SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended December 31, 1998
[ ] 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 1-8989
The Bear Stearns Companies Inc.
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(Exact name of registrant as specified in its charter)
Delaware 13-3286161
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
245 Park Avenue, New York, New York 10167
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(Address of principal executive offices) (Zip Code)
(212) 272-2000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of February 11, 1999, the latest practicable date, there were
111,361,528 shares of Common Stock, $1 par value, outstanding.
Explanatory Note
This amended Quarterly Report on Form 10-Q reflects changes to the discussion
captioned "Cash Flows" in Item 2 below.
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Certain statements contained in this discussion are "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to risks and uncertainties, which could
cause actual results to differ materially from those discussed in the
forward-looking statements.
The Company's principal business activities, investment banking, securities
trading and brokerage, are, by their nature, highly competitive and subject to
various risks, in particular volatile trading markets and fluctuations in the
volume of market activity. Consequently, the Company's net income and revenues
in the past have been, and are likely to continue to be, subject to wide
fluctuations, reflecting the impact of many factors including securities market
conditions, the level and volatility of interest rates, competitive conditions,
liquidity of global markets, international and regional political events,
regulatory developments and the size and timing of transactions.
For a description of the Company's business, including its trading in cash
instruments and derivative products, its underwriting and trading policies, and
their respective risks, and the Company's risk management policies and
procedures, see the Company's Annual Report on Form 10-K for the fiscal year
ended June 30, 1998.
Business Environment
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The business environment during the Company's second fiscal quarter ended
December 31, 1998 was characterized by rising domestic equity markets and growth
in both New York Stock Exchange ("NYSE") and NASDAQ trading volume. Equity
markets were positively impacted by strong investor interest in internet and
technology stocks. In addition, underwriting and merger and acquisition
activities experienced steady growth during the period.
In the fixed income markets, credit spreads tightened significantly during the
1998 quarter, which led to improved conditions in both the primary and secondary
markets, which was reflected in the Company's results in the mortgage-backed,
asset-backed and government securities business units.
Results of Operations
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Three-Months Ended December 31, 1998
Compared to December 31, 1997
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Net income in the 1998 quarter was $135.9 million, a decrease of 15.2% from the
$160.2 million in the comparable prior year quarter. Revenues, net of interest
expense ("net revenues"), decreased 4.9% to $1.0 billion in the 1998 quarter
from $1.1 billion in the comparable 1997 quarter. The decrease was primarily
attributable to decreased investment banking revenues partially offset by
increased principal transactions and commission revenues. Earnings per share
were $0.84 for the 1998 quarter versus $1.06 for the comparable 1997 quarter.
The earnings per share amounts have been adjusted for the 5% stock dividend
declared by the Company in January 1999.
Commission revenues increased 10.5% in the 1998 quarter to $254.7 million from
$230.5 million in the comparable 1997 quarter. This increase primarily reflects
increases in both institutional and private client services activities, which
benefited from a 24.9% increase in NYSE volume in the 1998 quarter compared to
the 1997 quarter.
The Company's principal transaction revenues by reporting categories, including
derivatives, are as follows:
Three-Months Ended Three-Months Ended
December 31, 1998 December 31, 1997
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Fixed Income $ 223,582 $ 226,903
Equity 139,170 108,297
Foreign Exchange & Other
Derivative Financial
Instruments 56,250 55,312
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$ 419,002 $ 390,512
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Revenues from principal transactions increased 7.3% in the 1998 quarter which
was principally attributable to an increase in equity based revenues, such as
those derived from the arbitrage, over-the-counter and international equity
business areas. Revenues derived from fixed income reflected increases in both
the mortgage-backed and government-backed business units as a result of
tightening credit spreads and increased customer activity.
Investment banking revenues decreased 41.3% to $163.7 million in the 1998
quarter from $278.9 million in the comparable 1997 quarter. This decrease
reflected a decrease in merger and acquisition fees as well as a decrease in
underwriting revenues. Market conditions worldwide served to dampen the
Company's underwriting activities and merger and acquisition activity during the
1998 quarter. The decrease in underwriting revenues was principally due to
decreased levels of equity and high yield new issue volume, partially offset by
an increase in investment-grade corporate debt new issue volume as compared to
the 1997 quarter.
