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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
| | FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
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 1-4346
SALOMON SMITH BARNEY HOLDINGS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEW YORK 11-2418067
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
388 GREENWICH STREET
NEW YORK, NEW YORK 10013
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 816-6000
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 | |
THE REGISTRANT IS A WHOLLY OWNED SUBSIDIARY OF CITIGROUP INC. AS OF THE DATE
HEREOF, 1000 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.01 PER SHARE,
WERE ISSUED AND OUTSTANDING.
REDUCED DISCLOSURE FORMAT
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H (1) (a)
AND (b) OF FORM 10-Q AND THEREFORE IS FILING THIS FORM WITH THE REDUCED
DISCLOSURE FORMAT CONTEMPLATED THEREBY.
AVAILABLE ON THE WEB @ www.citigroup.com.
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
PAGE
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Statements of Income (Unaudited) -
Three and nine months ended September 30, 2002 and 2001 1
Condensed Consolidated Statements of Financial Condition -
September 30, 2002 (Unaudited) and December 31, 2001 2 - 3
Condensed Consolidated Statements of Cash Flows (Unaudited) -
Nine months ended September 30, 2002 and 2001 4
Notes to Condensed Consolidated Financial Statements (Unaudited) 5 - 12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13 - 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Item 4. Controls and Procedures 20
Part II. Other Information
Item 1. Legal Proceedings 20 - 23
Item 6. Exhibits and Reports on Form 8-K 23
Exhibit Index 23
Signature 25
Certifications 26 - 27
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Dollars in millions Three Months Nine Months
Period Ended September 30, 2002 2001 2002 2001
-------- -------- -------- --------
Revenues:
Commissions $ 952 $ 826 $ 2,910 $ 2,760
Investment banking 757 815 2,631 2,933
Asset management and administration fees 765 842 2,449 2,499
Principal transactions (35) 8 628 1,741
Other 216 143 484 446
-------- -------- -------- --------
Total noninterest revenues 2,655 2,634 9,102 10,379
-------- -------- -------- --------
Interest and dividends 2,475 3,410 7,189 11,468
Interest expense 1,829 2,814 5,084 9,941
-------- -------- -------- --------
Net interest and dividends 646 596 2,105 1,527
-------- -------- -------- --------
Revenues, net of interest expense 3,301 3,230 11,207 11,906
-------- -------- -------- --------
Noninterest expenses:
Compensation and benefits 1,719 1,564 6,076 6,129
Floor brokerage and other production 162 162 488 528
Communications 161 161 475 498
Occupancy and equipment 136 152 402 472
Advertising and market development 66 72 212 276
Professional services 89 74 211 241
Other operating and administrative expenses 129 76 313 356
Restructuring charge (credit) (9) -- (9) 112
-------- -------- -------- --------
Total noninterest expenses 2,453 2,261 8,168 8,612
-------- -------- -------- --------
Income before income taxes and cumulative
effect of changes in accounting principles 848 969 3,039 3,294
Provision for income taxes 319 363 1,138 1,187
-------- -------- -------- --------
Income before cumulative effect of changes
in accounting principles 529 606 1,901 2,107
Cumulative effect of changes in accounting principles
(net of tax benefits of $16 and $1, respectively) -- -- (24) (1)
-------- -------- -------- --------
Net income $ 529 $ 606 $ 1,877 $ 2,106
======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
Dollars in millions 2002 2001
------------- ------------
(Unaudited)
Assets:
Cash and cash equivalents $ 3,011 $ 3,018
Cash segregated and on deposit for Federal and other regulations
or deposited with clearing organizations 2,639 5,327
Collateralized short-term financing agreements:
Securities purchased under agreements to resell $ 110,754 $ 94,204
Deposits paid for securities borrowed 48,617 45,337
--------- ---------
159,371 139,541
Financial instruments owned and contractual commitments:
(Approximately $20 billion and $34 billion were pledged to various
parties at September 30, 2002 and December 31, 2001, respectively)
U.S. government and government agency securities 37,867 45,813
Corporate debt securities 17,261 13,463
Non-U.S. government and government agency securities 15,690 8,084
Contractual commitments 13,720 9,333
Equity securities 10,724 10,987
Mortgage loans and collateralized mortgage securities 7,353 6,868
Money market instruments 6,735 4,663
Other financial instruments 5,463 5,157
--------- ---------
114,813 104,368
Receivables:
Customers 16,098 19,353
Brokers, dealers and clearing organizations 4,801 15,441
Other 2,058 2,793
--------- ---------
22,957 37,587
Property, equipment and leasehold improvements, net of
accumulated depreciation and amortization of $1,036 and
$959, respectively 1,080 1,204
Goodwill 1,534 1,400
Intangibles 792 941
Other assets 5,454 7,466
--------- ---------
Total assets $ 311,651 $ 300,852
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
Dollars in millions, except share data 2002 2001
------------- ------------
(Unaudited)
Liabilities and Stockholder's Equity:
Commercial paper and other short-term borrowings $ 21,990 $ 18,890
Collateralized short-term financing agreements:
Securities sold under agreements to repurchase $ 137,538 $ 126,118
Deposits received for securities loaned 10,825 13,050
---------- ----------
148,363 139,168
Financial instruments sold, not yet purchased, and
contractual commitments:
Non-U.S. government and government agency securities 21,181 14,970
U.S. government and government agency securities 20,276 20,024
Contractual commitments 14,954 9,542
Corporate debt securities and other 6,091 6,034
Equity securities 5,466 5,670
---------- ----------
67,968 56,240
Payables and accrued liabilities:
Customers 15,578 20,463
Brokers, dealers and clearing organizations 3,402 13,382
Other 11,323 13,392
---------- ----------
30,303 47,237
Term debt 29,976 27,219
Company-obligated mandatorily redeemable securities
of subsidiary trust holding solely junior subordinated debt
securities of the Company 400 400
Stockholder's equity:
Common stock (par value $.01 per share 1,000 shares
authorized; 1,000 shares issued and outstanding) -- --
Additional paid-in capital 2,511 2,479
Retained earnings 10,143 9,224
Accumulated changes in equity from nonowner sources (3) (5)
---------- ----------
Total stockholder's equity 12,651 11,698
---------- ----------
Total liabilities and stockholder's equity $ 311,651 $ 300,852
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Dollars in millions
Nine Months Ended September 30, 2002 2001
-------- --------
Cash flows from operating activities:
Net income $ 1,877 $ 2,106
Depreciation and amortization 242 398
-------- --------
Net income adjusted for noncash items 2,119 2,504
-------- --------
(Increase) decrease in operating assets -
Cash segregated and on deposit for Federal and other regulations or
deposited with clearing organizations 2,688 (1,623)
Collateralized short-term financing agreements (19,830) (26,194)
Financial instruments owned and contractual commitments (10,445) (24,408)
Receivables 14,630 (23,862)
Goodwill, intangibles and other assets, net 2,315 (163)
-------- --------
Increase in operating assets (10,642) (76,250)
-------- --------
Increase (decrease) in operating liabilities -
Collateralized short-term financing agreements 9,195 44,212
Financial instruments sold, not yet purchased, and contractual commitments 11,728 (3,034)
Payables and accrued liabilities (16,938) 36,161
-------- --------
Increase in operating liabilities 3,985 77,339
-------- --------
Net cash (used in) provided by operating activities (4,538) 3,593
-------- --------
Cash flows from financing activities:
Increase (decrease) in commercial paper and other short-term borrowings 3,100 (6,261)
Proceeds from issuance of term debt 9,034 10,339
Term debt maturities and repurchases (6,552) (4,850)
Repayment of mandatorily redeemable securities of subsidiary trust -- (345)
Dividends paid (954) (2,363)
Other capital transactions 12 203
-------- --------
Net cash (used in) provided by financing activities 4,640 (3,277)
-------- --------
Cash flows from investing activities:
Purchase of subsidiary -- (198)
Property, equipment and leasehold improvements, net (109) (160)
-------- --------
Net cash used in investing activities (109) (358)
-------- --------
Net decrease in cash and cash equivalents (7) (42)
Cash and cash equivalents at January 1, 3,018 2,623
-------- --------
Cash and cash equivalents at September 30, $ 3,011 $ 2,581
======== ========
Interest paid did not differ materially from the amount of interest expense
recorded for financial statement purposes.
