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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, 1998
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
- ----- OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number 1-6862
Donaldson, Lufkin & Jenrette, Inc.
- -------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 13-1898818
- --------------------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
277 Park Avenue, New York, New York 10172
VAddress 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 18, 1999, the latest practicable date, there were 124,425,447 shares
of Common Stock, $0.10 par value, outstanding.
At March 18, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $2,175.4 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 21,
1999, which definitive proxy statement (the "Proxy Statement") was filed by the
registrant with the Securities and Exchange Commission on March 18, 1999 not
later than 120 days after the year ended December 31, 1998.
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 Venture capital
o Correspondent brokerage services
o Securities lending
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, 1998 the Equitable owned 72.2% 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, 1998, approximately 59.7% of
Equitable's outstanding common stock.
In 1998 and prior years, the Company operated in three principal
segments in the financial service industry:
o Banking Group
o Capital Markets Group
o Financial Services Group
In 1998, the Company continued to make strides toward achieving the goal of
establishing a strong international presence. The Company launched an
international equities business headquartered in London and opened investment
banking offices in Buenos Aires, Hong Kong, Moscow, Paris and Seoul. The
Merchant Banking Group has expanded its international efforts, with investments
in the UK, Italy, France, Argentina and Brazil. At December 31, 1998 and 1997,
total net revenues related to the Company's foreign operations were
approximately $327.3 million and $371.1 million, respectively. At December 31,
1998 and 1997, total foreign assets were approximately $10.9 billion and $8.6
billion, respectively.
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 in Europe, Asia and Latin America. Through Investment Banking, the Company
manages and underwrites public offerings of securities, arranges private
placements, originates investment-grade debt, underwrites and syndicates senior
bank debt and provides advisory and other services in connection with mergers,
acquisitions, restructurings and other financial transactions. The Company's
Merchant Banking/Principal Investing 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 Sprout Group is Wall Street's oldest venture capital organization. In 1998,
the Banking Group expanded its capabilities in the technology,
telecommunications and financial services industries. In addition, significant
progress was made in establishing a strong presence in Europe, Asia and Latin
America. New offices were opened in Paris, Moscow, Buenos Aires and Seoul, and
the London office added 80 employees.
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CAPITAL MARKETS GROUP
---------------------
EQUITIES DIVISION. The Equities Division provides domestic and
international institutional clients with global research, trading and sales
services in U.S. listed and over-the-counter equities, and foreign equities
trading. In 1998, the division initiated an aggressive worldwide expansion plan,
successfully launching the International Equities Group, a research, sales and
trading operation dedicated to non-U.S. securities. The group is headquartered
in London, with additional locations in Hong Kong and New York City. A joint
venture has also been established in Johannesburg. The group began officially
trading European, Asian and emerging markets equities in January 1999. In
addition, the Company's Equity Derivatives Division provides a broad range of
equity and index option products. Autranet is one of the oldest distributors of
research and investment material.
FIXED INCOME DIVISION. 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. The Division is focused
on two major objectives. The first is enhancing its core businesses, which are
high-yield bonds and senior bank debt, U.S. government and investment-grade
corporate bonds and real estate finance. The second objective is the
development of new products and services that will meet specific client needs.
In 1998, the Company took two such initiatives, forming a global foreign
exchange sales and trading unit and a fixed-income derivatives business. 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.
FINANCIAL SERVICES GROUP.
- ------------------------
The Financial Services Group provides a broad array of services to
individual investors and the financial intermediaries that represent them.
Pershing is a leading provider of correspondent brokerage services, clearing
transactions for financial institutions which collectively maintain over 2.5
million active customer accounts. Through its Asset Management Group, the
Company provides cash management, investment advisory and trust services
primarily to high-net-worth individuals and families. 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.
DLJdirect is a leading provider of online discount brokerage and related
investment services, offering customers automated securities order placement
through the Internet and online service providers. DLJdirect's broad range of
investment services is targeted at self-directed, sophisticated online
investors.
NET REVENUES BY OPERATING GROUP
- -------------------------------
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 1998
presentation.
Years ended December 31,
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(in millions)
Banking Group.......................... $ 405.2 $ 667.6 $ 853.4 $ 1,220.2 $ 1,486.8
Capital Markets Group.................. 641.2 814.7 1,068.4 1,262.2 1,273.3
Financial Services Group............... 458.0 619.4 827.6 1,008.9 1,248.4
Offsets and eliminations............... 0.5 (23.7) 8.1 (4.0) (57.3)
------------ ------------ ------------- ------------ ------------
Net revenues........................... $ 1,504.9 $ 2,078.0 $ 2,757.5 $ 3,487.3 $ 3,951.2
========= ========= ========= ========= =========
The Company currently conducts its operations in 17 cities in the
U.S., including Atlanta, Austin, Boston, Charlotte, Chicago, Dallas, Deerfield,
Houston, Jersey City, Los Angeles, Menlo Park, Miami, New York, Oak Brook,
Parsippany, Philadelphia and San Francisco. The Company also has international
offices located in 12 cities, including Bangalore, Buenos Aires, Geneva, Hong
Kong, London, Lugano, Mexico City, Moscow, Paris, Sao Paulo, Seoul and Tokyo.
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BANKING GROUP
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MERGERS AND ACQUISITIONS
- ------------------------
The Company's global merger and acquisition ("M&A") practice is the
fastest-growing segment of the Banking Group, participating in a broad range of
domestic and international assignments. The M&A professionals use an
industry-intensive approach and work closely with the Company's industry
specialty groups in a broad range of sectors. The M&A specialists operate from
the firm's offices in the U.S., Europe, Asia and Latin America. As a result of
the firm's focus on international expansion, almost one-third of the M&A
assignments in 1998 involved a party outside the U.S.
CAPITAL RAISING
- ---------------
EQUITY AND EQUITY-LINKED OFFERINGS. The equity capital markets group
focuses on providing financing for issuers of equity and equity-linked
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 clients.
HIGH-YIELD DEBT UNDERWRITING. 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.
INVESTMENT-GRADE CORPORATE BONDS. The investment-grade debt
origination business provides strategic advice and execution services to
clients. In 1998, the group lead-managed 69 investment grade debt offerings,
totaling approximately $15 billion.
SENIOR BANK DEBT AND BRIDGE FINANCING. The Senior Bank Debt Group
underwrites and syndicates senior bank debt, offering clients the convenience
of "one-stop shopping". During 1998, the group arranged and syndicated $23
billion of senior bank debt. The Company also offers bridge financing to cover
gaps that may occur in the timing and financing of transactions.
STRUCTURED PRODUCTS. The Structured Products Group was launched in
1998. Structured products offer clients financing alternatives to traditional
capital markets instruments. The products are customized to meet each client's
strategic objectives.
PRIVATE FUND GROUP. 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 group raised over $15 billion
in private capital in 1998.
OTHER ADVISORY SERVICES. The Company also offers clients a variety of
other advisory services. The private capital placements group raises capital
within the private debt and equity markets. Additionally, the Company's
restructuring group advises both corporations and creditors in the complex
process of corporate restructuring. 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.
MERCHANT BANKING/PRINCIPAL INVESTING
- ------------------------------------
The Company entered the merchant banking investment business in 1985.
Through the Merchant Banking Group, the Company makes investments across the
entire capital structure, from venture capital equity to investments in the
largest leveraged buyouts. The funds invest in companies and real estate in the
U.S., Europe, Asia, Latin America, Australia and Canada. At December 31, 1998,
the Group had managed funds with committed capital of approximately $8 billion.