Net interest and dividends (revenues from interest and net dividends, less
interest expense) decreased 3.2% to $156.7 million in the 1998 quarter from
$162.0 million in the comparable 1997 quarter. This decrease was primarily
attributable to lower levels of customer margin debt. Average margin debt
balances decreased to $38.4 billion in the 1998 quarter from $44.3 billion in
the comparable 1997 quarter reflecting reduced activity from the Company's prime
brokerage customers. Average customer shorts increased to $61.8 billion in the
1998 quarter from $56.5
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billion in the comparable 1997 quarter. Average free credit balances increased
to $12.5 billion in the 1998 quarter from $11.0 billion in the comparable 1997
quarter.
Employee compensation and benefits increased 3.1% to $552.3 million in the 1998
quarter from $535.8 million in the comparable 1997 quarter. This increase was
attributable to an increase in salesmen's compensation resulting from increased
commission revenues and an increase in headcount from the 1997 quarter. Employee
compensation and benefits, as a percentage of net revenues, increased to 54.1%
in the 1998 quarter from 49.9% in the comparable 1997 quarter.
All other expenses decreased 6.2% to $261.0 million in the 1998 quarter from
$278.4 million in the comparable 1997 quarter. Legal expense decreased by $19.9
million in the 1998 quarter from the comparable 1997 quarter due to the accrual
for the NASDAQ antitrust settlement in the 1997 quarter. Expenses associated
with the Capital Accumulation Plan for Senior Managing Directors (the "CAP
Plan") decreased by $15.0 million from the comparable 1997 quarter reflecting
lower pre-tax earnings in the 1998 quarter. Communications, depreciation and
data processing expenses increased by approximately $15.7 million as a result of
both increased usage and the upgrading of existing communication and computer
systems.
The Company's effective tax rate decreased to 34.5% in the 1998 quarter compared
to 38.3% in the comparable 1997 quarter due lower levels of earnings and a
higher level of tax preference items in the 1998 quarter.
Six-Months Ended December 31, 1998
Compared to December 31, 1997
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Net income for the six-months ended December 31, 1998 was $200.0 million, a
decrease of 37.9% from $321.8 million for the comparable 1997 period. Net
revenues decreased 14.9% to $1.8 billion in the 1998 period from $2.1 billion in
the 1997 period. The decrease was primarily attributable to decreased investment
banking and principal transactions revenues partially offset by increased
commission revenues. Earnings per share were $1.22 for the 1998 period versus
$2.11 for the comparable 1997 period. The earnings per share amounts have been
adjusted for the 5% stock dividend declared by the Company in January 1999.
Commission revenues increased 11.6% in the 1998 period to $495.5 million from
$443.9 million in the comparable 1997 period. This increase was primarily
attributable to increased revenues from the firm's institutional equities and
securities clearance services which reflects the 29.4% increase in NYSE volume
in the 1998 period when compared to the 1997 period.
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The Company's principal transaction revenues by reporting categories, including
derivatives, are as follows:
Six-Months Ended Six-Months Ended
December 31, 1998 December 31, 1997
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Fixed Income $ 296,136 $ 441,125
Equity 212,790 201,196
Foreign Exchange & Other
Derivative Financial
Instruments 107,125 139,705
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$ 616,051 $ 782,026
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Revenues from principal transactions decreased 21.2% in the 1998 period to
$616.1 million from $782.0 million in the comparable 1997 period. This decrease
primarily reflects decreased revenues derived from the Company's fixed income
and derivative activities. Revenues from both of these activities decreased due
to the volatility experienced in the equity and fixed income markets and by the
widening of credit spreads during the first quarter of 1998. These conditions
led to the declines in revenues derived from several business units such as high
yield, emerging markets and corporate bonds.
Investment banking revenues decreased 42.7% to $285.4 million in the 1998 period
from $498.2 million in the comparable 1997 period. This decrease reflected a
decrease in merger and acquisition fees and advisory fees as well as a decrease
in underwriting revenues. The decrease in underwriting revenues was principally
due to decreased levels of equity and high yield new issue volume partially
offset by increased levels of corporate debt volume as compared to the 1997
period.
Net interest and dividends remained relatively constant with a slight increase
of 3.9% to $321.9 million in the 1998 period from $309.7 million in the
comparable 1997 period. The increase was primarily attributable to increased
levels of customer activity. Average customer margin debt declined to $41.5
billion in the 1998 period from $43.5 billion in the comparable 1997 period,
while average customer shorts increased to $63.0 billion from $55.3 billion.
Average free credit balances increased to $12.8 billion in the 1998 period from
$10.2 billion in the comparable 1997 period.