The Company paid cash for income taxes, net of refunds, of $1,620 million during
the nine months ended September 30, 2002 and received net refunds of $187
million during the nine months ended September 30, 2001.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The condensed consolidated financial statements reflect the accounts of Salomon
Smith Barney Holdings Inc. ("SSBH"), a New York corporation, and its
subsidiaries (collectively, the "Company"). The Company is a wholly owned
subsidiary of Citigroup Inc. Material intercompany transactions have been
eliminated.
The condensed consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America, which
require the use of management's best judgment and estimates. Estimates,
including the fair value of financial instruments and contractual commitments,
the outcome of litigation, realization of deferred tax assets and other matters
that affect the reported amounts and disclosures of contingencies in the
condensed consolidated financial statements, may vary from actual results. The
condensed consolidated financial statements are unaudited; however, in the
opinion of management, all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation have been reflected. Certain
prior period amounts have been reclassified or restated to conform to the
current period presentation.
These condensed consolidated financial statements should be read in conjunction
with the audited consolidated financial statements included in SSBH's Annual
Report on Form 10-K for the year ended December 31, 2001.
Certain financial information that is normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America, but that is not required for interim reporting
purposes, has been condensed or omitted.
ACCOUNTING CHANGES
GOODWILL AND INTANGIBLE ASSETS
Effective July 1, 2001, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 141, Business Combinations and
certain provisions of SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS
142") as required for goodwill and intangible assets resulting from business
combinations consummated after June 30, 2001. The new rules require that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method. The nonamortization provisions of the new rules affecting
goodwill and intangible assets deemed to have indefinite lives are effective for
all purchase business combinations completed after June 30, 2001.
On January 1, 2002, the Company adopted the remaining provisions of SFAS 142,
when the rules became effective for calendar year companies. Under the new
rules, effective January 1, 2002, goodwill and intangible assets deemed to have
indefinite lives are no longer amortized, but are subject to annual impairment
tests. Other intangible assets will continue to be amortized over their useful
lives.
The Company has performed the required impairment tests of goodwill and
indefinite lived intangible assets as of January 1, 2002. There was no
impairment of goodwill upon adoption of SFAS 142. The initial adoption resulted
in a cumulative adjustment of $24 million (net of tax benefit of $16 million)
recorded as a charge to earnings related to the impairment of certain intangible
assets related to the Asset Management segment.
5
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Net income adjusted to exclude amortization expense (net of taxes) related to
goodwill and indefinite lived intangible assets are as follows:
(In millions) Three Months Nine Months
------------ ------------
Period ended September 30, 2002 2001 2002 2001
-------- -------- -------- --------
Net income:
Reported net income $ 529 $ 606 $ 1,877 $ 2,106
Goodwill amortization 16 47
Indefinite lived intangible assets 10 30
-------- -------- -------- --------
Adjusted net income $ 529 $ 632 $ 1,877 $ 2,183
======== ======== ======== ========
During the three and nine months ended September 30, 2001, the after-tax
amortization expense related to goodwill and indefinite lived intangible assets
which are no longer amortized included $16 million and $47 million,
respectively, related to the Investment Services segment and $10 million and $30
million, respectively, related to the Asset Management segment.
Net income for the years ended December 31, 2001, 2000, and 1999 adjusted to
exclude amortization expense (net of taxes) related to goodwill and indefinite
lived intangible assets are as follows:
(In millions)
Year ended 2001 2000 1999
------ ------ ------
Net income:
Reported net income $2,627 $3,032 $2,812
Goodwill amortization 63 45 26
Indefinite lived intangible assets 39 45 46
------ ------ ------
Adjusted net income $2,729 $3,122 $2,884
====== ====== ======
For the years ended December 31, 2001, 2000 and 1999, the after-tax amortization
expense related to goodwill and indefinite lived intangible assets which are no
longer amortized included $62 million, $51 million and $34 million,
respectively, related to the Investment Services segment and $40 million, $39
million and $38 million, respectively, related to the Asset Management segment.
At January 1, 2002, the goodwill balance was $1,366 million for the Investment
Services segment and $34 million for the Asset Management segment. During the
first nine months of 2002, no goodwill was impaired or written off. In
connection with the adoption of SFAS 142, the Company reviewed the
classification of intangible assets and determined that $117 million of
workforce in-place should be reclassified to goodwill at January 1, 2002. During
the first nine months of 2002, the Company recorded additional goodwill of $17
million primarily related to adjustments to the purchase prices of AST
StockPlan, Inc. and Geneva Companies Inc. Each of these changes related to the
Investment Services segment. The Company's goodwill balances at September 30,
2002 were $1,499 million for the Investment Services segment and $35 million for
the Asset Management segment.
At September 30, 2002, $760 million of the Company's acquired intangible assets,
primarily asset management and administration contracts, were considered to be
of indefinite life and not subject to amortization.
6
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
All other acquired intangible assets are subject to amortization. During the
first nine months of 2002, the Company acquired $18 million in software
licenses, which will be amortized over approximately 3 years. No significant
residual value is estimated for these intangible assets. Intangible assets
amortization expense for the three and nine months ended September 30, 2002 was
$6 million and $13 million, respectively, and $2 million and $5 million for the
three and nine months ended September 30, 2001, respectively. The components of
intangible assets that are subject to amortization were as follows:
September 30, 2002 December 31, 2001
------------------------------------- ------------------------------------
Gross Carrying Gross Carrying
Accumulated Accumulated
(In millions) Amount Amortization Amount Amortization
------------------ ---------------- ---------------- ----------------
Software licenses $60 $28 $42 $15
=== === === ===
Intangible assets amortization expense is estimated to be $3 million for the
remainder of 2002, $10 million in 2003, $9 million in 2004, $5 million in 2005,
$4 million in 2006, and $1 million in 2007.