These funds include DLJ Merchant Banking Partners I and II, L.P. which focus
primarily on equity investments in leveraged transactions; the DLJ Bridge Fund,
a leader in domestic bridge financing; DLJ Investment Partners, L.P., which
focuses on opportunities in lower risk mezzanine securities;
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DLJ Real Estate Capital Partners, L.P., which makes investments in a broad range
of real estate-related assets in the U.S. and abroad; Global Retail Partners,
L.P., which pursues investment opportunities in the retail and electronic
commerce industries, and Phoenix Equity Partners II, which provides private
equity capital to established European businesses with leading market shares.
LEVERAGED EQUITY INVESTING. The Company's flagship fund, DLJ Merchant
Banking Partners II, L.P. has committed capital of $3 billion, with 25% of the
capital committed by DLJ and its employees. The fund makes 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.
Since its inception in 1996, the fund has invested approximately $1.5 billion
in 26 companies with an aggregate transaction value of more than $12 billion.
DLJ INVESTMENT PARTNERS. DLJ Investment Partners, L.P. commenced
operation in 1995 to pursue investments primarily in lower-risk mezzanine
securities. The fund has committed capital of $500 million, including $100
million from the Company and its employees.
DLJ REAL ESTATE CAPITAL PARTNERS. DLJ Real Estate Capital Partners,
L.P., focuses on investments in a broad range of real estate and real
estate-related assets in the U.S. and abroad. The fund has committed capital of
approximately $680 million from its general and limited partners, including
$100 million from the Company and its employees.
GLOBAL RETAIL PARTNERS. Global Retail Partners, L.P., commenced
operation in 1996 and focuses on growth retailing and electronic commerce
opportunities. The fund has committed capital of approximately $150 million.
PHOENIX EQUITY PARTNERS II. Phoenix Equity Partners II is a $220 million
fund dedicated to investing in mid-market companies in Europe. The Fund focuses
primarily on U.K. companies, invests in management buyouts and buy-ins and
provides development or expansion capital for midmarket private companies.
During 1998, the fund made four investments and is now two-thirds invested.
DLJ BRIDGE FUND. The Company is the sponsor of the $750 million DLJ
Bridge Fund ("the Bridge Fund") which is funded by a commitment from Equitable.
The Bridge Fund provides short-term loans in connection with DLJ's merchant
banking and financial advisory businesses. The Bridge Fund has a commitment of
subordinated debt from Equitable for the total amount of the loans. Any loans
made by the DLJ Bridge Fund are expected to be refinanced, and the outstanding
amounts repaid, within a short-term period. The Company has also agreed to pay
Equitable the amount, if any, by which any principal loss on an individual loan
exceeds $150 million. At December 31, 1998, the Bridge Fund does not have any
individual bridge loan outstanding in excess of $150 million. At December 31,
1998, the DLJ Bridge Fund had extended $295 million of short-term bridge loans,
which are expected to be refinanced in the first quarter of 1999.
SPROUT. 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.
Sprout has approximately $2 billion of committed capital and invests in
early-stage, high-growth companies; management buyouts; and mezzanine financing
of companies that are not yet ready to access the public capital markets.
During 1998, Sprout raised $860 million to launch a new fund, Sprout Capital
VIII that invests in growth companies at all stages of development. Sprout's
investors are major public and corporate pension funds, endowments, insurance
companies and wealthy individuals.
CAPITAL MARKETS GROUP
- ---------------------
EQUITIES DIVISION
- -----------------
RESEARCH. The Company's institutional equities research department
consists of approximately 90 research analysts and associates, based in New
York City, London and Hong Kong, 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, global
research efforts were expanded in 1998. Coverage of the following industries
was established: global oil and gas, airlines, airports, beverages, Latin
American banks, Asian technology and global media and communications. Coverage
of additional industries is planned for the first half of 1999.
4
SALES AND TRADING. The Company's equity sales and trading operation
covers nearly 2,000 of the world's largest institutional investors, in 50
countries around the world. The Company's trading strategy is client-driven.
The Company does not accumulate large positions for its own account, but
provides clients with liquidity by taking a position as a principal to
facilitate their transactions. In U.S. equities trading, the Company's traders
actively trade 95 percent of the S&P 500 companies. The over-the-counter desk
makes markets in approximately 400 stocks. The Company has also expanded its
convertible securities business, particularly in new issues.
AUTRANET. Autranet Inc., a registered broker-dealer and member firm of
the NYSE is active in the distribution of investment research products
purchased from "independent originators." Independent originators are research
specialists, not linked to a broker-dealer organization and range in size and
scope from large economic consulting firms to individual freelance analysts.
EQUITY DERIVATIVES. The Equity Derivatives Division, located in New
York and London, provides institutional clients with research, trading and
sales services in a broad range of products. 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 the firm's own position. The Company offers
derivatives based on all traded products including equities, commodities, debt
instruments, currencies and indices.
FIXED INCOME DIVISION
- ---------------------
HIGH-YIELD BONDS. The High-Yield department is the number one ranked
firm in the origination of high-yield bonds in the U.S. and Western Europe. The
department provides institutional clients with research, trading and sales
services and distributes non-investment-grade securities in connection with
offerings underwritten by the Company.
SENIOR BANK DEBT GROUP. The Senior Bank Debt Group syndicates
leveraged loans and enters into commitments to extend credit primarily to
non-investment grade borrowers. This group provides the Company's clients with
the convenience of a single financing source. The group's base of institutional
investors has expanded to include pension funds, mutual funds and insurance
companies. In 1998, the Group acted as lead agent on 55 loans aggregating
approximately $23 billion.
INVESTMENT-GRADE CORPORATE BONDS. The Company is 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. In 1998, the Group introduced the Financial
Engineering Desktop ("FED") to its clients. FED is a proprietary technology
which provides live market data, state-of-the art analytics and historical
information on investment-grade corporate debt.
GOVERNMENT BONDS. The Company is a primary dealer in the $3 trillion
market for U.S. Treasuries The Government Bond department acts as underwriter
and market maker in U.S. Treasury bills, notes, bonds, and securities of
Federal agencies. 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.
Institutional clients include insurance companies, money managers, commercial
banks, hedge funds and pension funds. 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. In addition it acts as an intermediary
between borrowers and lenders of short-term funds utilizing repurchase and
reverse repurchase agreements.
REAL ESTATE FINANCE GROUP. The group provides capital and financial
advisory services for major participants in the commercial and residential real
estate markets. In 1998, approximately $6 billion was raised for clients. The
Real Estate Finance Group also originates loans secured by multifamily and
commercial properties and, acting as agent, places mortgage-backed debt for
clients. The Company's commercial mortgage lending subsidiary, Column
Financial, originates, acquires and enhances mortgage loans for securitization
and sale to investors in the form of CMOs. During 1998, Column Financial
originated over $2.5 billion in loans.
FOREIGN EXCHANGE. The Company's Foreign Exchange Group began 24 hour
trading in 1998. The Group serves broad ranges of clients worldwide, including
multinational corporations, money managers, hedge funds, banks and
high-net-worth individuals. The group is based in New York and London, and an
operation in Asia is planned for 1999.
5
DERIVATIVES. In 1998, a full-service unit was formed to provide
hedging alternatives, linked to high-yield and investment-grade securities, to
institutional investors and corporate issuers. Three types of derivative
products are offered: interest rate derivatives, emerging markets derivatives
and credit-structured products. This unit has offices in New York, London, Hong
Kong and Tokyo.
RESEARCH. The Fixed Income Research Group provides investment analysis
and recommendations on more than 500 issuers. In addition, the Group provides
proprietary research on a variety of structured products and global economic
analyses.
