and that defendants breached
their fiduciary duties by, among other things, providing false, misleading or
incomplete information to deliberately understate the value of NGC. The class
action complaint seeks compensatory and punitive damages purportedly sustained
by the class. On October 10, 1997, DLJSC and
13
others were named as defendants in a new adversary proceeding in the Bankruptcy
Court brought by the NGC Settlement Trust, an entity created by the NGC plan of
reorganization to deal with asbestos-related claims. The Trust's allegations
are substantially similar to the claims in the State Court action. On January
21, 1998, the Bankruptcy Court ruled that the State Court plaintiff's claims
were not barred by the NGC plan or reorganization insofar as they alleged
nondisclosure of certain cost reductions announced by NGC in October 1993.
DLJSC intends to defend itself vigorously against all of the allegations
contained in the complaints. Although there can be no assurance, the Company
does not believe that the ultimate outcome of this litigation will have a
material adverse effect on its consolidated financial condition. Due to the
early stage of such litigation, based upon the information currently available
to it, management cannot make an estimate of loss, if any, or predict whether
or not such litigation will have a material adverse effect on the Company's
results of operations in any particular period.
In November and December 1995, DLJSC, along with various other
parties, was named as a defendant in a number of purported class actions filed
in the U.S. District Court for the Eastern District of Louisiana. The
complaints allege violations of the federal securities laws arising out of a
public offering in 1994 of $435 million of first mortgage notes of Harrah's
Jazz Company and Harrah's Jazz Finance Corp. The complaints seek to hold DLJSC
liable for various alleged misstatements and omissions contained in the
prospectus dated November 9, 1994. On February 26, 1997, the parties agreed to
a settlement of these actions, subject to the District Court's approval, which
was granted on July 31, 1997. The settlement is also subject to the approval by
the U.S. Bankruptcy Court for the Eastern District of Louisiana of proposed
modifications to a confirmed plan of reorganization for Harrah's Jazz Company
and Harrah's Jazz Finance Corp., and the satisfaction or waiver of all
conditions to the effectiveness of the plan, as provided in the plan. There can
be no assurance of the Bankruptcy Court's approval of the modifications to the
plan of reorganization, or that the conditions to the effectiveness of the plan
will be satisfied or waived. In the opinion of management the ultimate
resolution of this matter will not have a material adverse effect on the
Company's results of operations or on its consolidated financial condition.
On January 26, 1996, a purported purchaser of certain notes and
warrants to purchase shares of common stock of Rickel Home Centers, Inc.
("Rickel") filed a class action complaint against DLJSC and certain other
defendants for unspecified compensatory and punitive damages in the U.S.
District Court for the Southern District of New York. The suit was brought on
behalf of the purchasers of 126,457 units consisting of $126,457,000 aggregate
principal amount of 13 1/2% senior notes due 2001 and 126,457 warrants to
purchase shares of common stock of Rickel (the "Units") issued by Rickel in
October 1994. The complaint alleges violations of federal securities laws and
common law fraud against DLJSC, as the underwriter of the Units and as an owner
of 7.3% of the common stock of Rickel, Eos Partners, L.P. and General Electric
Capital Corporation, each as owners of 44.2% of the common stock of Rickel, and
members of the board of directors of Rickel, including a DLJSC managing
director. The complaint seeks to hold DLJSC liable for alleged misstatements
and omissions contained in the prospectus and registration statement filed in
connection with the offering of the Units, alleging that the defendants knew of
financial losses and a decline in value of Rickel in the months prior to the
offering and did not disclose such information. The complaint also alleges that
Rickel failed to pay its semi-annual interest payment due on the Units on
December 15, 1995, and that Rickel filed a voluntary petition for
reorganization pursuant to Chapter 11 of the Bankruptcy Code on January 10,
1996. DLJSC intends to defend itself vigorously against all of the allegations
contained in the complaint. Although there can be no assurance, the Company
does not believe that the outcome of this litigation will have a material
adverse effect on its consolidated financial condition. Due to the early stage
of this litigation, based on the information currently available to it,
management cannot make an estimate of loss, if any, or predict whether or not
such litigation will have a material adverse effect on the Company's results of
operations in any particular period.
In addition to the matters described above, the Company has been named
as a defendant in various civil actions and arbitrations arising out of its
activities as a broker-dealer in securities, as an underwriter and as an
employer and arising out of alleged employee misconduct. The Company is also
involved, from time to time, in proceedings with, and investigations by,
governmental agencies and SRO's. See "Regulation." The Company does not believe
that any such matters, claims or investigations will have a material adverse
effect on its results of operations or its consolidated financial condition.
14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
During the fourth quarter of 1997, no matters were submitted to a vote of
security holders.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
-------------------------------------------------------------
MATTERS
-------
Market and Dividend Information
- -------------------------------
The principal market for trading DLJ Common Stock is the New York Stock
Exchange. Its stock symbol is "DLJ."