SFAS 133
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended ("SFAS 133"), on January 1, 2001 and recorded a
cumulative after-tax transition charge of $1 million.
Under SFAS 133, an entity is required to recognize all freestanding and embedded
derivative instruments at fair value in earnings unless the derivative
instruments can be designated as hedges of certain exposures for which specific
hedge accounting is prescribed. If certain conditions are met, a derivative
instrument may be designated as a hedge of the fair value changes of a
recognized asset, liability or an unrecognized firm commitment; or a hedge of
the exposure to variable cash flows of a recognized asset, liability or a
forecasted transaction; or a hedge of the foreign currency exposure of a
recognized asset, liability, a net investment in a foreign operation, an
unrecognized firm commitment or a forecasted transaction. If certain conditions
are met, a non-derivative instrument may be designated as a fair value hedge of
a foreign currency denominated unrecognized firm commitment or a hedge of the
foreign currency exposure of a net investment in a foreign operation.
For the three and nine months ended September 30, 2002 and 2001, hedge
ineffectiveness resulting from designating interest rate swaps as fair value
hedges of fixed rate term debt was reported in the condensed consolidated
statement of income in "Other revenue" and was not material.
For the three and nine months ended September 30, 2002 and 2001, hedges of net
investments in foreign operations were considered effective. A gain of $12
million and a loss of $70 million for the three and nine months ended September
30, 2002, respectively, and a loss of $27 million and gain of $40 million for
the three and nine months ended September 30, 2001, respectively, that pertained
to the designated hedging instruments are included in cumulative translation
adjustments, a component of "Accumulated changes in equity from nonowner
sources" in the condensed consolidated statement of financial condition.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146").
SFAS 146 requires that a liability for costs associated with exit or disposal
activities be recognized when the liability is incurred. Existing generally
accepted accounting
7
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
principles provide for the recognition of such costs at the date of management's
commitment to an exit plan. In addition, SFAS 146 requires that the liability be
measured at fair value and adjusted for changes in estimated cash flows.
The provisions of the new standard are effective for exit or disposal activities
initiated after December 31, 2002. It is not expected that SFAS 146 will
materially affect the Company's financial statements.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company currently applies Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock-based compensation plans, under which there is
generally no charge to earnings for employee stock option awards. Alternatively,
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), allows
companies to recognize compensation expense over the related service period
based on the grant-date fair value of the stock award. Beginning in 2003, the
Company intends to account for stock-based compensation issued in 2003 and
thereafter in accordance with the fair-value method prescribed by SFAS 123.
NOTE 2. RESTRUCTURING CHARGES (CREDITS)
In the third quarter of 2002, the Company recorded an adjustment of $9 million
($5 million after tax) to the restructuring reserve, which was recorded in 2001.
The adjustment relates to severance related costs, which were lower than
originally anticipated.
During 2001, the Company recorded restructuring charges of $70 million ($41
million after tax), $42 million ($26 million after tax) and $5 million ($3
million after tax) in the first, second and fourth quarters of 2001,
respectively, for severance and related costs associated with the reduction of
staffing in certain businesses. These amounts apply to the involuntary
termination of approximately 2,000 employees (90% located in the United States
and 10% overseas). The second quarter charge is net of a reversal of $18 million
($11 million after tax), which relates to the accrual in the first quarter of
2001 of severance and other related costs associated with the reduction of
staffing in certain businesses which were subsequently sold. These related costs
were not borne by the Company in the sale, which closed in the third quarter of
2001. At September 30, 2002, the remaining restructuring reserve balance of $1
million is included in the condensed consolidated statement of financial
condition in "Payables and accrued liabilities-other".
NOTE 3. COMPREHENSIVE INCOME
Comprehensive income represents the sum of net income and other changes in
stockholder's equity from nonowner sources, which, for the Company, are
comprised of cumulative translation adjustments, net of tax:
Dollars in millions Three Months Nine Months
Period ended September 30, 2002 2001 2002 2001
-------- -------- -------- --------
Net income $ 529 $ 606 $ 1,877 $ 2,106
Other changes in equity from
nonowner sources (3) (1) 2 (2)
-------- -------- -------- --------
Total comprehensive income $ 526 $ 605 $ 1,879 $ 2,104
======== ======== ======== ========
8
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4. CAPITAL REQUIREMENTS
Certain U.S. and non-U.S. subsidiaries are subject to securities and commodities
regulations and capital adequacy requirements promulgated by the regulatory and
exchange authorities of the countries in which they operate. Capital
requirements related to SSBH's principal regulated subsidiaries at September 30,
2002 are as follows:
NET EXCESS OVER
(DOLLARS IN MILLIONS) CAPITAL OR MINIMUM
SUBSIDIARY JURISDICTION EQUIVALENT REQUIREMENTS
- --------------------------------------- ----------------------------------------------- ----------- ------------
Salomon Smith Barney Inc. U.S. Securities and Exchange Commission
Uniform Net Capital Rule (Rule 15c3-1) $3,296 $2,917
Salomon Brothers International Limited United Kingdom's Financial Services Authority $3,143 $ 784
In addition, in order to maintain its triple-A rating, Salomon Swapco Inc.
("Swapco"), an indirect wholly owned subsidiary of SSBH, must maintain minimum
levels of capital in accordance with agreements with its rating agencies. At
September 30, 2002, Swapco was in compliance with all such agreements. Swapco's
capital requirements are dynamic, varying with the size and concentration of its
counterparty receivables.
9
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5. CONTRACTUAL COMMITMENTS
Contractual commitments used for trading purposes include derivative instruments
such as interest rate, equity, currency and commodity swap agreements, swap
options, caps and floors, options, warrants and financial commodity futures and
forward contracts. The fair values (unrealized gains and losses) associated with
contractual commitments are reported net by counterparty, provided a legally
enforceable master netting agreement exists, and are netted across products and
against cash collateral when such provisions are stated in the master netting
agreement. Contractual commitments in a net receivable position, as well as
options owned and warrants held, are reported as assets in "Contractual
commitments." Similarly, contractual commitments in a net payable position, as
well as options written and warrants issued are reported as liabilities in
"Contractual commitments." Revenues generated from these contractual commitments
are reported primarily as "Principal transactions" and include realized gains
and losses as well as unrealized gains and losses resulting from changes in the
market or fair value of such instruments.