FINANCIAL SERVICES GROUP
- ------------------------
PERSHING DIVISION. 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 over 600 correspondents, which collectively maintain over
2.5 million active customer accounts holding more than $279 billion of assets
at December 31, 1998. 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 services on a fee-for-service 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 information and recommendations provided through its
own research analysts' action-oriented opinions and advice available to its
correspondents.
Sophisticated communications and information management is 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.
LONDON GLOBAL SECURITIES. London Global Securities, with operations in
London and Australia, provides securities lending and financing services to
institutional investors in 25 countries.
DLJDIRECT. DLJdirect is a leading provider of online discount
brokerage and related investment services, offering customers automated
securities order placement and information and research capabilities through
the Internet and online service providers. DLJdirect's broad range of
investment services is targeted at self-directed, sophisticated online
investors, who on average have higher account balances than other online
investors. DLJdirect was one of the pioneers of online investing. DLJdirect
started in the online brokerage business in September 1988 under the name PC
Financial Network. In September 1997, PC Financial Network changed its name to
DLJdirect and relaunched its Internet site as DLJdirect (www.dljdirect.com). In
its ten year history, DLJdirect has been recognized as a high-quality provider
of online brokerage services.
DLJdirect's investment services and products include:
o online order entry for stocks, options mutual funds and U.S. Treasury
securities
o access to selected DLJ-managed initial public offerings and other
equity offerings
o company and industry research from DLJ
o DLJdirect's MarketSpeed(TM), its proprietary software with enhanced
graphics and greater ease of use permitting DLJdirect's customers to
access DLJdirect's online services an average of five times faster
than other major Internet brokers
o stock and mutual fund evaluation tools, including its proprietary
StockScan(TM) for screening over 9,500 public companies and its
proprietary FundScan(TM) for analyzing over 7,000 mutual funds
o research and analysis from independent research organizations,
including Standard & Poor's, Zacks Investment Research Incorporated
and Thomson Investors Network
o daily market commentary from TheStreet.com and Briefing.com
DLJdirect's in-house technology group develops Internet-based products
for DLJ businesses as well as independent clients.
On March 17, 1999 the Company filed a Registration Statement with the
Securities and Exchange Commission relating to a proposed initial public
offering of a new class of common stock that will track the performance of
DLLJdirect, its on line brokerage business.
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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 and corporations.
At the end of 1998, the Group had ten offices in the U.S. and one in London.
The London office has global trading capabilities in a broad range of equity,
fixed income and derivative products and also offers a Swiss banking facility.
In 1998, the Group introduced DLJ Preferred Advisors, which enables clients to
choose from ten professionally managed portfolios in five equity investment
classes. In 1999, clients qualifying for DLJ Private Client Service will be
able to trade online, in addition to reviewing account balances, accessing DLJ
research and obtaining information on DLJ lead-managed securities offerings.
ASSET MANAGEMENT GROUP. The Asset Management Group consists of two
divisions: Wood, Struthers & Winthrop and DLJ Investment Management
Corporation. The group specializes in individual and institutional investment
management and has a total of $17.6 billion of assets under management.
Wood, Struthers & Winthrop Management Corp., founded in 1871, is a
registered investment advisor, managing over $9 billion in assets at December
31, 1998. Wood, Struthers & Winthrop specializes in investment management, tax,
trust and estate planning and has a client base of high-net-worth individuals
and families. 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 $5.7 billion portfolio of
private placements which it originated.
Wood, Struthers & Winthrop is the investment advisor to a domestic
family of five diversified open-end mutual funds. These funds consist of three
U.S. equity funds and two fixed-income funds which aggregate approximately $709
million. In addition, Wood, Struthers & Winthrop and DLJ Investment Management
Corp., are the advisors to the DLJ Winthrop Opportunity Funds, a family of
diversified open-end mutual funds. These funds aggregate $178.6 million at
December 31, 1998.
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.
DLJ Investment Management Corp. provides cash management services to
institutional clients. During 1998, assets under management increased from $5
billion to $8 billion, a gain of 60 percent. In 1998, DLJ Investment Management
Corp. launched the DLJ High-Yield Bond Fund, a $500 million closed-end
investment company.
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 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, 1998, the Company had approximately 8,500 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.
7
REGULATION
- ----------
The Company's business, and the securities industry in general is
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 non-U.S. securities financial regulatory authorities.
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/or
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, required procedures for trading on securities exchanges
and in the over-the-counter market, and procedures for the clearance and
settlement of trades. 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.
8
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
Securities and Futures Authority ("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 Securities and Futures Commission ("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 them 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
- --------------------
DLJSC, Pershing Trading, DLJdirect and Autranet are broker-dealers
registered with the Commission and subject to the capital requirements of the
Commission. In addition, as member firms of the NYSE and/or NASD, they are
subject to the capital requirements of their respective SRO. 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 unusually 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.
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, 1998 and 1997, the Company's foreign broker-dealer
subsidiaries were in compliance with all applicable regulatory capital adequacy
requirements.
9
ITEM 2. PROPERTIES
----------
The Company's principal executive offices are presently located at 277
Park Avenue, New York, New York and occupy approximately 1.2 million square
feet under a lease expiring in 2021. The Company has leased space at 280 Park
Avenue, New York, New York, aggregating approximately 190,000 square feet under
a lease expiring at various dates through 2014. 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 98,000 square feet under a
lease expiring in 2011. In 1998, the Company entered into a lease at 111 Old
Broad Street aggregating approximately 130,000 square feet. This lease expires
in 2018.
Pershing also leases approximately 460,000 square feet in Jersey City,
New Jersey, under leases that expire at various dates through 2009. The Company
also owns land and a building with approximately 142,000 square feet in Florham
Park, New Jersey.
The Company leases an aggregate of approximately 730,000 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, Moscow, Paris, Sao Paulo, Seoul 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. DLJSC's motions for summary judgments were denied in April 1998.
Trial has been scheduled for May 17, 1999. DLJSC believes that it has
meritorious defenses to the complaints and is contesting the suits vigorously.
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 $550.0 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 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 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 of reorganization insofar as they alleged nondisclosure of certain cost
reductions announced by NGC in October 1993. DLJSC has appealed the Bankruptcy
Court's ruling. On May 7, 1998, DLJSC and others were named as defendants in a
second action in a Texas State Court brought by the NGC Settlement Trust. The
allegations of this second Texas State Court
10
action are substantially similar to those of the earlier class action pending
in State Court. In an amended order dated January 5, 1999, the State Court
granted the class action plaintiff's motion for class certification. In an
order dated March 1, 1999, the State Court granted motions for summary judgment
filed by DLJSC and the other defendants. The plaintiffs have indicated that
they intend to appeal. DLJSC intends to defend itself vigorously against all of
the allegations contained in the complaints.
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. In April
1998, DLJSC's motion to dismiss the complaint against it was denied, and
plaintiff's motion for class certification was denied. In December 1998, the
motion of two other potential class representatives to intervene in the action
was denied. DLJSC intends to defend itself vigorously against all of the
allegations contained in the complaint.