QUARTERS
1997 1st 2nd 3rd 4th
- ---- ---- ---- ---- -----
High................. 47 3/8 64 1/4 71 9/16 87 5/8
Low.................. 36 36 1/2 57 68
Common dividends..... $ 0.125 $ 0.125 $ 0.125 $ 0.125
QUARTERS
1996 1st 2nd 3rd 4th
- ---- ---- ---- ---- ----
High................. 33 1/2 34 3/4 35 1/8 36
Low.................. 28 5/8 30 3/8 27 5/8 32 1/8
Common dividends..... $ 0.125 $ 0.125 $ 0.125 $ 0.125
The approximate number of holders of DLJ Common Stock at March 5,
1998, was 7,500.
15
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
---------- ---------- --------- ---------- ----------
(In millions, except share and per share data)
INCOME STATEMENT DATA:
REVENUES
- --------
Commissions................................. $ 690.2 $ 573.3 $ 460.2 $ 376.1 $ 358.8
Underwritings............................... 831.7 714.2 441.5 261.1 574.6
Fees........................................ 767.3 470.0 369.1 281.3 211.3
Interest, net (1)........................... 1,652.1 1,074.2 904.1 791.9 657.3
Principal transactions-net:
Trading..................................... 437.1 435.4 364.9 165.7 381.5
Investment.................................. 194.5 163.0 163.7 97.6 79.9
Other....................................... 67.6 60.7 55.1 35.0 21.9
----------- --------- --------- ---------- ---------
Total revenues............................ 4,640.5 3,490.8 2,758.6 2,008.7 2,285.3
----------- --------- --------- ---------- ---------
COSTS AND EXPENSES
- ------------------
Compensation and benefits.................. 1,908.2 1,538.8 1,261.4 897.8 1,200.4
Compensation expense-
restricted stock units................... - - 6.2 - -
Interest................................... 1,153.2 733.2 680.6 503.8 381.7
Brokerage, clearing, exchange
fees and other........................... 231.4 201.3 168.1 135.6 133.8
Occupancy and equipment.................... 189.9 159.3 127.1 90.1 80.0
Communications............................. 64.0 53.7 42.8 36.6 31.9
Other operating expenses................... 432.7 330.7 173.9 139.8 155.5
----------- --------- --------- ---------- ---------
Total costs and expenses................ 3,979.4 3,017.0 2,460.1 1,803.7 1,983.3
----------- ---------- --------- ----------- ----------
Income before provision for
income taxes.............................. 661.1 473.8 298.5 205.0 302.0
Provision for income taxes................... 252.8 182.5 119.4 82.0 115.9
---------- --------- --------- ---------- ---------
Net income................................... $ 408.3 $ 291.3 $ 179.1 $ 123.0 $ 186.1
========== ========= ========= ========== =========
Dividends on preferred stock................. $ 12.2 $ 18.7 $ 19.9 $ 21.0 $ -
========== ========= ========= ========== =========
Earnings applicable to
common shares............................. $ 396.1 $ 272.6 $ 159.2 $ 102.0 $ 186.1
========== ========= ========= ========== ========
Weighted average common
shares outstanding (2):
Basic................................... 55,159 53,300 50,570
========== ========= ========
Diluted................................. 62,749 59,356 51,580
========== ========= ========
Earnings per common share (2):
Basic................................... $ 7.18 $ 5.12 $ 3.15
========== ========= ===========
Diluted................................. $ 6.32 $ 4.59 $ 3.09
========== ========= ===========
Pro forma weighted average
common shares outstanding (3)..............
Basic................................... 50,000 50,000
========== =========
Diluted................................. 51,475 51,475
========== =========
Pro forma earnings per
common share (3)...........................
Basic................................... $ 2.04 $ 3.72
========== ========
Diluted................................. $ 1.98 $ 3.62
========== ========
16
YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ---------
(In millions, except share and per share data and financial ratios)
BALANCE SHEET DATA (AT END OF PERIOD):
Securities purchased under
agreements to resell and
securities borrowed $ 43,227.4 $ 29,954.2 $ 27,793.1 $ 19,166.9 $ 21,575.2
Total assets................................ 70,505.8 55,503.7 44,576.5 33,261.6 38,766.7
Securities sold under agreements to
repurchase and securities loaned 43,694.1 32,103.1 29,369.0 20,385.4 24,116.7
Long-term borrowings........................ 2,251.9 1,541.6 983.4 539.9 549.0
Redeemable preferred stock 200.0 200.0 225.0 225.0 225.0
Stockholders' equity ....................... 2,061.5 1,647.2 1,198.7 820.3 750.3
OTHER FINANCIAL DATA (AT END OF PERIOD):
Book value per common share
oustanding................................ $ 31.44 $ 24.79 $ 20.50 $ 16.41 $ 15.01
Ratio of net assets to
stockholders' equity (4)................. 13.2x 15.51x 14.00x 17.18x 22.91x
Ratio of long-term borrowings
to total capitalization (5).............. 0.50 0.44 0.37 0.30 0.34
Return on average equity (6)................ 24.1% 20.6% 17.1% 13.1% 30.5%
Ratio of earnings to fixed charges.......... 1.16x 1.16x 1.11x 1.10x 1.20x
Ratio of earnings to combined fixed
charges and preferred stock
dividends (7)............................. 1.16x 1.16x 1.10x 1.09x -
(1) Interest is net of interest expense to finance U.S. government, agency and
mortgage-backed securities of $ 2.9 billion, $2.1 billion, $2.0 billion,
$1.6 billion and $1.1 billion, respectively.