A summary of the Company's contractual commitments as of September 30, 2002 and
December 31, 2001 is as follows:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
--------------------------------------- ---------------------------------------
Notional Current Market or Notional Current Market or
or Fair Value or Fair Value
Contractual ------------------------- Contractual -------------------------
Amounts Amounts
----------- ----------- ----------- ----------- ----------- -----------
Dollars in billions Assets Liabilities Assets Liabilities
----------- ----------- ----------- ----------- ----------- -----------
Exchange-traded products:
Futures contracts (a) $ 168.0 $ -- $ -- $ 172.5 $ -- $ --
Other exchange-traded products:
Equity contracts 211.7 1.5 2.0 86.2 .4 .5
Fixed income contracts 10.5 -- -- 26.1 -- --
Commodity contracts 1.9 -- -- 1.0 -- --
----------- ----------- ----------- ----------- ----------- -----------
Total exchange-traded products 392.1 1.5 2.0 285.8 .4 .5
----------- ----------- ----------- ----------- ----------- -----------
Over-the-counter ("OTC") swaps, swap
options, caps, floors and forward rate
agreements:
Swaps 2,731.6 2,603.1
Swap options written 63.7 86.2
Swap options purchased 54.6 50.4
Caps, floors and forward rate agreements 173.5 181.4
----------- ----------- ----------- ----------- ----------- -----------
Total OTC swaps, swap options, caps, floors
and forward rate agreements (b) 3,023.4 9.5 9.4 2,921.1 6.7 5.9
----------- ----------- ----------- ----------- ----------- -----------
Other options and contractual commitments:
Options and warrants on equities and equity
indices 69.2 1.7 2.8 66.8 1.1 2.2
Options and forward contracts on fixed-income
securities 595.6 .8 .5 1,134.8 .5 .3
Foreign exchange contracts and options(b) 64.7 .1 .2 49.1 .5 .5
Commodity contracts 7.7 .1 .1 9.9 .1 .1
----------- ----------- ----------- ----------- ----------- -----------
Total contractual commitments $ 4,152.7 $ 13.7 $ 15.0 $ 4,467.5 $ 9.3 $ 9.5
=========== =========== =========== =========== =========== ===========
(a) Margin on futures contracts is included in receivable/payables to brokers,
dealers and clearing organizations on the condensed consolidated
statements of financial condition.
(b) Includes notional values of swap agreements and forward currency contracts
for non-trading activities (primarily related to the Company's fixed-rate
long-term debt) of $13.0 billion and $4.8 billion at September 30, 2002,
respectively, and $14.1 billion and $2.7 billion at December 31, 2001,
respectively.
10
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 6. SEGMENT INFORMATION
The following table summarizes the results of operations for the Company's two
operating segments, Investment Services and Asset Management.
Dollars in millions Three Months Nine Months
Period ended September 30, 2002 2001 2002 2001
-------- -------- -------- --------
Noninterest revenues:
Investment Services $ 2,330 $ 2,302 $ 8,102 $ 9,400
Asset Management 325 332 1,000 979
-------- -------- -------- --------
Total $ 2,655 $ 2,634 $ 9,102 $ 10,379
======== ======== ======== ========
Net interest and dividends:
Investment Services $ 644 $ 597 $ 2,105 $ 1,532
Asset Management 2 (1) -- (5)
-------- -------- -------- --------
Total $ 646 $ 596 $ 2,105 $ 1,527
======== ======== ======== ========
Income before cumulative effect of changes
in accounting principles:
Investment Services $ 427 $ 515 $ 1,604 $ 1,849
Asset Management 102 91 297 258
-------- -------- -------- --------
Total $ 529 $ 606 $ 1,901 $ 2,107
======== ======== ======== ========
Total assets of the Investment Services and Asset Management segments were
$309.9 billion and $1.8 billion, respectively, at September 30, 2002 and $299.2
billion and $1.7 billion, respectively, at December 31, 2001. For further
discussion of the Company's operating segments, please refer to the Results of
Operations section of Management's Discussion and Analysis.
11
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7. TERM DEBT
Term debt consists of issues with original maturities in excess of one year.
Certain issues are redeemable, in whole or in part, at par or at premiums prior
to maturity.
Fixed Rate Equity-
Obligations Fixed Rate Total Fixed Variable Linked & Total
Swapped to Obligations Rate Rate Indexed September Total
Dollars in millions Variable Not Swapped Obligations Obligations Obligations 30, 2002 Dec. 31, 2001
(1)
------------ ------------ ------------ ------------ ------------ ---------- --------------
U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (SSBH) $ 7,875 $ 246 $ 8,121 $ 13,077 $ 1,462 $ 22,660 $ 19,947
Subsidiaries -- -- -- 525 1,272 1,797 2,750
------------ ------------ ------------ ------------ ------------ ---------- ------------
U.S. dollar denominated $ 7,875 $ 246 $ 8,121 13,602 2,734 $ 24,457 $ 22,697
------------ ------------ ------------ ------------ ------------ ---------- ------------
Non-U.S. dollar denominated:
Salomon Smith Barney Holdings
Inc. (SSBH) 1,866 -- 1,866 2,209 650 4,725 4,020
Subsidiaries 436 11 447 347 -- 794 502
------------ ------------ ------------ ------------ ------------ ---------- ------------
Non-U.S. dollar denominated 2,302 11 2,313 2,556 650 5,519 4,522
------------ ------------ ------------ ------------ ------------ ---------- ------------
Term debt $ 10,177 $ 257 $ 10,434 $ 16,158 $ 3,384 $ 29,976 $ 27,219
============ ============ ============ ============ ============ ========== ============
(1) Includes Targeted Growth Enhanced Term Securities ("TARGETS") with carrying
values of $400 million issued by TARGETS Trusts IV through XVI at September 30,
2002 and $460 million issued by TARGETS Trusts III through XIII at December 31,
2001 (collectively the "Trusts"). The Company owns all of the voting securities
of the Trusts which are consolidated in the Company's condensed consolidated
statements of financial condition. The Trusts have no assets, operations,
revenues or cash flows other than those related to the issuance, administration,
and repayment of the TARGETS and the Trusts' common securities. The Trusts'
obligations under the TARGETS are fully and unconditionally guaranteed by the
Company.
NOTE 8. LEGAL PROCEEDINGS
In addition to those matters discussed under Part II, Item 1, "Legal
Proceedings", the Company has also been named as a defendant in legal actions
relating to its operations, some of which seek damages of material or
indeterminate amounts. From time to time, the Company is also a party to
examinations and inquiries by various regulatory and self-regulatory bodies. In
connection with its discontinued commodities processing operations, the Company
and certain of its subsidiaries are subject to claims asserted by the U.S.
Environmental Protection Agency, certain state agencies and private parties in
connection with environmental matters. Management of the Company, after
consultation with outside legal counsel, believes that the ultimate resolution
of legal proceedings and environmental matters (net of applicable reserves) will
not have a material adverse effect on the Company's financial condition;
however, such resolution could have a material adverse impact on operating
results in future periods depending in part on the results for such periods.
12
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ITEM 2.
RESULTS OF OPERATIONS
The Company recorded net income of $529 million for the three months ended
September 30, 2002 (the "2002 Quarter") compared to net income of $606 million
for the three months ended September 30, 2001 (the "2001 Quarter"). Revenues,
net of interest expense, were $3,301 million in the 2002 Quarter compared to
$3,230 million in the 2001 Quarter. Principal transaction revenues decreased to
a loss of ($35) million in the 2002 Quarter as a result of a decline in equity
trading. Investment banking revenues declined to $757 million in the 2002
Quarter compared to $815 million in the 2001 Quarter as a result of declines in
merger and acquisition fees and high grade debt underwriting, offset to an
extent by increased equity and public finance underwriting. Asset management
fees decreased to $765 million in the 2002 Quarter compared to $842 million in
the 2001 Quarter primarily reflecting negative market action. The decreases were
partially offset by an increase in OTC commission revenue.