On January 24, 1997, various money management firms and others who
allegedly purchased and/or beneficially owned $116 million aggregate principal
amount of Senior Subordinated Notes (the "Notes") issued in May 1994 by
Mid-American Waste Systems, Inc. ("Mid-American") filed a complaint against
DLJSC and a number of other financial institutions and several former officers
and directors of Mid-American in the Court of Common Pleas, Franklin County,
Ohio. The action seeks rescission, compensatory and punitive damages. The suit
alleges violations of federal securities laws and the Ohio Securities Act, and
common law fraud, aiding and abetting common law fraud, negligent
misrepresentation, breach of contract, breach of fiduciary duty/acting in
concert and negligence. DLJSC was an underwriter for the initial offering of
the Notes. The Notes went into default in February 1996 and Mid-American filed
a voluntary petition for reorganization pursuant to Chapter 11 of the United
States Bankruptcy Code in January 1997. The complaint seeks to hold DLJSC
liable for various alleged misrepresentations and omissions contained in the
prospectus for the Notes and other filings and for various oral representations
concerning the Notes, which plaintiffs claim were false and misleading. Fact
discovery is complete and expert discovery is ongoing. Both DLJSC and
plaintiffs filed motions for summary judgment, all of which are pending. Trial
is currently scheduled to commence on May 4, 1999. Other alleged purchasers
and/or beneficial owners of an additional $15 million aggregate principal
amount of the Notes issued by Mid-American described above filed two additional
lawsuits against DLJSC both in the U.S. District Court for the Southern
District of Ohio, on April 14, 1997 and December 30, 1997. The allegations are
substantially similar to those described above. Discovery in these actions,
consolidated with fact discovery in the Ohio state court action described
above, is still ongoing. No trial date has been set in either case. On July 31,
1998, DLJSC filed a motion to dismiss the later filed action for lack of timely
service of valid process, which is pending. DLJSC believes that it has
meritorious defenses to all of the allegations contained in all of the
complaints described above and is contesting the suits vigorously.
On January 20, 1999, the Plan Administrator for the bankruptcy estate
of Mid-American, represented by counsel for plaintiffs in the Ohio state court
action against DLJSC described above, filed another action against DLJSC and
other financial institutions, several individuals and two law firms in the
Supreme Court of the State of New York based on factual allegations similar to
those made in the Ohio state court action. The actions seeks compensatory and
punitive damages. The plaintiff alleges claims against DLJSC for breach of
fiduciary duty, aiding and abetting breach of fiduciary duty, professional
malpractice, common law fraud, constructive fraud, aiding and abetting common
law fraud, negligence, negligent misrepresentation and breach of contract. The
complaint alleges that, as an underwriter, DLJSC is liable for alleged
misrepresentations and omissions in the prospectus for the Mid-American Senior
Subordinated
11
Notes, and that, as Mid-American's financial advisor after the initial
offering, DLJSC allegedly knew or should have known about and should have
disclosed to Mid-American that Mid-American's financial condition was
precarious and that publicly disclosed documents were false and misleading
regarding Mid-American's finances and operations. There has been no discovery
or other proceedings in this action. DLJSC believes that it has meritorious
defenses to all of the allegations contained in the complaint and will contest
the suit vigorously.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
During the fourth quarter of 1998, 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
1998 1st 2nd 3rd 4th
---- --- --- --- ---
High.................... 44 3/4 52 63 3/4 44 1/16
Low..................... 31 3/8 42 5/16 24 1/8 20 3/8
Common dividends........ $ .0625 $ .0625 $ .0625 $ .0625
Quarters
1997 1st 2nd 3rd 4th
---- --- --- --- ---
High.................... 23 11/16 32 1/8 35 25/32 43 13/16
Low..................... 18 18 1/4 28 1/2 34
Common dividends........ $ .0625 $ .0625 $ .0625 $ .0625
The approximate number of holders of DLJ Common Stock at March 5, 1999,
was 15,000.
* All figures are adjusted for the two-for-one split of DLJ Common Stock
that occurred on May 12, 1998.
12
SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In millions, except share and per share data)
Income Statement Data:
Revenues
- --------
Commissions....................... $ 854.7 $ 690.2 $ 573.3 $ 460.2 $ 376.1
Underwritings..................... 1,077.7 905.6 755.6 473.3 290.7
Fees.............................. 1,191.7 767.3 470.0 369.1 281.3
Interest, net (1)................. 2,189.1 1,652.1 1,074.2 904.1 791.9
Principal transactions-net:
Trading......................... (92.8) 363.2 394.0 333.1 136.1
Investment...................... 126.0 194.5 163.0 163.7 97.6
Other............................. 60.6 67.6 60.7 55.1 35.0
---------- ---------- ---------- ---------- ----------
Total revenues................ 5,407.0 4,640.5 3,490.8 2,758.6 2,008.7
---------- ---------- ---------- ---------- ----------
Costs and Expenses
Compensation and benefits........ 2,231.7 1,908.2 1,538.8 1,261.4 897.8
Compensation expense-
Restricted stock units......... - - - 6.2 -
Interest......................... 1,455.9 1,153.2 733.2 680.6 503.8
Brokerage, clearing, exchange
fees and other................. 258.6 231.4 201.3 168.1 135.6
Occupancy and equipment........... 269.9 189.9 159.3 127.1 90.1
Communications.................... 89.8 64.0 53.7 42.8 36.6
Other operating expenses.......... 500.6 432.7 330.7 173.9 139.8
---------- ---------- ---------- ---------- ----------
Total costs and expenses...... 4,806.5 3,979.4 3,017.0 2,460.1 1,803.7
---------- ---------- ---------- ---------- ----------
Income before provision for
Income taxes..................... 600.5 661.1 473.8 298.5 205.0
Provision for income taxes.......... 229.7 252.8 182.5 119.4 82.0
---------- ---------- ---------- ---------- ----------
Net income.......................... $ 370.8 $ 408.3 $ 291.3 $ 179.1 $ 123.0
============ =========== ========== ========== =========
Dividends on preferred stock........ $ 21.3 $ 12.2 $ 18.7 $ 19.9 $ 21.0
============ =========== ========== ========== =========
Earnings applicable to
Common shares..................... $ 349.5 $ 396.1 $ 272.6 $ 159.2 $ 102.0
============ =========== ========== ========== =========
Weighted average common
Shares outstanding (2):
Basic.......................... 119,260 110,318 106,600 101,140 100,000
============ =========== ========== ========== ==========
Diluted........................ 131,980 125,498 118,712 103,160 102,950
============ =========== ========== ========== ==========
Earnings per common share (2):
Basic.......................... $ 2.93 $ 3.59 $ 2.56 $ 1.58 $ 1.02
============ =========== ========== ========== ===========
Diluted........................ $ 2.65 $ 3.16 $ 2.30 $ 1.55 $ .99
============ =========== ========== ========== ===========
13
Years Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(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.............. $ 44,031.0 $ 43,227.4 $ 29,954.2 $ 27,793.1 $ 19,166.9
Total assets....................... 72,282.2 70,505.8 55,503.7 44,576.5 33,261.6
Securities sold under agreements
to repurchase and securities 43,097.8 43,694.1 32,103.1 29,369.0 20,385.4
loaned..........................
Long-term borrowings............... 3,482.0 2,128.2 1,325.4 958.9 539.9
Redeemable preferred stock ........ 200.0 200.0 200.0 225.0 225.0
Stockholders' equity .............. 2,927.7 2,061.5 1,647.2 1,198.7 820.3
Other Financial Data (at end of period):
Book value per common share
outstanding...................... $ 20.44 $ 15.72 $ 12.40 $ 10.25 $ 8.21
Ratio of net assets to
stockholders' equity (3)........ 9.6x 13.2x 15.51x 14.00x 17.18x
Ratio of long-term borrowings
to total capitalization (4)...... 0.52 0.48 0.40 0.37 0.30
Return on average equity (5)....... 16.5% 24.1% 20.6% 17.1% 13.1%
Ratio of earnings to fixed charges. 1.13x 1.16x 1.16x 1.11x 1.10x
Ratio of earnings to combined
fixed charges and preferred
stock 1.13x 1.16x 1.16x 1.10x 1.09x
dividends (6)...................