(2) In December 1997, the Company adopted SFAS No. 128 "Earnings per Share"
which is effective for financial statements issued for periods ending after
December 15, 1997. SFAS No. 128 replaces the primary and fully diluted
earnings per share amounts with a presentation of basic and diluted earnings
per share. All earnings per common share amounts reflect the adoption of
this statement.
Basic earnings per common share amounts have been calculated by dividing
earnings applicable to common shares (net income less preferred dividends)
by the weighted average common shares outstanding i.e. excluding the effect
of potentially dilutive securities. Diluted earnings per common share also
include the dilutive effects of common stock issuable under the Restricted
Stock Unit Plan and the dilutive effect of options and convertible debt
under the treasury stock method and "if-converted" method, respectively.
(3) Pro forma diluted earnings per common share are calculated by dividing
earnings applicable to common shares (net income less preferred dividends),
by the pro forma weighted average number of diluted common shares
outstanding. Pro forma common shares outstanding represent actual
historical shares outstanding adjusted for the dilutive effect of the
Restricted Stock Units (RSUs) using the treasury stock method.
(4) Net assets are total assets excluding securities purchased under agreements
to resell and securities borrowed.
(5) Long-term borrowings and total capitalization (the sum of long-term
borrowings, preferred stock and stockholders' equity) exclude current
maturities (one year or less) of long-term borrowings.
(6) After payment of dividends on the Company's preferred stock.
(7) For the purpose of calculating the ratio of earnings to combined fixed
charges and preferred stock dividends (i) earnings consist of income before
the provision for income taxes and fixed charges and (ii) fixed charges
consist of interest expense and one-third of rental expense which is deemed
representative of an interest factor. No preferred dividends were paid in
1993.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
BUSINESS ENVIRONMENT
- --------------------
The Company's principal business activities, investment and merchant
banking, securities sales and trading and correspondent brokerage services are,
by their nature, highly competitive and subject to general market conditions,
volatile trading markets and fluctuations in the volume of market activity.
Consequently, the Company's net income and revenues have been and are likely to
continue to be, subject to wide fluctuations, reflecting the impact of many
factors beyond the Company's control, including securities market conditions,
the level and volatility of interest rates, competitive conditions and the size
and timing of transactions.
The strong market conditions that existed throughout 1996 continued
during 1997 resulting in record levels of underwriting and merger and
acquisition activity. Record levels were also achieved by major stock indices,
such as the Dow Jones Industrial Average, the Standard & Poor's 500 Index and
the NASDAQ composite. These favorable market conditions combined with rising
stock prices created a robust investment banking atmosphere.
RECENT DEVELOPMENTS
- -------------------
In March 1997, the Company acquired a London-based investment bank,
Phoenix Group Limited (Phoenix). Phoenix is an international financial advisory
and investment management business with offices in London and Hong Kong. It has
two principal operations, a corporate finance and advisory business and private
equity fund management business investing in private securities. It also makes
investments as principal.
In April 1997, a bridge loan aggregating $150 million was repaid in
full and the Company realized the $28.8 million previously reserved, plus
interest.
In October 1997, the Company sold for cash approximately $250.0 million
of mortgage loans and related assets secured by 38 multi-family properties.
These assets were obtained through the repurchase in 1994 of certain mortgage
related securities previously underwritten by the Company. The sales price
approximated the Company's carrying value of these assets.
In October 1997, the Company acquired London Global Securities ("LGS"),
a securities financing intermediary located in London. LGS is active in
approximately 25 equity markets and offers institutional investors and
financial institutions financing services for a full range of securities,
including equities, convertible bonds, warrants and emerging markets debt
through a variety of transaction structures such as swaps, repurchase
agreements, buy/sell arrangements and collateral management programs.
In December 1997, the Company's shelf registration statement which
enables the Company to issue, from time to time, up to $300 million of senior
or subordinated debt securities or preferred stock, was declared effective.
In January 1998, the Company issued an initial 3.5 million shares of
Fixed/Adjustable Rate Cumulative Preferred Stock, Series B, with a liquidation
preference of $50 per share ($175.0 million aggregate liquidation value) from
such shelf registration statement.
In February 1998, the Board of Directors declared a two-for-one common
stock split of the Company's common stock. The stock split is subject to
shareholder approval of the increase in the number of authorized common shares
from 150 million to 300 million. The split will be effected in the form of a
stock dividend. The par value of the common stock will remain at $.10 per
share. After the split is implemented, the Company's quarterly dividend rate
will be adjusted proportionately downward. All share and per share amounts will
be restated upon approval of the shareholders.
In March 1998, the Company issued $150 million of 6 1/2% Senior Notes
due 2008.
RESULTS OF OPERATIONS
- ---------------------
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
- ---------------------------------------------------------------------
Total revenues for 1997 were $4.6 billion, an increase of $1,149.7
million or 32.9% over 1996. Revenues increased in all of the Company's major
areas of activity during 1997.
18
Commission revenues increased by $116.8 million or 20.4% to $690.2
million due to increased business in all areas, and is generally consistent
with the overall growth in listed share volume on major equity exchanges.
Underwriting revenues increased by $117.5 million or 16.5% to $831.7
million. The Company experienced increases in all areas of underwriting during
1997.