For the nine months ended September 30, 2002 (the "2002 Period"), net income
decreased to $1,877 million compared to $2,106 million recorded for the nine
months ended September 30, 2001 (the "2001 Period"). Revenues, net of interest
expense, were $11,207 million in the 2002 Period compared to $11,906 million in
the 2001 Period. This decrease is primarily the result of a decrease in
principal transaction revenues in the 2002 Period, particularly fixed income and
equity trading. For fixed income, the decline was more than offset by increased
net interest revenue related to fixed income trading activities. Investment
banking revenues decreased in the 2002 Period as a result of decreases in merger
and acquisition fees and high grade debt underwriting, which were partially
offset by increases in equity and public finance underwriting. Included in
investment banking revenues for the 2002 Period were fees from the Travelers
Property Casualty Corp. initial public offering in the first quarter of 2002.
The decreases in revenue were partially offset by an increase in OTC commission
revenue.
Total noninterest expenses in the 2002 Quarter and 2002 Period increased $239
million and decreased $208 million, respectively, from the comparable 2001
periods, excluding the restructuring charge (credit) and the absence of
goodwill and other indefinite-lived intangible amortization due to the
adoption of Statement of Financial Accounting Standards ("SFAS") No. 141,
Business Combinations ("SFAS 141") and certain provisions of SFAS No. 142,
Goodwill and Other Intangible Assets ("SFAS 142"). The increase in the 2002
Quarter was primarily the result of increased compensation and benefits
expense. The decrease in the 2002 Period was across all expense categories.
During the 2002 Quarter, the Company recorded an adjustment of $9 million ($5
million after tax) to the restructuring reserve, which was recorded in 2001. The
adjustment relates to severance related costs, which were lower than originally
anticipated. In the first and second quarters of 2001, the Company recorded
restructuring charges of $70 million ($41 million after tax) and $42 million
($26 million after tax), respectively, relating to severance and related costs
associated with the reduction of staffing in certain businesses (see Note 2 to
the condensed consolidated financial statements for further discussion of the
restructuring charges /credits). In the first quarter of 2002, the Company
recorded a cumulative after-tax loss of $24 million (net of tax benefit of $16
million), which related to the adoption of SFAS 142. During the first quarter of
2001, the Company recorded a cumulative after-tax loss of $1 million (net of tax
benefit of $1 million), which related to the adoption of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities.
13
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In the 2002 Quarter, the Company reached a settlement with the National
Association of Securities Dealers relating to Winstar (an equity research
issue). The Company paid a $5 million penalty and did not admit to any
allegation of wrongdoing.
Following is a discussion of the Company's two operating segments, Investment
Services and Asset Management.
INVESTMENT SERVICES
Dollars in millions Three Months Nine Months
Period Ended September 30, 2002 2001 2002 2001
-------- -------- -------- --------
Revenues:
Commissions $ 946 $ 824 $ 2,896 $ 2,753
Investment banking 753 805 2,619 2,904
Asset management and administration fees 460 522 1,490 1,554
Principal transactions (38) 8 623 1,749
Other 209 143 474 440
-------- -------- -------- --------
Total noninterest revenues 2,330 2,302 8,102 9,400
-------- -------- -------- --------
Net interest and dividends 644 597 2,105 1,532
-------- -------- -------- --------
Revenues, net of interest expense 2,974 2,899 10,207 10,932
-------- -------- -------- --------
Noninterest expenses:
Other operating and administrative expenses 2,304 2,080 7,669 7,954
Restructuring charge (credit) (9) -- (9) 111
-------- -------- -------- --------
Total noninterest expense 2,295 2,080 7,660 8,065
-------- -------- -------- --------
Income before income taxes and cumulative
effect of changes in accounting principles 679 819 2,547 2,867
-------- -------- -------- --------
Provision for income taxes 252 304 943 1,018
-------- -------- -------- --------
Income before cumulative effect of changes
in accounting principles $ 427 $ 515 $ 1,604 $ 1,849
======== ======== ======== ========
The Company's Investment Services segment reported income of $427 million and
$1,604 million for the 2002 Quarter and 2002 Period, respectively, compared to
$515 million and $1,849 million for the 2001 Quarter and 2001 Period,
respectively. Revenues, net of interest expense, were $2,974 million and $10,207
million in the 2002 Quarter and 2002 Period, respectively, compared to $2,899
million and $10,932 million in the 2001 Quarter and 2001 Period, respectively.
Commission revenues increased to $946 million and $2,896 million in the 2002
Quarter and 2002 Period, respectively, compared to $824 million and $2,753
million in the 2001 Quarter and 2001 Period, respectively. These increases were
primarily the result of increases in OTC commissions. In the 2002 Period, the
increase was partially offset by a decline in listed commissions.
14
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Investment banking revenues decreased to $753 million in the 2002 Quarter
compared to $805 million in the 2001 Quarter, primarily due to declines in
merger and acquisition fees and high grade debt underwriting, which were
partially offset by increases in equity and public finance underwriting. In the
2002 Period, investment banking revenues decreased to $2,619 million compared to
$2,904 million in the 2001 Period. Included in investment banking revenues for
the 2002 Period were fees from the Travelers Property Casualty Corp. initial
public offering in the first quarter of 2002.
The Investment Services segment includes results from assets managed by the
Company's Financial Consultants and assets that are managed through the
Consulting Group. Asset management and administration fees decreased to $460
million in the 2002 Quarter and $1,490 million in the 2002 Period compared to
$522 million in the 2001 Quarter and $1,554 million in the 2001 Period, due
primarily to a decrease in net asset flows and negative market action.
Principal transactions revenues decreased to a loss of ($38) million in the 2002
Quarter and revenues of $623 million in the 2002 Period compared to revenues of
$8 million and $1,749 million in the 2001 Quarter and the 2001 Period,
respectively. The 2002 Quarter decrease was the result of a decline in equity
trading. Also contributing to the decrease in the 2002 Period was a decline in
fixed income trading. For fixed income, the decline was more than offset by
increased net interest revenue related to fixed income trading activities.
Other revenues increased to $209 million in the 2002 Quarter compared to $143
million in the 2001 Quarter as a result of increased revenues from the Company's
Korean Joint Ventures and Nikko Salomon Smith Barney Limited, the Company's
joint venture with Nikko Securities Co. Ltd. In the 2002 Period, other revenues
increased to $474 million compared to $440 million in the 2001 Period, as a
result of increased revenues from the Company's Korean Joint Ventures.