(1) Interest is net of interest expense to finance U.S. government, agency and
mortgage-backed securities of $3.0 billion, $2.9 billion, $2.1 billion,
$2.0 billion and $1.6 billion, respectively.
(2) 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.
The weighted average common shares outstanding and earnings per common
share amounts are pro forma for the year ended December 31, 1994. 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.
(3) Net assets are total assets excluding securities purchased under agreements
to resell and securities borrowed.
(4) 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.
(5) After payment of dividends on the Company's preferred stock.
(6) For the purpose of calculating the ratio of earnings to combined fixed
charges and 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.
14
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 the state of the global economy,
securities market conditions, the level and volatility of interest rates,
competitive conditions and the size and timing of transactions.
The unprecedented volatility in the global capital markets in 1998 had
a significant negative impact on revenue and net earnings in the financial
services industry. The collapse of the Russian economy in mid-year and the
economic conditions in Japan, Asia and in worldwide emerging markets led to the
widespread sell-off of fixed income and equity securities throughout the world.
After the Russian crisis, there was a flight to quality resulting in increased
purchases of U.S. government securities and larger spreads between these and
almost all other fixed income securities. In the U.S. these conditions
diminished liquidity and greatly reduced fixed income and equity underwriting.
The effect was particularly damaging in the high yield sector and emerging
markets. These same conditions negatively impacted fixed income and equity
markets worldwide which resulted in efforts by the Federal Reserve Bank to
restore liquidity to the capital markets by cutting interest rates three times
in the latter stages of 1998. The investment climate improved so that most
market indices rebounded into positive returns.
Although the merger market was also impacted by the global market
turmoil in the third quarter, worldwide merger and acquisition activity
increased 54% over 1997. Equity and high yield underwriting declined
significantly during the third and fourth quarters due to extreme market
volatility and illiquidity. Initial public offering ("IPO") activity declined
for the second consecutive year.
RESULTS OF OPERATIONS
- ---------------------
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
- ---------------------------------------------------------------------
For 1998, total revenues of $5.4 billion increased $766.6 million or
16.5%. During 1998, revenues increased primarily as a result of increases in
commissions, fees, underwriting revenues and net interest income offset in part
by decreases in trading and investment gains. Changes in net revenues from
external sources for each of the Company's industry segments were: Banking
Group revenues increased by $271.3 million primarily as a result of increased
underwriting and fees; Capital Markets Group revenues decreased by $17.6
million principally as a result of decreased trading revenues in fixed income
offsetting increases in commissions and underwriting revenues in institutional
equities and fixed income; Financial Services Group revenues increased $185.4
million primarily as a result of increased brokerage and correspondent
clearance commissions and fees from asset management activities. Net revenues
in 1998 include $5.0 million related to the Emerging Markets Group. This
represents a decrease of $112.8 million from net revenues in 1997 as a result
of losses incurred primarily from the collapse of the Russian economy. The
Company ceased its proprietary trading in emerging markets in September 1998
and eliminated the bulk of its trading positions during the fourth quarter of
1998.
Commission revenues increased $164.5 million or 23.8% to $854.7
million due to increased levels of activity in virtually all business groups.
This increase is consistent with the increased volume on major exchanges during
the year.
Underwriting revenues increased $172.1 million or 19.0% to $1,077.7
million. During 1998, the Company experienced market share increases in equity,
convertibles and high yield underwriting.
Fee revenues increased $424.4 million or 55.3% to $1,191.7 million.
These results primarily reflect the Company's continuing market share growth in
merger and acquisition advisory services. During 1998, asset management and
other advisory service activities also increased.
15
Interest, net of interest expense to finance U.S. government, agency
and mortgage-backed securities, increased $537.0 million or 32.5% to $2,189.1
million. The bulk of the increase occurred in the stock loan/borrowed business.
In addition, increases in domestic and foreign margin balances and higher
levels of foreign fixed income securities, primarily in the Emerging Markets
area prior to the Company's withdrawal from that activity, resulted in
increases in interest income.
Principal transactions-net, trading revenues decreased by $456.0
million or 125.5% to $(92.8) million primarily in the Emerging Markets and High
Yield areas.
Principal transactions-net, investment revenues decreased $68.5
million or 35.2% to $126.0 million. The decrease is primarily due to a lower
amount of realized gains from securities sold coupled with a reduced increase
in fair value of investments remaining in the portfolio, as a result of
volatile market conditions throughout the year, but in particular during the
second half of the year. In 1998, realized gains on sales of investments were
$117.1 million, net unrealized carrying values increased $8.9 million,
including $5.6 million to eliminate net unrealized depreciation on investments
sold, and a $3.3 million increase in net unrealized appreciation on retained
investments.
Other revenues decreased $7.0 million or 10.3% to $60.6 million. Other
revenues consist primarily of dividends and miscellaneous transaction revenues.
Total costs and expenses for 1998 increased $827.2 million or 20.8% to
$4,806.5 million. During 1998, the Company started a non-dollar international
equities group, expanded its Banking Group in the U.S. and internationally,
established a high-yield business in London and generally increased capacity in
its processing oriented businesses to handle significantly increased levels of
activity.
Compensation and benefits increased $323.5 million or 17.0% to
$2,231.7 million. Incentive and production-related compensation increased 9.0%.
Base compensation, including benefits and all payroll taxes, increased by 40.0%
due to the hiring of more senior level executives by various business groups.
Full-time personnel increased 1,412 or 20.0% to 8,465 at year-end 1998.
Interest expense increased $302.7 million or 26.2% to $1,455.9
million. Most of this increase was related to the financing of Pershing's
domestic and foreign stock loan/borrowed business.
As noted below, all other expenses increased $201.0 million or 21.9%
to $1,119.0 million.
Brokerage, clearing, exchange fees and other expenses increased $27.2
million due to increased share volume and transaction fee payments. Occupancy
and equipment costs increased $80.1 million as a result of the Company's
domestic and international expansion. Communications costs increased $25.8
million due to expanded facilities and the overall growth in professional
staff. All other operating expenses increased $67.9 million. These expenses
include professional fees, travel and entertainment, and printing and
stationery, which increased $61.7 million reflecting an overall increase in
business activity and including the costs for the Year 2000 project (see "Year
2000").
The changes in income before income taxes for each industry segment
were: Banking Group pre-tax income increased by $33.9 million, as a result of
increased profitability in the Company's investment and merchant banking
activities; Capital Markets Group pre-tax income decreased by $128.6 million
due to decreased trading revenues in the fixed income area and the investment
spending related to the development of a non-dollar international equities
business; Financial Services Group pre-tax income increased by $28.0 million as
a result of increased commissions and fees from the Company's correspondent
clearing and asset management businesses.
The Company's income tax provision for 1998 and 1997 was $229.7
million and $252.8 million, respectively, which represented a 38.3% and 38.2%
effective tax rate for each period.
Net income for 1998 decreased $37.5 million or 9.2% to $370.8 million.
Using the treasury stock method diluted earnings per common share were $2.65
for 1998 and $3.16 for 1997.
16
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
- ---------------------------------------------------------------------
For 1997, total revenues of $4,640.5 million increased $1,149.7
million or 32.9%. During 1997, revenues increased in all of the Company's major
areas of activity. Changes in net revenues from external sources for each of
the Company's industry segments were: Banking Group revenues increased by
$375.3 million primarily as a result of increased underwriting activity and
fees; Capital Markets Group revenues increased by $192.3 million principally as
a result of increased commission revenues in domestic equities and increased
fixed income underwriting revenues particularly in the high yield group;
Financial Service Group revenues increased $113.2 million primarily as a result
of an increase in commissions and fees from asset management activities.