Fee revenues increased by $297.3 million or 63.3% to $767.3 million.
Overall, merger and acquisition ("M&A"), private placements and other advisory
services activities increased during 1997. Private equity capital raised for
other investment organizations increased in 1997. In addition, fees from the
Company's asset management group increased due to an increase in assets under
management from $5.6 billion at the beginning of 1997 to $12.0 billion at the
end of the year.
Interest, net of interest expense to finance U.S. government, agency
and mortgage-backed securities, increased by $577.9 million or 53.8% to $1.7
billion. Higher levels of foreign fixed-income financing instruments in the
Company's newly acquired London Global Securities division and higher interest
rates earned in the Emerging Markets business accounted for most of the
increase. The remaining increase was due to higher levels of inventory in the
Fixed Income Division and increased customer margin balances at Pershing.
Principal transactions-net, trading revenues increased by $1.7 million
or 0.4% to $437.1 million.
Principal transactions-net, investment revenues increased by $31.6
million or 19.4% to $194.5 million. Realized gains on investments were $160.0
million. Net unrealized carrying values increased by $34.5 million, which
includes the elimination of net unrealized depreciation of $45.6 million on
investments sold and an increase in net unrealized depreciation of $11.1
million on retained investments.
Other revenues, consisting primarily of dividends and miscellaneous
transaction revenues, increased by $6.9 million or 11.4% to $67.6 million due
to increased revenue sharing arrangements at Pershing.
Total costs and expenses for 1997 were $4.0 billion, an increase of
$962.4 million or 31.9% over 1996.
Compensation and benefits increased $369.4 million or 24.0% to $1.9
billion. Most of the increase was due to increased variable incentive and
production-related compensation, which resulted from higher revenues and
operating results. Incentive and production-related compensation increased by
22.6% in 1997, while base compensation, including benefits and payroll taxes,
increased by 28.2% due to expansion in various business groups, consistent with
the growth of the Company's international businesses. At December 31, 1997,
full-time personnel totaled 7,053 compared to 5,885 at December 31, 1996, an
increase of 1,168 or 19.8%.
Interest expense increased $420.0 million or 57.3% to $1,153.2 million.
Most of this increase was related to expanded levels of inventory of
fixed-income related products in the Real Estate Finance department and as a
result of the London Global acquisition.
All other expenses, as noted below, increased by $173.0 million or
23.2% to $918.0 million in 1997.
Brokerage, clearing, exchange fees and other expenses increased by
$30.1 million due to increased share volume, underwriting related expenses and
transaction fee payments. Occupancy and equipment costs increased by $30.6
million as a result of the full year impact of the firm's relocation and
expansion of the Company's principal office in the U.S. as well as expansion of
the Company's other domestic and international offices. During the fourth
quarter of 1997, the Company moved its principal London operations to a new and
expanded location. Communications costs increased by $10.3 million due to
expanded facilities and growth in professional staff. All other operating
expenses increased by $102.0 million. Included therein are data processing,
professional fees, travel and entertainment, and printing and stationery which
increased by $110.5 million reflecting an overall increase in the level of
business activity and costs for Year 2000 project (See "Year 2000"). Increased
advertising expenses relate primarily to a major national print, television and
online advertising campaign on behalf of DLJdirect, the Company's online
investing broker. These increases were offset by a reduction of expenses
incurred on previously underwritten mortgage-related securities, the assets of
which were sold in the fourth quarter of 1997.
19
The Company's income tax provision for 1997 and 1996 was $252.8
million and $182.5 million, respectively, which represented a 38.2% and 38.5%
effective tax rate for each period.
Net income for 1997 was $408.3 million, up $117.0 million or 40.1% as
compared to 1996. Diluted earnings per common share using the treasury stock
method were $6.32 and $4.59 for 1997 and 1996, respectively.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
- ---------------------------------------------------------------------
Total revenues for 1996 were $3.5 billion, an increase of $732.1
million or 26.5% over 1995. Revenues increased in most of the Company's major
areas of activity during 1996.
Commission revenues increased by $113.1 million or 24.6% to $573.3
million due to increased business in all areas, and is generally consistent
with the overall growth in listed share volume on major equity exchanges.
Underwriting revenues increased by $272.6 million or 61.7% to $714.2
million. The Company experienced increases in all areas of underwriting during
1996.
Fee revenues increased by $100.9 million or 27.3% to $470.0 million.
Overall, merger and acquisition ("M&A"), asset management and other advisory
services activities have increased during 1996. In 1996, the Company closed DLJ
Merchant Banking Partners II, L.P. and related investment entities with total
committed capital in excess of $3.0 billion. At December 31, 1996, the Company
had approximately $8.0 billion of committed capital related to its merchant
banking activities.
Interest, net of interest expense to finance U.S. government, agency
and mortgage-backed securities, increased by $170.1 million or 18.8% to $1.1
billion. Higher levels of foreign fixed-income securities in the Company's
Emerging Markets business accounted for approximately one half of the increase.
The remaining increase was due to higher levels of inventory in the Fixed
Income Division and increased margin balances at Pershing.