Net interest and dividends increased to $644 million in the 2002 Quarter and
$2,105 million in the 2002 Period. The increase in the 2002 Quarter was the
result of increased dividend income. Also contributing to the increase in the
2002 Period was an increase in mortgage-backed trading interest.
Total expenses in the 2002 Quarter increased 11%, excluding interest and the
restructuring charge (credit), as a result of increased compensation and
benefits expense. This increase was partially offset by the absence of goodwill
and other indefinite-lived intangible amortization due to the adoption of SFAS
141 and SFAS 142 in 2002 and the recognition of an insurance recovery relating
to operations at 7 World Trade Center. Total expenses in the 2002 Period
decreased 4%, excluding interest and the restructuring charge (credit), to
$7,669 million. This decrease was primarily the result of a decrease in
compensation and benefits expense, reduced communications, occupancy and floor
brokerage expense and savings from restructuring actions initiated during the
first and second quarters of 2001. The Company continues to maintain its focus
on controlling fixed expenses. Also contributing to the decrease in the 2002
Period was the absence of goodwill and other indefinite-lived intangible
amortization due to the adoption of SFAS 141 and SFAS 142.
15
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ASSET MANAGEMENT
Dollars in millions Three Months Nine Months
Period Ended September 30, 2002 2001 2002 2001
-------- -------- -------- --------
Revenues:
Asset management and administration fees $ 305 $ 320 $ 959 $ 945
Other revenue, net 22 11 41 29
-------- -------- -------- --------
Revenues, net of interest expense 327 331 1,000 974
-------- -------- -------- --------
Noninterest expenses:
Other operating and administrative expenses 158 181 508 546
Restructuring charge -- -- -- 1
-------- -------- -------- --------
Total noninterest expense 158 181 508 547
-------- -------- -------- --------
Income before income taxes and cumulative
effect of changes in accounting principles 169 150 492 427
-------- -------- -------- --------
Provision for income taxes 67 59 195 169
-------- -------- -------- --------
Income before cumulative effect of changes
in accounting principles $ 102 $ 91 $ 297 $ 258
======== ======== ======== ========
The Company's Asset Management segment revenues, net of interest expense, were
$327 million and $1,000 million in the 2002 Quarter and 2002 Period,
respectively, compared to $331 million and $974 million in the 2001 Quarter and
2001 Period, respectively. The primary revenue for the Asset Management segment
is asset management and administration fees, which were $305 million and $959
million in the 2002 Quarter and 2002 Period, respectively, compared to $320
million and $945 million in the 2001 Quarter and 2001 Period, respectively. The
decrease in the 2002 Quarter reflects negative market action and decreased U.S.
retail money market revenues offsetting the impact of positive net flows and the
transfer of the managed futures business into the Asset Management Segment. The
increase in total revenues for the 2002 Period reflects the impact of cumulative
positive net flows and the transfer of the managed futures business offsetting
negative market action and decreased U.S. retail money market revenues. Assets
under management for the segment reached $246.9 billion at September 30, 2002,
compared to $257.9 billion at September 30, 2001. This decrease is primarily due
to the impact of transfers of U.S. retail money market assets to the SSB Bank
Deposit Program, as well as the impact of negative market action. These
decreases were partially offset by positive net flows. Other revenues include
the net revenue contribution to the Asset Management segment for the structuring
of unit investment trusts, as well as custody fees, and realized and unrealized
investment income.
Total noninterest expenses were $158 million and $508 million in the 2002
Quarter and 2002 Period, respectively, compared to $181 million and $546 million
in the 2001 Quarter and 2001 Period, respectively. The decrease in the 2002
Quarter and the 2002 Period from the prior-year periods is primarily due to the
absence of goodwill/intangible amortization as a result of adopting SFAS 141 and
SFAS 142, as well as reduced compensation and benefits expense, occupancy
expense and lower advertising and marketing expenses. Also contributing to the
decrease was the recognition of an insurance recovery relating to operations at
7 World Trade Center. Other operating and administrative expenses include
amortization of deferred commissions, which relate to the sale of load mutual
funds.
16
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Total assets under fee-based management were as follows:
Dollars in billions
At September 30, 2002 2001
-------- --------
Money market and institutional liquidity funds $ 92.4 $ 97.9
Mutual funds 65.4 67.1
Managed accounts 82.3 85.4
Unit investment trusts held in client accounts 5.5 7.5
Managed commodity pools 1.3 --
-------- --------
Salomon Smith Barney Asset Management 246.9 257.9
Financial Consultant managed accounts * 44.3 49.4
Consulting Group and internally managed assets * 118.2 134.9
-------- --------
Total assets under fee-based management $ 409.4 $ 442.2
======== ========
* Related results included in Investment Services segment.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total assets were $312 billion at September 30, 2002, an increase
from $301 billion at year-end 2001. Due to the nature of the Company's trading
activities, it is not uncommon for the Company's asset levels to fluctuate from
period to period.
The Company's condensed consolidated statement of financial condition is highly
liquid, with the vast majority of its assets consisting of marketable securities
and collateralized short-term financing agreements arising from securities
transactions. The highly liquid nature of these assets provides the Company with
flexibility in financing and managing its business. The Company monitors and
evaluates the adequacy of its capital and borrowing base on a daily basis in
order to allow for flexibility in its funding, to maintain liquidity, and to
ensure that its capital base supports the regulatory capital requirements of its
subsidiaries.
The Company funds its operations through the use of collateralized and
uncollateralized short-term borrowings, long-term borrowings, mandatorily
redeemable securities of subsidiary trusts, and its equity. Collateralized
short-term financing, including repurchase agreements and secured loans, is the
Company's principal funding source. Such borrowings are reported net by
counterparty, when applicable, pursuant to the provisions of Financial
Accounting Standards Board Interpretation 41, Offsetting of Amounts Related to
Certain Repurchase and Reverse Repurchase Agreements ("FIN 41"). Excluding the
impact of FIN 41, short-term collateralized borrowings totaled $284.1 billion at
September 30, 2002. Uncollateralized short-term borrowings provide the Company
with a source of short-term liquidity and are also utilized as an alternative to
secured financing when they represent a cheaper funding source. Sources of
short-term uncollateralized borrowings include commercial paper, unsecured bank
borrowings, deposit liabilities, promissory notes and corporate loans.
Short-term uncollateralized borrowings totaled $22.0 billion at September 30,
2002.
The Company has a $5.0 billion 364-day committed uncollateralized revolving line
of credit with unaffiliated banks. Commitments to lend under this facility
terminate in May 2003. Any borrowings under this facility would mature in May
2005. The Company also has a $100 million 364-day committed uncollateralized
revolving line of credit with an unaffiliated bank that extends through June
2003, with any borrowings under this facility maturing in June 2004. The Company
may borrow under these revolving credit facilities at various
17
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
interest rate options (LIBOR or base rate), and compensates the banks for these
facilities through facility fees. At September 30, 2002, there were no
outstanding borrowings under these facilities. The Company also has committed
long-term financing facilities with unaffiliated banks. At September 30, 2002,
the Company had drawn down the full $1.7 billion then available under these
facilities. A bank can terminate its facility by giving the Company one year's
notice. The Company compensates the banks for the facilities through facility
fees. Under all of these facilities, the Company is required to maintain a
certain level of consolidated adjusted net worth (as defined in the respective
agreements). At September 30, 2002, these requirements were exceeded by
approximately $4.9 billion. The Company also has substantial borrowing
arrangements consisting of facilities that the Company has been advised are
available, but where no contractual lending obligation exists. These
arrangements are reviewed on an ongoing basis to ensure flexibility in meeting
the Company's short-term requirements.