Commission revenues increased $116.8 million or 20.4% to $690.2
million due to increased business in all areas. This increase is generally
consistent with the overall growth in listed share volume on major equity
exchanges.
Underwriting revenues increased $150.0 million or 19.8% to $905.6
million. During 1997, the Company experienced increases in all areas of
underwriting.
Fee revenues increased $297.3 million or 63.3% to $767.3 million.
Overall, revenue from merger and acquisition, private placements and other
advisory services activities increased during 1997. In 1997, private equity
capital raised for other investment organizations increased. In addition, fees
from the Company's asset management group increased due to an increase in
assets under management from $5.6 billion at year-end 1996 to $12.0 billion at
year-end 1997.
Interest, net of interest expense to finance U.S. government, agency
and mortgage-backed securities, increased $577.9 million or 53.8% to $1,652.1
million. This increase was driven by 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. 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 decreased $30.8 million
or 7.8% to $363.2 million.
Principal transactions-net, investment revenues increased $31.6
million or 19.4% to $194.5 million. During 1997, realized gains on sales of
investments were $160.0 million. Net unrealized carrying values increased $34.5
million, including $45.6 million to eliminate net unrealized depreciation on
investments sold and a $11.1 million increase in net unrealized depreciation on
retained investments.
Other revenues increased $6.9 million or 11.4% to $67.6 million due to
increased revenue sharing arrangements at Pershing. Other revenues consist
primarily of dividends and miscellaneous transaction revenues.
Total costs and expenses for 1997 increased $962.4 million or 31.9% to
$3,979.4 million.
Compensation and benefits increased $369.4 million or 24.0% to
$1,908.2 million. Most of the increase was due to increased variable incentive
and production-related compensation, which resulted from higher revenues and
operating results. 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. Incentive and
production-related compensation increased 22.6%. Full-time personnel increased
1,168 or 19.8% to 7,053 at year-end 1997.
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 Securities acquisition.
As noted below, all other expenses increased $173.0 million or 23.2%
to $918.0 million.
17
Brokerage, clearing, exchange fees and other expenses increased $30.1
million due to increased share volume, underwriting expenses and transaction
fee payments. Occupancy and equipment costs increased $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. and 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 $10.3
million due to expanded facilities and growth in professional staff. All other
operating expenses increased $102.0 million. These expenses include data
processing, professional fees, travel and entertainment, and printing and
stationery, which increased $110.5 million reflecting an overall increase in
business activity and costs for the 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. This increase was offset by lower expenses
on previously underwritten mortgage-related securities, the assets of which
were sold in the fourth quarter of 1997.
The changes in income before income taxes for each industry segment
were: the Banking Group pre-tax income increased $116.0 million primarily as a
result of increased profits in the investment banking area; Capital Markets
Group pre-tax income increased $48.4 million as a result of increased
underwritings in the high yield area offset by losses in institutional
equities; and Financial Services Group pre-tax income increased $15.4 million
due to increased commissions and fees from the Company's asset management
activities.
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 rose $117.0 million or 40.1% to $408.3 million.
Using the treasury stock method diluted earnings per common share were $3.16
for 1997 and $2.30 for 1996.
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. The
collateralized receivables consist primarily of resale agreements and
securities borrowed, both of which are secured by U.S. government and agency
securities, marketable corporate debt and equity securities. In addition, the
Company has significant receivables that turn over frequently from customers,
brokers and dealers. To meet client needs, as a securities dealer, the Company
may carry significant levels of trading inventories. As such, because of
changes in customer needs, economic and market conditions and proprietary
trading strategies, the Company's total assets or the components of total
assets vary significantly from period to period. A relatively small percentage
of total assets is fixed or held for a period of longer than one year. At
December 31, 1998 and 1997, the Company's total assets were $72.3 billion and
$70.5 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 payables to brokers and dealers. Short-term
funding is generally obtained at rates related to Federal funds, LIBOR and
money market rates. Depending upon prevailing market conditions, other
borrowing costs are negotiated. The Company monitors overall liquidity by
tracking the extent to which unencumbered marketable assets exceed short-term
unsecured borrowings.
During 1998, the Company amended its $2.0 billion revolving credit
facility to increase the aggregate commitment of banks thereunder to $2.8
billion, of which $1.7 billion may be unsecured. There were no borrowings
outstanding under this agreement at December 31, 1998.
Certain of the Company's businesses are capital intensive. In addition
to normal operating requirements, capital is required to cover financing and
regulatory requirements 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.
18
During 1998, the Company has been active in raising additional long-term
financing, including the issuance of $650.0 million 6 1/2% Senior Notes, $250.0
million 6% Senior Notes and $350.0 million medium-term notes. In the third
quarter of 1998, a subsidiary of the Company issued non-recourse Senior Secured
and Senior Subordinated Secured Floating Rate Notes in the principal amounts of
$200.0 million and $250.0 million due March 15, 2005 and September 15, 2005,
respectively. At December 31, 1998, a portfolio of investments, primarily
senior bank debt valued at $441.0 million, collateralizes the non-recourse
notes. In addition, in May 1998, the Company repaid its $325.0 million senior
subordinated revolving credit agreement and terminated the related credit
facility.
In January 1998, the Company issued 3.5 million shares of
Fixed/Adjustable Rate Cumulative Preferred Stock, Series B, with a liquidation
preference of $50.00 per share ($175.0 million aggregate liquidation value).
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 under Section 4(2)
("the Securities Act."). The Notes rank pari passu with the Company's other
unsecured and unsubordinated indebtedness. At December 31, 1998, $30.9 million
of Notes were outstanding under this program.
In July 1998, the Company sold an aggregate of five million shares of
newly issued common stock to its parent companies, Equitable and AXA for $300.0
million in a transaction exempt from the registration requirements of the
Securities Act.
On March 17, 1999 the Company filed a Registration Statement with the
Securities and Exchange Commission relating to a proposed initial public
offering of a new class of common stock that will track the performance of
DLJdirect, its online brokerage business.
In March 1999, the Company filed a shelf registration statement,
which enables it to issue, from time to time, up to $2 billion of senior or
subordinated debt securities or preferred stock. In March 1999, the Company
issued $650 million of 5 7/8% Senior Notes due 2002 pursuant to such
registration statement.
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 D-1
Fitch IBCA A F-1
Moody's A3 P-2
Standard & Poors A- A-2
Thomson Bank Watch A+ TBW-1
The Company's principal wholly owned subsidiary, 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 regulate 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, 1998, DLJSC had aggregate
regulatory "net capital," after adjustments required by Rule 15c3-1 under the
Exchange Act, of approximately $1.2 billion, which exceeded minimum net capital
requirements by approximately $1.1 billion and which exceeded the net capital
required by DLJSC's most restrictive debt covenants by $777.0 million. 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, 1998, 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.
The Company continues to explore potential acquisition opportunities
as a means of expanding its business. Such opportunities may involve
acquisitions which are material in size and may require the raising of
additional capital.
19
CASH FLOWS
- ----------
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------
At December 31, 1998, 1997 and 1996 cash and cash equivalents totaled
$1,049.3 million, $273.2 million and $158.8 million, respectively, an increase
of $776.1 million, $114.3 million and $51.1 million, respectively.