Employee compensation and benefits decreased 7.4% to $958.2 million in the 1998
period from $1,035.0 million in the comparable 1997 period. The decrease in
employee compensation and benefits was primarily attributable to a decrease in
incentive and discretionary bonus accruals. Employee compensation and benefits,
as a percentage of net revenues, increased to 54.4% in the 1998 period from
50.0% in the comparable 1997 period.
All other expenses decreased 1.1% to $502.7 million in the 1998 period from
$508.1 million in the comparable 1997 period. CAP Plan expense decreased by
$27.0 million in the 1998 period from the comparable 1997 period reflecting the
reduced level of earnings. Legal expense decreased by $19.7 million in the 1998
period from the comparable 1997 period, which reflected
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the accrual of the NASDAQ antitrust settlement. These decreases were partially
offset by increases in communications expense and depreciation expense.
Communications expense increased by $12.5 million in the 1998 period from the
comparable 1997 period, reflecting an increase in information services and the
installation of higher capacity telecommunication networks. Depreciation expense
increased by $11.7 million in the 1998 period from the comparable 1997 period
due to computer equipment upgrades throughout the Company.
The Company's effective tax rate decreased to 33.5% in the 1998 period compared
to 38.9% in the comparable 1997 period due lower levels of earnings and a higher
level of tax preference items in the 1998 period.
Liquidity and Capital Resources
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Financial Leverage
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The Company maintains a highly liquid balance sheet with a majority of the
Company's assets consisting of marketable securities inventories, which are
marked to market daily, and collateralized receivables arising from
customer-related and proprietary securities transactions. Collateralized
receivables consist of resale agreements secured predominantly by U.S.
government and agency securities, customer margin loans and securities borrowed
which are typically secured by marketable corporate debt and equity securities.
The Company's total assets and financial leverage can fluctuate significantly
depending largely upon economic and market conditions, volume of activity,
customer demand, and underwriting commitments.
The Company's total assets at December 31, 1998 decreased to $151.1 billion from
$154.5 billion at June 30, 1998. The decrease is primarily attributable to
decreases in financial instruments owned, customer receivables and securities
borrowed, partially offset by an increase in securities purchased under
agreements to resell.
The Company's ability to support fluctuations in total assets is a function of
its ability to obtain short-term secured and unsecured funding and its access to
sources of long-term capital in the form of long-term borrowings and equity,
which together form its capital base. The Company continuously monitors the
adequacy of its capital base which is a function of asset quality and liquidity.
Highly liquid assets, such as U.S. government and agency securities, typically
are funded by the use of repurchase agreements and securities lending
arrangements which require low levels of margin. In contrast, assets of lower
quality or liquidity require higher levels of overcollateralization, or margin,
in order to obtain secured financing and consequently increased levels of
capital. Accordingly, the mix of assets being held by the Company significantly
influences the amount of leverage the Company can employ and the adequacy of its
capital base.
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Funding Strategy
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The Company's general funding strategy provides for the diversification of its
short-term funding sources in order to maximize liquidity. Sources of short-term
funding consist principally of collateralized borrowings, including repurchase
transactions and securities lending arrangements, customer free credit balances,
unsecured commercial paper, medium-term notes and bank borrowings generally
having maturities from overnight to one year.
Repurchase transactions, whereby securities are sold with a commitment for
repurchase by the Company at a future date, represent the dominant component of
secured short-term funding.
In addition to short-term funding sources, the Company utilizes long-term senior
debt, including medium-term notes, as a longer term source of unsecured
financing. During the six months ended December 31, 1998, the Company issued
$1.9 billion in long-term debt which, net of retirements, served to increase
long-term debt to $13.8 billion at December 31, 1998 from $13.3 billion at June
30, 1998.
The Company maintains an alternative funding strategy focused on the liquidity
and self-funding ability of the underlying assets. The objective of the strategy
is to maintain sufficient sources of alternative funding to enable the Company
to fund debt obligations without issuing any new unsecured debt, including
commercial paper. The most significant source of alternative funding is the
Company's ability to hypothecate or pledge its unencumbered assets as collateral
for short-term funding.
As part of the Company's alternative funding strategy, the Company regularly
monitors and analyzes the size, composition, and liquidity characteristics of
the assets being financed and evaluates its liquidity needs in light of current
market conditions and available funding alternatives. Through this analysis, the
Company can continuously evaluate the adequacy of its equity base and the
schedule of maturing term-debt supporting its present asset levels. The Company
can then seek to adjust its maturity schedule, in light of market conditions and
funding alternatives.