The Company's borrowing relationships are with a broad range of banks, financial
institutions and other firms from which it draws funds. The volume of the
Company's borrowings generally fluctuates in response to changes in the level of
the Company's financial instruments, commodities and contractual commitments,
customer balances, the amount of securities purchased under agreements to resell
and securities borrowed transactions. As the Company's activities increase,
borrowings generally increase to fund the additional activities. Availability of
financing to the Company can vary depending upon market conditions, credit
ratings, and the overall availability of credit to the securities industry. The
Company seeks to expand and diversify its funding mix as well as its creditor
sources. Concentration levels for these sources, particularly for short-term
lenders, are closely monitored both in terms of single investor limits and daily
maturities.
The Company monitors liquidity by tracking asset levels, collateral and funding
availability to maintain flexibility to meet its financial commitments. As a
policy, the Company attempts to maintain sufficient capital and funding sources
in order to have the capacity to finance itself on a fully collateralized basis
in the event that the Company's access to uncollateralized financing is
temporarily impaired. The Company's liquidity management process includes a
contingency funding plan designed to ensure adequate liquidity even if access to
unsecured funding sources is severely restricted or unavailable. This plan is
reviewed periodically to keep the funding options current and in line with
market conditions. The management of this plan includes an analysis used to
determine the Company's ability to withstand varying levels of stress, including
ratings downgrades, which could impact its liquidation horizons and required
margins. In addition, the Company monitors its leverage and capital ratios on a
daily basis.
RISK MANAGEMENT
MARKET RISK
Measuring market risk using statistical risk management models has recently
become the main focus of risk management efforts by many companies whose
earnings are exposed to changes in the fair value of financial instruments.
Management believes that statistical models alone do not provide a reliable
method of monitoring and controlling risk. While Value at Risk ("VAR") models
are relatively sophisticated, they are of limited use for internal risk
management because they do not give any indication of the direction or magnitude
of individual risk exposures or which market scenarios represent the largest
risk exposures. These models are used by the Company only as a supplement to
other risk management tools.
The following table shows the results of the Company's VAR analysis, which
includes all of the Company's
18
SALOMON SMITH BARNEY HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
financial assets and liabilities which are marked to market at September 30,
2002 and December 31, 2001. The VAR relating to accrual portfolios has been
excluded from this analysis.
RISK EXPOSURES September 30, Third Quarter Third Quarter Third Quarter December 31,
($ IN MILLIONS) 2002 2002 Average 2002 High 2002 Low 2001
------------- ------------ ------------- ------------- ------------
Interest rate $ 41 $ 46 $ 68 $ 38 $ 37
Equities 11 26 44 11 4
Commodities 12 10 15 4 14
Currency 7 7 14 4 --
Diversification Benefit (25) (30) N/A N/A (12)
---- ---- ---- ---- ----
Total $ 46 $ 59 $ 72 $ 46 $ 43
==== ==== ==== ==== ====
The quantification of market risk using VAR analysis requires a number of key
assumptions. In calculating VAR at September 30, 2002, the Company simulates
changes in market factors by using historical volatilities and correlations and
assuming lognormal distributions for changes in each market factor. VAR is
calculated at the 99% confidence level, assuming a static portfolio subject to a
one-day change in market factors. The historical volatilities and correlations
used in the simulation are calculated using a look back period of three years.
The Company is in the middle of a large-scale, long-term process of calculating
its VAR by a more robust methodology. Approximately 60% of the total portfolio
is calculated under the new methodology, which simulates tens of thousands of
market factors to measure VAR. The previous methodology simulated fewer market
factors to measure VAR. VAR reflects the risk profile of the Company at
September 30, 2002, and is not a predictor of future results.
FORWARD-LOOKING STATEMENTS
Certain of the statements contained herein that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act. The Company's actual results may differ materially from
those included in the forward-looking statements. Forward-looking statements are
typically identified by the words "believe," "expect," "anticipate," "intend,"
"estimate," and similar expressions. These forward-looking statements involve
risks and uncertainties including, but not limited to, the following: changes in
economic conditions, including the performance of global financial markets, and
risks associated with fluctuating currency values and interest rates;
competitive, regulatory or tax changes that affect the cost of or the demand for
the Company's products; the impact of the implementation of new accounting
rules; and the resolution of legal proceedings and environmental matters.
19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 2, "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The Company's Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"). Based on such evaluation,
such officers have concluded that, as of the Evaluation Date, the Company's
disclosure controls and procedures are effective in alerting them on a timely
basis to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's reports
filed or submitted under the Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have not been
any significant changes in the Company's internal controls or in other factors
that could significantly affect such controls.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Enron Corp.
In April 2002, Citigroup Inc. ("Citigroup") and, in one case, Salomon Smith
Barney Inc. ("SSB") were named as defendants along with, among others,
commercial and/or investment banks, certain current and former Enron officers
and directors, lawyers and accountants in two putative consolidated class action
complaints that were filed in the United States District Court for the Southern
District of Texas seeking unspecified damages. One action, brought on behalf of
individuals who purchased Enron securities (Newby, et al. v. Enron Corp., et
al.), alleges violations of Sections 11 and 15 of the Securities Act of 1933, as
amended, and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as
amended, and the other action, brought on behalf of current and former Enron
employees (Tittle, et al. v. Enron Corp., et al.), alleges violations of the
Employment Retirement Income Security Act of 1974, as amended ("ERISA"), and the
Racketeer Influenced and Corrupt Organizations Act ("RICO"), as well as claims
for negligence and civil conspiracy. On May 8, 2002, Citigroup and SSB filed
motions to dismiss the complaints, which are pending.
In July 2002, Citigroup, SSB and various of its affiliates and certain of their
officers and other employees were named as defendants, along with, among others,
commercial and/or investment banks, certain current and former Enron officers
and directors, lawyers and accountants in a putative class action filed in the
United States District Court for the Southern District of New York on behalf of
purchasers of the Yosemite Notes and Enron Credit-Linked Notes, among other
securities (Hudson Soft Co., Ltd. v. Credit Suisse First Boston Corporation, et
al.). The amended complaint alleges violations of RICO and of Sections 10(b) and
20(a) of the Securities Exchange Act of 1934, as amended, and seeks unspecified
damages.