Cash used in operating activities totaled $2.4 billion, $5.3 billion
and $1.5 billion in 1998, 1997 and 1996, respectively. In 1998, there were
increases in assets including securities borrowed of $3.4 billion, receivables
from customers of $2.1 billion, and a decrease in financial instruments sold
not yet purchased of $1.5 billion. These changes were offset by an increase in
payables to customers of $1.8 billion and a decrease in financial instruments
owned of $3.3 billion. In 1997, securities borrowed increased $11.2 billion and
receivables from customers increased $1.2 billion. These increases in assets
were offset by increases in operating liabilities including securities loaned
of $5.0 billion, payables to customers of $1.2 billion and financial
instruments sold not yet purchased of $1.0 billion. In 1996, financial
instruments owned increased by $4.9 billion, receivables from brokers, dealers
and other increased by $2.3 billion, and receivables from customers increased
by $0.8 billion. These changes were offset by increases in financial
instruments sold not yet purchased of $2.7 billion, increases in payables to
brokers, dealers and other of $2.5 billion and payables to customers of $1.3
billion.
In 1998, net cash used in investing activities of $334.0 million
consisted primarily of purchases to expand the Company's domestic and
international offices and net purchases of long-term corporate development
investments. In 1997 and 1996, net cash used in investing activities of $216.0
million and $107.0 million, respectively, consisted primarily of purchases to
move the Company's principal offices. Additionally, in 1997, cash was used for
the purchases of long-term corporate development investments. While in 1996
cash was provided from the sales of long-term corporate development
investments.
In 1998, 1997 and 1996, net cash provided by financing activities
totaled $3.5 billion, $5.6 billion, and $1.7 billion, respectively, of which
$1.7 billion, $4.9 billion and $1.2 billion, respectively, was provided by
short-term financings. In 1998, cash of $325.0 million was used to repay the
subordinated revolving credit agreement, while $893.6 million was provided by
issuing senior notes, $349.3 million was provided by issuing medium-term notes,
$450.0 million was provided by issuing senior secured floating rate notes,
$300.0 million was provided from the sale of Common Stock to Equitable/AXA, and
$175.0 million was provided by issuing Series B Preferred Stock. In 1997,
$347.8 million was provided by issuing global floating-rate notes, $359.6
million was provided by issuing medium-term notes and $118.5 million was
provided by a drawdown of 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 issuing medium-term notes, $200.0 million was provided by issuing
mandatorily redeemable preferred securities by the Company's wholly owned
Trust, and $200.0 million was provided by issuing Series A Fixed/Adjustable
Rate Cumulative Preferred Stock.
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, "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
options, forward and futures contracts and swaps. 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 uses derivatives
primarily to provide products to its clients, rather than to cover its own
positions.
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.
20
Options:
--------
The Company writes option contracts specifically designed to meet
customers' needs. Since the Company, not its counterparty, is obligated to
perform, the options do not expose the Company to credit risk. At the beginning
of the contract period, the Company receives a cash premium. During the
contract period, the Company bears the risk of unfavorable changes in the value
of the financial instruments underlying the options ("market risk"). To cover
this market risk, the Company purchases or sells cash or derivative financial
instruments on a proprietary basis. Such purchases and sales may include debt
and equity securities, forward and futures contracts and options. The
counterparties to these purchases and sales are reviewed to determine whether
they are creditworthy. Future cash requirements for options written equal 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.
The notional (contract) value, or the market value for cash
instruments, of the written options was $5.1 billion at year-end 1998 and $5.4
billion at year-end 1997. These options contracts were covered by the following
financial instruments:
December 31,
1998 1997
---- ----
(In millions)
U.S. government, mortgage-backed
securities and options thereon............................... $ 3,396 $ 3,773
Foreign sovereign debt securities................................. 89 73
Forward rate agreements........................................... 38 -
Futures contracts................................................. 76 219
Equities and other................................................ 1,545 1,340
-------- --------
Total.................................................. $ 5,144 $ 5,405
======= =======
Forwards and Futures Trading:
-----------------------------
The Company enters into forward purchases and sales contracts for
mortgage-backed securities and foreign currencies. In addition, the Company
enters into futures contracts on equity-based indices, foreign currencies and
other financial instruments as well as options on futures contracts. Forward
and futures contracts are treated as off-balance sheet items. Market risk is
the price movement on the notional value of the contracts.
For forward contracts, cash is generally not required at inception;
cash equal to the notional value on the contract is required at settlement. For
futures contracts, the original margin is required in cash at inception; cash
equal to the change in market value is required at settlement. Futures contracts
are settled daily.
For the years ended December 31, 1998 and 1997, respectively the
average monthly fair values were approximately $(2.0) million and $(2.0)
million for forward contracts and $(23.0) million and $1.0 million for futures
contracts. At December 31, 1998 and 1997, respectively the receivables from or
payables to brokers, dealers and other captions in the Company's consolidated
statements of financial condition included net unrealized gains (losses) of
approximately $(6.0) million and $6.0 million related to forward contracts and
approximately $3.0 million and $(2.0) million related to futures contracts. For
the years ended December 31, 1998, 1997 and 1996 unrealized gains and losses on
forward and futures contracts are recorded in earnings. Net trading gains
(losses) on forward contracts were $7.0 million, $(5.1) million and $39.0
million and net trading gains (losses) on futures contracts were $(86.0)
million, $(24.0) million and $8.0 million, for the years ended
December 31, 1998, 1997, and 1996 respectively.
21
Off balance sheet values:
December 31,
1998 1997
---- ----
(in millions)
Forward Contracts:
Purchased at notional (contract) value....................... $ 41,254 $ 18,366
Sold at notional (contract) value............................ $ 39,767 $ 27,028
Futures Contracts and Options on Future Contracts:
Purchased at market value.................................... $ 1,184 $ 988
Sold at market value......................................... $ 1,607 $ 2,767
Swaps
-----
The notional (contract) value of swap agreements, consisting primarily
of interest rate and equity swaps, was approximately $8.0 billion and $686.9
million at December 31, 1998 and December 31, 1997, respectively. The notional
or contract amounts indicate the extent of the Company's involvement in the
derivative instruments noted above. They do not measure the Company's exposure
to market or credit risk and do not represent the future cash requirements of
such contracts.
MERCHANT BANKING AND BRIDGE LENDING ACTIVITIES
- ----------------------------------------------
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. At December 31, 1998, in connection with these merchant banking
activities, the Company had investments of $380.7 million and had potential
commitments to invest up to an additional $718.0 million.
Equitable has committed, subject to approval by Equitable on a
transaction-by-transaction basis, to provide $750.0 million of subordinated
debt financing to the DLJ Bridge Fund. The Company has agreed to pay Equitable
the first $25.0 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 $150.0 million. At December 31,
1998, the DLJ Bridge Fund does not have any individual bridge loan outstanding
in excess of $150.0 million. At December 31, 1998, the DLJ Bridge Fund had
extended $295.0 million of short-term bridge loans, which are expected to be
refinanced in the first quarter of 1999.
HIGH-YIELD AND NON-INVESTMENT GRADE SECURITIES
- ----------------------------------------------
The Company underwrites, trades, sells and holds high-yield and
non-investment-grade securities. Non-investment-grade securities are securities
or loans to companies rated BB+ or lower as well as non-rated securities or
loans. Due to credit considerations, liquidity of secondary trading markets and
vulnerability to general economic conditions, these securities generally
involve greater risk than investment-grade holdings. During the third quarter,
the Company's high-yield and non-investment grade holdings were reduced in
response to the volatile market conditions. The Company ceased trading in its
emerging markets proprietary debt trading group in September 1998 and has made
other adjustments to lower its risk profile.