Principal transactions-net, trading revenues increased by $70.5 million
or 19.3% to $435.4 million. Most of the increase took place in the Fixed Income
Division due to improved trading results in high-grade corporates and
high-yield securities.
Principal transactions-net, investment revenues decreased by $0.7
million or 0.4% to $163.0 million. Realized gains on investments were $213.3
million. Net unrealized carrying values decreased by $50.3 million, which
includes the elimination of net unrealized appreciation of $47.6 million on
investments sold and a decrease in net unrealized appreciation of $2.7 million
on retained investments.
Other revenues, consisting primarily of dividends and miscellaneous
transaction revenues, increased by $5.5 million or 10.0% to $60.7 million due
to increased business activity.
Total costs and expenses for 1996 were $3,017.0 million, an increase
of $556.8 million or 22.6% over 1995.
Compensation and benefits increased $271.2 million or 21.4% to
$1,538.8 million. Most of the increase was due to increased variable incentive
and production-related compensation, which resulted from higher revenues and
operating results. Incentive and production-related compensation increased by
26.7% in 1996, while base compensation, including benefits and payroll taxes,
increased by 9.6% due to expansion in various business groups. At December 31,
1996, full-time personnel totaled 5,885 compared to 4,918 at December 31, 1995,
an increase of 967 or 19.7%.
Interest expense increased $52.6 million or 7.7% to $733.2 million.
Most of this increase was related to expanded levels of inventory of
fixed-income related products including equity derivatives and foreign local
fixed-income securities.
All other expenses, as noted below, increased by $233.1 million or
45.5% to $745.0 million in 1996.
Brokerage, clearing, exchange fees and other expenses increased by
$33.2 million due to increased share volume, underwriting related expenses and
transaction fee payments. Occupancy and equipment costs increased by $32.2
million as a result of the expansion of the Company's principal office in the
U.S.
20
and the expansion of the Company's other domestic and overseas offices.
Communications costs increased by $10.9 million due to expanded facilities and
growth in professional staff. All other operating expenses increased by $156.8
million. Included therein are data processing, professional fees, travel and
entertainment, and printing and stationery which increased by $82.1 million
reflecting an overall increase in the level of business activity. In addition,
during 1996, $35.7 million of expenses were incurred in connection with
mortgage-related securities previously underwritten by the Company.
The Company's income tax provision for 1996 and 1995 was $182.5
million and $119.4 million, respectively, which represented a 38.5% and 40.0%
effective tax rate for each period.
Net income for 1996 was $291.3 million, up $112.2 million or 62.6% from
the comparable 1995 period. Diluted earnings per common share using the
treasury stock method were $4.59 and $3.09 for 1996 and 1995, respectively.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company's assets are highly liquid with the majority consisting of
securities inventories and collateralized receivables, both of which fluctuate
depending on the levels of proprietary trading and customer business. Such
collateralized receivables consist primarily of resale agreements and
securities borrowed, both of which are secured by U.S. government and agency
securities, and marketable corporate debt and equity securities. In addition,
the Company has significant receivables from customers, brokers and dealers
which turn over frequently. As a securities dealer, the Company may carry
significant levels of trading inventories to meet client needs. As such, the
Company's total assets or the individual components of total assets vary
significantly from period to period because of changes relating to customer
needs, economic and market conditions and proprietary trading strategies. A
relatively small percentage of total assets is fixed or held for a period of
longer than one year. The Company's total assets at December 31, 1997 and 1996
were $70.5 billion and $55.5 billion, respectively.
The majority of the Company's assets are financed through daily
operations by repurchase agreements, securities sold not yet purchased,
securities loaned, bank loans, and through payables to brokers and dealers.
Short-term funding is generally obtained at rates related to Federal funds,
LIBOR and money market rates. Other borrowing costs are negotiated depending
upon prevailing market conditions. The Company monitors overall liquidity by
tracking the extent to which unencumbered marketable assets exceed short-term
unsecured borrowings.
In March 1996, the Company moved its principal offices from 140
Broadway to 277 Park Avenue in New York City. In 1997, the Company moved its
principal London operations to a new and expanded location. The Company
financed expenditures related to the moves with available operating capital.
During the second quarter of 1997, the Company replaced several
individual credit facilities aggregating $1.925 billion with a $2.0 billion
revolving credit facility, of which $1.0 billion may be unsecured. There were
no borrowings outstanding under this agreement at December 31, 1997.
Certain of the Company's businesses are capital intensive. In addition
to normal operating requirements, capital is required to cover financing and
regulatory charges on securities inventories, merchant banking investments and
investments in fixed assets. The Company's overall capital needs are
continually reviewed to ensure that its capital base can appropriately support
the anticipated needs of its business units as well as the regulatory capital
requirements of subsidiaries. Based upon these analyses, management believes
that the Company's debt and equity base is adequate for current operating
levels. The Company has been active in raising additional long-term financing,
including extending the maturity of its senior subordinated revolving credit
agreement of $325.0 million.
The Company issues structured notes which are customized financing
instruments in which the amount of interest or principal paid on the debt
obligation is linked to the return on specific cash instruments. At December
31, 1997 and 1996, the Company had issued long-term structured notes with
principal amounts of $123.7 million and $216.2 million outstanding,
respectively. The Company covers its obligations on structured notes primarily
by purchasing and selling the financial instruments to which the value of its
structured notes are linked.