As part of the Company's alternative funding strategy, the Company maintains a
committed revolving-credit facility (the "facility") totaling $2.875 billion
which permits borrowing on a secured basis by Bear Stearns, BSSC and certain
affiliates. The facility provides that up to $1.4375 billion of the total
facility may be borrowed by the Company on an unsecured basis. Secured
borrowings can be collateralized by both investment-grade and
non-investment-grade financial instruments. In addition, this agreement provides
for defined margin levels on a wide range of eligible financial instruments that
may be pledged under the secured portion of the facility. The facility
terminates in October 1999 with all loans outstanding at that date payable no
later than October 2000.
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Capital Resources
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The Company conducts a substantial portion of its operating activities within
its regulated broker-dealer subsidiaries, Bear Stearns, BSSC, BSIL and Bear
Stearns International Trading Limited ("BSIT"). In connection therewith, a
substantial portion of the Company's long-term borrowings and equity have been
used to fund investments in, and advances to, Bear Stearns, BSSC, BSIL and BSIT.
The Company regularly monitors the nature and significance of those assets or
activities conducted outside the broker-dealer subsidiaries and attempts to fund
such assets with either capital or borrowings having maturities consistent with
the nature and the liquidity of the assets being financed.
In December 1998, Bear Stearns Capital Trust II (the "Trust"), a wholly owned
subsidiary of the Company, issued $300 million of fixed rate securities (the
"Preferred Securities"). See Note 8 to the Consolidated Financial Statements for
a more complete description of the Preferred Securities issued.
During the six-months ended December 31, 1998, the Company repurchased 5,994,620
shares of Common Stock in connection with the CAP Plan at a cost of
approximately $232.9 million. Included in the shares purchased during this
period were 3,763,083 shares with a cost of $153.8 million, which were credited
to participants' deferred compensation accounts with respect to deferrals made
during fiscal 1998. The Company intends, subject to market conditions, to
continue to purchase, in future periods, a sufficient number of shares of Common
Stock in the open market to enable the Company to issue shares in respect of all
compensation deferred and any additional amounts allocated to participants under
the CAP Plan. Repurchases of Common Stock under the CAP Plan are not made
pursuant to the Company's Stock Repurchase Plan (the "Repurchase Plan")
authorized by the Board of Directors and are not included in calculating the
maximum aggregate number of shares of Common Stock that the Company may
repurchase under the Repurchase Plan. As of February 11, 1999, there have been
no purchases under the Repurchase Plan.
Cash Flows
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Cash and cash equivalents increased by $590.3 million during the six-months
ended December 31, 1998 to $1.7 billion. Cash provided by operating activities
during the six-months ended December 31, 1998 was $4.5 billion, mainly
representing increases in customer payables, securities sold under agreements to
repurchase, and a decrease in customer receivables, partially offset by a
decrease in financial instruments sold, but not yet purchased and an increase in
securities purchased under agreements to resell. Financing activities used cash
of $3.9 billion, primarily due to net repayments of short term borrowings,
partially offset by net proceeds from issuances of long term borrowings.
Regulated Subsidiaries
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As registered broker-dealers, Bear Stearns and BSSC are subject to the net
capital requirements of the Securities Exchange Act of 1934, the New York Stock
Exchange, and the Commodity Futures Trading Commission, which are designed to
measure the general financial soundness
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and liquidity of broker-dealers. BSIL and BSIT, London-based broker-dealer
subsidiaries, are subject to the regulatory capital requirements of the
Securities and Futures Authority, a self-regulatory organization established
pursuant to the United Kingdom Financial Services Act of 1986. Additionally,
Bear Stearns Bank Plc ("BSB") is subject to the regulatory capital requirements
of the Central Bank of Ireland. At December 31, 1998 Bear Stearns, BSSC, BSIL,
BSIT, and BSB were in compliance with such regulatory capital requirements.
Merchant Banking and Non-Investment-Grade Debt Securities
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As part of the Company's merchant banking activities, it participates from time
to time in principal investments in leveraged acquisitions. As part of these
activities, the Company originates, structures and invests in merger,
acquisition, restructuring, and leveraged capital transactions, including
leveraged buyouts. The Company's principal investments in these transactions are
generally made in the form of equity investments or subordinated loans, and have
not required significant levels of capital investment. At December 31, 1998, the
Company's aggregate investments in leveraged transactions and its exposure
related to any one transaction were not material to the Company's consolidated
financial position.