22
The Company records high-yield securities at market value and records
non-investment grade holdings at market or fair value. Unrealized gains and
losses are recognized currently in earnings. Long and short holdings (excluding
derivatives and structured notes) are as follows:
1998 1997
------------------ ------------
Long Short Long Short
---- ----- ---- -----
(in millions)
High-Yield................................. $ 429.3 $ 345.3 $ 645.6 $ 389.6
Senior Bank Debt........................... 1,261.6 - 864.1 -
Foreign Sovereign Debt..................... 423.6 13.8 1,615.4 543.3
Mortgage Whole Loans ...................... 722.3 - 1,555.7 -
Convertible Securities..................... 460.6 8.0 534.8 3.1
Other Non-Investment Grade................. 243.2 21.5 44.4 4.9
---------- --------- ----------- ----------
Totals............................. $ 3,540.6 $ 388.6 $ 5,260.0 $ 940.9
========= ======= ========= =======
RISK MANAGEMENT
- ---------------
Exposure to risk and the ways in which the Company manages the various
types of risks on a day-to-day basis is critical to its survival and financial
success. Each day, the Company monitors its market and counterparty risk
through a number of control procedures designed to identify and evaluate the
various risks to which the Company is exposed. The Company has established an
Independent Risk Oversight function to oversee risk policies and risk
monitoring and management capabilities throughout the firm and coordinate the
risk management practices of the various business groups. This department is
assisted by a Risk Committee comprised of senior professionals from each of the
operating and key administrative groups.
To help senior management manage risk associated with investment
banking and merchant banking transactions the Company has established various
committees. These committees review potential clients and engagements, use
experience with similar clients and situations, analyze credit for certain
commitments and analyze the Company's potential role as a principal investor.
To control the risks associated with its banking activities, various committees
review the details of all transactions before accepting an engagement.
The Company has formed the following committees: the Fairness and
Valuation Opinion Committee, the Private Placement Committee, the Restructuring
Coordinating Committee, the Equity Commitment Committee, the High-Yield
Underwriting Committee, the Bridge Commitment Committee, the Banking Review
Committee, the Finance Committee and the Executive Committee.
From time to time, the Company invests in certain merchant banking
transactions or other long-term corporate development investments. DLJ's
Merchant Banking Group has established several investment entities, each of
which has formed its own investment committee. These committees decide on all
investments and dispositions with respect to potential and existing portfolio
companies. In addition, each quarter, senior officers of the Company meet to
review merchant banking and corporate development investments. After discussing
the financial and operational aspects of the companies involved, the senior
officers recommend carrying values for each investment to the Finance
Committee. The Finance Committee then reviews such recommendations and
determines fair value.
The Company often acts as principal in customer-related transactions
in financial instruments that expose the Company to market risks. The Company
also engages in proprietary trading and arbitrage activities and makes dealer
markets in equity securities, investment-grade corporate debt, high-yield
securities, U.S. government and agency securities, mortgages and
mortgage-backed securities and selected derivatives. As such, to facilitate
customer order flow the Company may be required to maintain certain amounts of
inventories. The Company covers its exposure to market risk by limiting its net
long or short position by selling or buying similar instruments and by using
various derivative financial instruments in the exchange-traded and OTC
markets.
23
Position limits in trading and inventory accounts are established and
monitored continuously. Current and proposed underwriting, corporate
development, merchant banking and other commitments are subject to due diligence
reviews by senior management and by professionals in the appropriate business
and support units involved.
Trading activities generally result in inventory positions. Each day,
position and exposure reports are prepared by operations staff in each of the
business groups engaged in trading activities for traders, trading managers,
department managers, division management and group management. These reports
are independently reviewed by the Company's corporate accounting group. The
corporate accounting group prepares a consolidated summarized position report
listing long and short exposure, and approved limits. The position report is
distributed to various levels of management throughout the Company, including
the Chief Executive Officer, and it enables senior management to control
inventory levels and monitor results of the trading groups. The Company also
reviews and monitors inventory aging, pricing, concentration and securities
ratings.
In addition to position and exposure reports the Company produces a
daily revenue report that summarizes the trading, interest, commissions, fees,
underwriting and other revenue items for each of the business groups. Daily
revenue is reviewed for various risk factors and is independently verified by
the corporate accounting group. The daily revenue report is distributed to
various levels of management throughout the Company, including the Chief
Executive Officer, and together with the position and exposure report, enables
senior management to monitor and control overall activity of the trading
groups.
Market risk
- -----------
Market risk represents the potential loss as a result of absolute and
relative price movements in financial instruments due to changes in interest
rates, foreign exchange rates, equity prices, and other factors. The Company's
exposure to market risk is directly related to its role as financial
intermediary in customer-related transactions and to its proprietary trading
activities. As of December 31, 1998, the Company's primary market risk
exposures include interest rate risk, credit spread risk and equity price risk.
Interest rate risk results from maintaining inventory positions and trading in
interest rate sensititive financial instruments and arises from various sources
including changes in the absolute and relative level of interest rates,
interest rate volatility, mortgage prepayment rates and the shape of the yield
curves in various markets. To cover its exposure to interest rate risk, the
Company enters into transactions in U.S. government securities, options and
futures and forward contracts designed to reduce the Company's risk profile.
The Company's investment grade and high-yield corporate bonds, mortgages,
equities, derivatives and convertible debt activities, also expose it to the
risk of loss related to changes in credit spreads. Credit spread risk arises
from the potential changes in an issuer's credit rating that affect the value
of financial instruments. Equity price risk results from maintaining inventory
positions and making markets in equity securities and arises from changes in
the level or volatility of equity prices, equity index exposure and equity
index spreads, which affect the value of equity securities. To cover its
exposure to equity price risk, the Company enters into transactions in options
and futures designed to reduce the Company's risk profile.
Value at risk
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In 1997 the Company developed a Company-wide Value-at-Risk (VAR)
model. This model used a variance-covariance approach with a confidence
interval of 95% and a one-day holding period, based on historical data for one
year. The Company has made changes to the model in the course of 1998. In
response to the volatile and illiquid markets of the third quarter of 1998,
which departed markedly from the normal statistical distributions that underlie
the variance-covariance approach, the Company has estimated VAR by using an
historical simulation model based on two years of weekly historical data, a 95%
confidence interval, and a one-day holding period. The effect of this change in
approach was not material.
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The VAR number is the statistically expected maximum loss on the fair
value of the Company's market sensitive instruments for 19 of 20 trading days.
In other words, on one of 20 trading days, the loss is expected to be
statistically greater than the VAR number. However, the model does not indicate
how much greater.
VAR models are designed to assist in risk management and to provide
senior management with one probabilistic indicator of risk at the firm level.
VAR numbers should not be interpreted as a predictor of actual results. The VAR
model has been specifically tailored for the Company's risk management needs
and risk profile.
The VAR model includes the following limitations: (1) a daily VAR does not
capture the risk inherent in trading positions that cannot be liquidated or
hedged in one day, (2) VAR is based on historical market data and assumes that
past trading patterns will predict the future, (3) all inherent market risks
cannot be perfectly modeled, and (4) correlations between market movements can
vary, particularly in times of market stress.
The Company believes that a Company-wide VAR analysis is an important
advance in risk management, but it is aware of the limitations inherent in any
statistical analysis. Because a VAR model alone is not a sufficient tool to
measure and monitor market risk, the Company will continue to use other risk
management measures, such as stress testing, independent review of position and
trading limits and daily revenue reports.
At December 31, 1998 and December 31, 1997 the Company-wide VAR for
trading was approximately $22.0 million and $11.0 million, respectively. The
Company-wide VAR for non-trading market risk sensitive instruments is not
separately disclosed because the amount is not significant. Due to the benefit
of diversification the Company-wide VAR is less than the sum of the individual
components. At December 31, 1998 and December 31, 1997 the three main
components