21
In April 1997, the Company commenced a program for the offering of up
to $300 million Medium-Term Notes due nine months or more from the date of
issuance. The Medium-Term Note program was established under a shelf
registration statement previously filed by the Company. The notes may bear
interest at fixed or floating rates and may be issued as indexed notes, dual
currency notes, renewable notes, amortizing notes or original issue discount
notes. At December 31, 1997, the Company had $200.0 million of notes
outstanding under this program with a weighted average interest rate of 6.48%.
The Company has entered into interest rate swap transactions to convert $190.0
million of such fixed rate notes into floating rate notes based upon LIBOR. At
December 31, 1997, the weighted average effective interest rates on these notes
was 6.08%.
In September 1997, the Company filed a shelf registration statement
which enables the Company to issue from time to time up to $1.0 billion in
aggregate principal amount of senior or subordinated debt securities. In
addition, the Company commenced a program under such shelf registration for the
offering of up to $500 million Medium-Term Notes due nine months or more from
the date of issuance. The notes may bear interest at fixed or floating rates
and may be issued as indexed notes, dual currency notes, renewable notes,
amortizing notes or original issue discount notes. At December 31, 1997, there
were $150 million notes outstanding under this program with a fixed rate of
6.90%. In October 1997, the Company issued an additional $100 million
Medium-Term Notes from this same shelf registration statement. These notes
mature on October 29, 2007 and bear interest at a floating rate of 6.28% at
December 31, 1997 based upon LIBOR. The Company has entered into an interest
rate swap transaction to convert such notes to fixed rate notes at 6.94%. In
addition, in September 1997, the Company issued $350 million Global Floating
Rate Notes from the $1.0 billion shelf registration statement. Such notes bear
interest at a floating rate equal to LIBOR plus 0.25% and mature on September
18, 2002. The notes are redeemable by the Company in whole or in part on any
interest payment date on or after September 2000.
In December 1997, the Company's shelf registration statement which
enables the Company to issue, from time to time, up to $300 million of senior
or subordinated debt securities or preferred stock, was declared effective. In
January 1998, the Company issued an initial 3.5 million shares of
Fixed/Adjustable Rate Cumulative Preferred Stock, Series B, with a liquidation
preference of $50 per share ($175.0 million aggregate liquidation value) from
such shelf registration statement.
In January 1998, the Company commenced a $1.0 billion commercial paper
program. Obligations issued thereunder (the "Notes") are exempt from
registration under the Securities Act of 1933, as amended. The Notes rank pari
passu with the Company's other unsecured and unsubordinated indebtedness.
The Company's current credit ratings of its long-term debt and commercial paper
are as follows:
Long-Term Debt Commercial Paper
----------------- --------------------------
Duff & Phelps A -
Fitch IBCA A F-1
Moody's A3 P-2
Standard & Poors A- A-2
Thomson BankWatch A+ TBW-1
On December 19, 1997, Moody's Investors Service upgraded the ratings of the
Company's senior debt to A3 from Baal and assigned a P-2 rating to the
Company's commercial paper.
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJSC") is
subject to the capital requirements of the Securities and Exchange Commission,
the New York Stock Exchange, Inc., the Commodities Futures Trading Commission
and the Chicago Board of Trade, all of which should ensure the general capital
adequacy and liquidity of broker-dealers and/or futures commission merchants.
DLJSC has consistently maintained capital substantially in excess of the
minimum requirements of such capital rules. At December 31, 1997, DLJSC had
aggregate regulatory "net capital," after adjustments required by Rule 15c3-1
under the Exchange Act of 1934, of approximately $762.2 million, which exceeded
minimum net capital requirements by $654.9 million and which exceeded the net
capital required by DLJSC's most restrictive debt covenants by $394.7 million.
22
Certain of the Company's London-based broker-dealer subsidiaries are
subject to the requirements of the Securities and Futures Authority, a
self-regulatory organization established pursuant to the United Kingdom
Financial Services Act of 1986. Other U.S. and foreign broker-dealer
subsidiaries of the Company are subject to net capital requirements of their
respective regulatory agencies. At December 31, 1997 and 1996, the Company and
its broker-dealer subsidiaries were in compliance with all applicable
regulatory capital adequacy requirements.
The Company's overall capital and funding needs are continually
reviewed to ensure that its capital base can support the estimated needs of its
business units.
CASH FLOWS
- ----------
The Company's consolidated statements of cash flows classify cash flows
into three broad categories: cash flows from operating activities, investing
activities and financing activities. The Company's net cash flows are
principally associated with operating and financing activities, which support
the Company's trading, customer and banking activities.
Years Ended December 31, 1997, 1996 and 1995
- --------------------------------------------
Cash and cash equivalents at December 31, 1997, 1996 and 1995 totaled
$273.2 million, $158.8 million and $107.8 million, respectively, an increase of
$114.3 million, $51.1 million and $12.9 million, respectively.
Cash (used in) provided by operating activities totaled $(5.2)
billion, $(1.7) billion and $93.8 million in 1997, 1996 and 1995, respectively.