As part of the Company's fixed-income securities activities, the Company
participates in the trading and sale of high yield, non-investment-grade debt
securities, non-investment-grade mortgage loans and the securities of companies
that are the subject of pending bankruptcy proceedings (collectively "high yield
securities"). Non-investment-grade mortgage loans are principally secured by
residential properties and include both non-performing loans and real estate
owned. At December 31, 1998, the Company held high yield instruments of $1.7
billion in assets and $0.2 billion in liabilities, as compared to $1.8 billion
in assets and $0.3 billion in liabilities as of June 30, 1998.
These investments generally involve greater risk than investment-grade debt
securities due to credit considerations, liquidity of secondary trading markets
and vulnerability to general economic conditions.
The level of the Company's high yield securities inventories, and the impact of
such activities upon the Company's results of operations, can fluctuate from
period to period as a result of customer demands and economic and market
considerations. Bear Stearns' Risk Committee continuously monitors exposure to
market and credit risk with respect to high yield securities inventories and
establishes limits with respect to overall market exposure and concentrations of
risk by both individual issuer and industry group.
Year 2000 Issue
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The Year 2000 issue is the result of legacy computer programs being written
using two digits rather than four digits to define the applicable year and
therefore, without consideration of the impact of the upcoming change in the
century. Such programs may not be able to accurately process dates ending in the
year 2000 and thereafter. The Company determined that it needed to modify or
replace portions of its software and hardware so that its computer systems would
properly utilize dates beyond December 31, 1999.
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Over three years ago, the Company established a task force to review and develop
an action plan to address the Year 2000 issue. The Company's action plan
addresses both information technology and non-information technology system
compliance issues. Since then, the ongoing assessment and monitoring phase has
continued and includes assessment of the degree of compliance of its significant
vendors, facility operators, custodial banks and fiduciary agents to determine
the extent to which the Company is vulnerable to those third parties' failure to
remediate their own Year 2000 issues. The Company has contacted all significant
external vendors in an effort to confirm their readiness for the Year 2000 and
plans to test compatibility with such converted systems. The Company also
participates actively in industry-wide tests.
The Company has and will continue to utilize both internal and external
resources to reprogram, or replace, and test the software and hardware for Year
2000 modifications. To date, the amounts incurred related to the assessment of,
and efforts in connection with, the Year 2000 and the development of a
remediation plan have approximated $31.3 million. The Company's total projected
Year 2000 project cost, including the estimated costs and time associated with
the impact of third party Year 2000 issues, are based on currently available
information. The total remaining Year 2000 project cost is estimated at
approximately $28.7 million, which will be funded through operating cash flows
and primarily expensed as incurred.
The Company presently believes that the activities that it is undertaking in the
Year 2000 project should satisfactorily resolve Year 2000 compliance exposures
within its own systems worldwide. The Company has substantially completed the
reprogramming and replacement phase of the project. Testing has commenced and
will proceed through calendar 1999. However, if such modifications and
conversions are not operationally effective on a timely basis, the Year 2000
issue could have a material impact on the operations of the Company.
Additionally, there can be no assurance that the systems of other companies on
which the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
While the Company does not have a specific, formal contingency plan, the
Company's action plan is designed to safeguard the interests of the Company and
its customers. The Company believes that this action plan significantly reduces
the risk of a Year 2000 issue serious enough to cause a business disruption.
With regard to Year 2000 compliance of other external entities, the Company is
monitoring developments closely. Should it appear that a major utility, such as
a stock exchange, would not be ready, the Company will work with other firms in
the industry to plan an appropriate course of action.
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Effects of Statements of Financial Accounting Standards
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In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information," which redefines how operating segments are
determined and requires disclosure of certain financial and descriptive
information about a company's operating segments. This statement is effective
for fiscal years beginning after December 15, 1997. The Company expects to adopt
this standard when required in fiscal year 1999 and is currently determining the
potential impact on the Company's financial statement disclosure.
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Financial
Instruments and Hedging Activities." SFAS 133 establishes standards for
accounting and reporting of derivative financial instruments embedded in other
contracts, and hedging activities. SFAS 133 is effective for fiscal quarters of
fiscal years beginning after June 15, 1999. The Company expects to adopt this
standard when required in fiscal year 2000 and is currently determining the
potential impact on the Company's accounting for such activities.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Bear Stearns Companies Inc.
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(Registrant)
Date: February 25, 1999 By: /s/ Marshall J Levinson
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Marshall J Levinson
Controller and Assistant Secretary
(Principal Accounting Officer)