In 1997, there were increases in securities borrowed of $11.2 billion and
receivables from customers of $1.2 billion. These increases were offset by
increases in operating liabilities including securities loaned of $5.0 billion,
payables to customers of $1.2 billion, securities sold not yet purchased of
$1.0 billion and accounts payable and accrued expenses of $397.9 million. In
1996, there were increases in securities sold not yet purchased of $2.7
billion, payables to brokers, dealers and other of $2.3 billion and payables to
customers of $1.3 billion. These increases were more than offset by increases
in assets including trading inventories of $4.9 billion, receivables from
brokers, dealers and other of $2.3 billion, and receivables from customers of
$813.3 million. In 1995, there were increases in assets including trading
inventories of $1.8 billion, receivables from customers of $707.3 million and
securities borrowed of $354.5 million. These increases in operating assets were
offset by increases in liabilities, including securities sold not yet purchased
of $1.2 billion, payables to customers of $604.6 million and securities loaned
of $595.5 million.
In 1997, net cash used in investing activities of $216.0 million
consisted primarily of fixed asset purchases related to the expansion of the
Company's domestic and international offices and net purchases of long-term
corporate development investments. Such purchases were partially offset by
proceeds received from the sale of mortgage loans and related assets secured by
38 multi-family properties totaling $250.0 million. In 1996 and 1995, net cash
used in investing activities of $107.0 million and $120.0 million,
respectively, consisted primarily of fixed asset purchases related to the
Company's move of its principal offices. Additionally, in 1996, cash was
provided from the sales of long-term corporate development investments.
In 1997 and 1996, net cash provided by financing activities totaled
$5.6 billion and $1.9 billion, respectively, of which, $4.9 billion and $1.2
billion was provided by short-term financings. In 1997, cash of $88.0 million
was used to repay medium-term notes due in 1997, $347.8 million was provided by
the issuance of global floating rate notes, $447.6 million was provided by the
issuance of medium-term notes and $118.5 million was provided by the issuance
of an addition to the subordinated revolving credit agreement. In 1996, cash of
$105.5 million was used to repay Swiss Franc Bonds. $249.5 million was provided
by the issuance of medium-term notes, $200.0 million was provided by the
issuance of mandatorily redeemable preferred securities by the Company's wholly
owned Trust, and $200.0 million was provided by the issuance of Series A
Fixed/Adjustable Rate Cumulative Preferred Stock of the Company. In 1995, cash
of $541.8 million was used to repay short-term funding (principally repurchase
agreements). Additionally, $496.8 million was provided from the issuance of
Senior Notes, $100.0 million from the issuance of restricted stock units, $81.2
million from the issuance of common stock in the IPO and $250.0 million from a
secured term loan agreement. This loan agreement as well as $79.0 million of
other long-term debt was repaid in 1995.
23
DERIVATIVE FINANCIAL INSTRUMENTS
- --------------------------------
Derivatives are financial instruments, the payments on which are linked
to the prices, or relationships between prices, of securities or commodities,
interest rates, currency exchange rates or other financial measures
(collectively referred to as "cash market instruments"). Derivatives enable the
Company and its clients to manage their exposure to interest rates and currency
exchange rates, and security and other price risks. Derivatives may include
swaps, futures or forward contracts and options. Certain types of derivatives,
including forwards and certain options, are traded in the over the counter
("OTC") markets. Other types of derivatives, including futures contracts and
listed options are traded on regulated exchanges. The Company's involvement in
derivative products is related primarily to revenue generation through the
provision of products to its clients as opposed to covers of the Company's own
positions.
The Company's derivative activities are not as extensive as many of
its competitors. Instead, the Company has focused its derivative activities on
writing OTC options contracts to accommodate its customers' needs, trading in
forward contracts in U.S. government and agency issued or guaranteed
securities, trading in futures contracts on equity-based indices, interest rate
instruments, and foreign currencies, and issuing structured products based on
emerging market financial instruments and indices. The Company's involvement in
swap contracts which may involve greater risk and volatility, is not
significant.
Options:
-------
As part of customer accommodations, the Company writes option
contracts specifically designed to meet customers' needs. As a writer of OTC
option contracts, the Company receives a cash premium at the beginning of the
contract period and bears the risk of unfavorable changes in the value of the
financial instruments underlying the options. Options written do not expose the
Company to credit risk since they obligate the Company (not its counterparty)
to perform. With respect to the financial instruments underlying these options,
the Company makes a determination that credit exposures are appropriate for the
particular counterparty with whom business is conducted. The Company generally
covers its market risk associated with the options business by purchasing or
selling cash or other derivative financial instruments on a proprietary basis
to cover the options written. Such purchases and sales may include debt and
equity securities, futures and forward contracts and options. The Company
reviews the creditworthiness of the counterparties of such covering
transactions. Future cash requirements for options written are equal to the
fair value of the options. Option contracts are typically written for a
duration of less than 13 months and are included in the consolidated statements
of financial condition at fair value. Option premiums are recognized as revenue
over the life of the option contracts on a straight-line basis or are
recognized as revenue through the change in the fair value of the option.
The notional (contract) values of the written options were $5.4
billion and $8.6 billion at December 31, 1997 and 1996, respectively. The
overall decrease in the notional value of all options was due primarily to
decreases in customer activity related to foreign sovereign debt securities
resulting from competitive pressures and overall market conditions. Such
options contracts are covered by the following financial instruments which the
Company has purchased or sold on a proprietary basis and are reflected in the
table below at either the underlying contract (notional) amounts for derivative
instruments or at market value for cash instruments:
December 31,
1997 1996
-------- --------
(In millions)
U.S. government, mortgage-backed
securities and options thereon.............. $ 3,773 $ 4,679
Foreign sovereign debt securities............... 73 2,460
Futures contracts............................... 219 306
Equities and other.............................. 1,340 1,167
-------- -------
Total.................................... $ 5,405 $ 8,612
======== =======
24
Forwards and Futures Trading:
----------------------------
As part of the Company's trading activities, including trading
activities in the related cash market instruments, the Company enters into
forward and futures contracts primarily involving securities, foreign
currencies, indices and forward rate agreements, as well as options on futures
contracts. Such forward and futures contracts are entered into as part of the
Company's covering transactions and are not used for speculative purposes.
Forward contracts generally call for the purchase or sale by the
Company, on a delayed settlement basis, of debt securities or currencies, or
other financial instruments. Futures contracts and options on futures contracts
are exchange traded contracts which settle daily and generally call for the
purchase or sale by the Company of a financial instrument at a specified future
date at a specified price. The Company generally profits when the value of
assets that it has purchased on a delayed settlement basis rises or the value
of assets that it has sold on a delayed settlement basis falls. Conversely, the
Company generally incurs losses when assets purchased for delayed settlement
decline in value or assets sold increase in value. Forward and futures
contracts, unlike cash market transactions in the financial instruments to
which such forwards or futures relate, have both on-and off-balance sheet
implications. The notional contractual value of forward and futures contracts
are treated as off-balance sheet items, while the related unrealized gains and
losses are included in assets and liabilities.
The average monthly net unrealized gains (losses) were approximately
$(2.0) million and $(10.0) million for forward contracts and $1.0 million and
$2.0 million for futures contracts for the years ended December 31, 1997 and
1996, respectively. Net unrealized gains (losses) of approximately $(6.0)
million and $(3.0) million related to forward contracts and approximately
$(2.0) million and $6.0 million related to futures contracts at December 31,
1997 and 1996, respectively, were included in the receivables from or payables
to brokers, dealers and other captions in the Company's consolidated statements
of financial condition. Unrealized gains and losses on forward and futures
contracts are recorded in earnings. Net trading gains (losses) on forward
contracts were $(5.1) million, $39.0 million and $149.0 million and net trading
gains (losses) on futures contracts were $(24.0) million, $8.0 million and
$(58.0) million for the years ended December 31, 1997, 1996 and 1995,
respectively.
The notional contract and market values of the forward and futures
contracts at December 31, 1997 and 1996 were as follows:
December 31,
1997 1996
---- ----
(In millions)
Forward Contracts:
Purchased at notional (contract) value $ 18,366 $ 14,070
Sold at notional (contract) value 27,028 17,917
Futures Contracts and Options on Future Contracts:
Purchased at market value....................................... $ 988 $ 1,420
Sold at market value............................................ 2,767 2,774
MERCHANT BANKING AND BRIDGE LENDING ACTIVITIES
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The Company's merchant banking activities include investments in
various partnerships, for which subsidiaries of the Company act as general
partner, as well as direct investments in connection with its merchant banking
activities. As of December 31, 1997 the Company has investments of $245.8
million and has potential commitments to invest up to an additional $885.6
million in connection with these merchant banking activities.
The Company is the sponsor of the $1.25 billion DLJ Bridge Fund which
provides short-term loans in connection with DLJ's merchant banking and
financial advisory businesses. The Bridge Fund has a $750 million commitment of
subordinated debt from Equitable and $500 million of senior revolving credit
by a commercial bank syndicate, certain terms of which are being renegotiated.
Any loans made by the DLJ Bridge Fund would be expected to be refinanced, and
the outstanding amounts repaid, within a short-term period. The Company has
agreed to pay Equitable the first $25 million of aggregate principal losses
incurred by Equitable with respect to all bridge loans. To the extent such
payments by the Company do not fully cover any such losses incurred by
Equitable, Equitable is entitled to receive all other distributions
25
otherwise payable to the Company with respect to DLJ Bridge Fund activities
until such losses have been recovered. The Company has also agreed to pay
Equitable the amount, if any, by which any principal loss on an individual loan
exceeds $150 million. The DLJ Bridge Fund currently has one individual bridge
loan outstanding in excess of $150 million. Pursuant to arrangements between
the Company and the commercial bank syndicate, the Company is at risk for a
significant portion of any loans funded by such banks. However, substantially
all of the bridge loans have been made without using the bank commitment. At
December 31, 1997, the DLJ Bridge Fund had extended $565.1 million of
short-term bridge loans which are expected to be refinanced in the first
quarter of 1998.
HIGH-YIELD AND NON-INVESTMENT GRADE DEBT SECURITIES
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The Company participates in the underwriting, trading, sales and
holding of high-yield and non-investment-grade securities. Non-investment-grade
securities are defined as securities or loans to companies rated BB+ or lower
as well as non-rated securities or loans. These securities genera