Additional actions have been filed against Citigroup and certain of its
affiliates, along with other parties, including (i) two actions brought in
different state courts by state pension plans alleging violations of state
20
securities law and claims for common law fraud and unjust enrichment; (ii) an
action by banks that participated in two Enron revolving credit facilities,
alleging fraud, gross negligence, and breach of implied duties in connection
with defendants' administration of a credit facility with Enron; (iii) an action
brought by several funds in connection with secondary market purchases of Enron
Corp. debt securities alleging violations of the federal securities law,
including Section 11 of the Securities Act of 1933, as amended, and claims for
fraud and misrepresentation; (iv) a series of putative class actions by
purchasers of NewPower Holdings common stock alleging violations of the federal
securities law, including Section 11 of the Securities Act of 1933, as amended,
and Section 10(b) of the Securities Exchange Act of 1934, as amended; (v) an
action brought by two investment funds in connection with purchases of
Enron-related securities for alleged violations of state securities and unfair
competition statutes; (vi) an action brought by several investment funds and
fund owners in connection with purchases of notes of the Osprey I and Osprey II
Trusts for alleged violation of state and federal securities laws and claims for
common law fraud, misrepresentation and conspiracy; (vii) an action brought by
several investment funds and fund owners in connection with purchases of notes
of the Osprey I and Osprey II Trusts for alleged violation of state and federal
securities laws and state unfair competition laws and claims for common law
fraud and misrepresentation; and (viii) an action brought by the Attorney
General of Connecticut in connection with various commercial and investment
banking services provided to Enron. Several of these cases have been
consolidated with the Newby action and stayed pending the Court's decision on
the pending motions to dismiss Newby.
Additionally, Citigroup and certain of its affiliates have received inquiries
and requests for information from various regulatory and governmental agencies
and Congressional committees, as well as from the Special Examiner in the Enron
bankruptcy, regarding certain transactions and business relationships with Enron
and its affiliates. Citigroup is cooperating fully with all such requests.
Research
Since May 2002, SSB and Jack Grubman have been named as defendants in
approximately 62 putative class action complaints by purchasers of various
securities alleging they violated federal securities law, including Sections 10
and 20 of the Securities Exchange Act of 1934, as amended, for allegedly issuing
research reports without a reasonable basis in fact and for allegedly failing to
disclose conflicts of interest with companies in connection with published
investment research, including Global Crossing, WorldCom, Inc., AT&T, Winstar,
Rhythm Net Connections, Level 3 Communications, MetroMedia Fiber Network, XO
Communications and Williams Communications Group Inc. Similar claims with
respect to research have also been included in approximately 100 cases pending
against SSB and other broker dealers in the IPO Allocation Securities Litigation
and the IPO Allocation Antitrust Litigation, disclosed below under the caption
"Other". Nearly all of these actions are pending in the United States District
Court for the Southern District of New York.
Since April 2002, SSB and several other broker dealers have received subpoenas
and/or requests for information from various governmental and self-regulatory
agencies and Congressional committees, including the National Association of
Securities Dealers (the "NASD") which has raised issues about SSB's internal
e-mail retention practices and research on Winstar Communications, Inc. With
respect to Winstar, SSB and the NASD have entered into a settlement agreement.
SSB agreed to pay a penalty in the amount of $5 million and did not admit to any
allegation of wrongdoing. With respect to other such matters, these agencies
have been engaged in discussions with a number of broker dealers, including SSB,
about resolving potential enforcement proceedings relating to research. SSB is
cooperating fully with all such requests.
WorldCom, Inc.
Citigroup and SSB are involved in a number of lawsuits arising out of the
underwriting of debt securities of
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WorldCom, Inc. These lawsuits include putative class actions filed in July 2002
by alleged purchasers of WorldCom debt securities in the United States District
Court for the Southern District of New York (Above Paradise Investments Ltd. v.
WorldCom, Inc., et al.; Municipal Police Employees Retirement System of
Louisiana v. WorldCom, Inc., et al.), and in the United States District Court
for the Southern District of Mississippi (Longacre Master Fund v. WorldCom,
Inc., et al.). These putative class action complaints assert violations of
federal securities law, including Sections 11 and 12 of the Securities Act of
1933, as amended, and seek unspecified damages from the underwriters.
On October 11, 2002, the Above Paradise and Municipal Police Employees lawsuits
filed in the United States District Court for the Southern District of New York
were superseded by the filing of a consolidated putative class action complaint
in the United States District Court for the Southern District of New York (In re
WorldCom, Inc. Securities Litigation). In the consolidated complaint, in
addition to the claims of violations by the underwriters of the federal
securities law, including Sections 11 and 12 of the Securities Act of 1933, as
amended, the plaintiffs allege violations of Section 10(b) of the Securities
Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, by SSB
arising out of alleged conflicts of interest of SSB and Jack Grubman. The
plaintiffs continue to seek unspecified compensatory damages. In addition to the
consolidated class action complaint, the Southern District of Mississippi class
action has been transferred by the Judicial Panel on MultiDistrict Litigation to
the Southern District of New York for centralized pre-trial proceedings with
other WorldCom-related actions.
In addition to the several putative class actions that have been commenced,
certain individual actions have been filed in various federal and state courts
against Citigroup and SSB, along with other parties, concerning WorldCom debt
securities including individual state court actions brought by various pension
funds in connection with the underwriting of debt securities of WorldCom
alleging violations of Section 11 of the Securities Act of 1933, as amended,
and, in one case, violations of various state securities laws and common law
fraud. Most of these actions have been removed to federal court and an
application has been made to have them transferred to the Southern District of
New York for centralized pre-trial proceedings with other WorldCom-related
actions.
A putative class action on behalf of participants in WorldCom's 401(k) salary
savings plan and those WorldCom benefit plans covered by ERISA alleging
violations of ERISA and common law fraud (Emanuele v. WorldCom, Inc., et al.),
which was commenced in the United States District Court for the District of
Columbia, also has been transferred by the Judicial Panel on MultiDistrict
Litigation to the Southern District of New York for centralized pre-trial
proceedings with other WorldCom-related actions.
Additional lawsuits containing similar claims to those described above may be
filed in the future.
Other
In April 2002, consolidated amended complaints were filed against the Company
and other investment banks named in numerous putative class actions filed in the
United States District Court for the Southern District of New York alleging
violations of certain federal securities laws (including Section 11 of the
Securities Act of 1933, as amended, and Section 10(b) of the Securities Exchange
Act of 1934, as amended) with respect to the allocation of shares for certain
initial public offerings and related aftermarket transactions and damage to
investors caused by allegedly biased research analyst reports. The defendants in
these actions have moved to dismiss the consolidated amended complaints but the
Court has not yet rendered a decision on those motions. Also pending in the
Southern District of New York against the Company and other investment banks are
several putative class actions which have been consolidated into a single class
action alleging violations of certain federal and state antitrust laws in
connection with the allocation of shares in initial public offerings when acting
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as underwriters. The defendants in this action have moved to dismiss the
consolidated amended complaint but the Court has not yet rendered a decision on
those motions.
For information concerning a suit filed by a hedge fund and its investment
advisor against SSB, see the description that appears in the fourth paragraph
under the caption "Legal Proceedings" beginning on page 11 of the Annual Report
on Form 10-K of SSBH for the year ended December 31, 2001 (File No. 1-4346),
which description is included as Exhibit 99.02 to this Form 10-Q and
incorporated by reference herein. In August 2002, SSB filed a motion for summary
judgment.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: See Exhibit Index.
(b) Reports on Form 8-K:
On July 18, 2002, the Company filed a Current Report on Form 8-K, dated July 17,
2002, reporting under Item 5 thereof the results of its operations for the
three- and six-month periods ended June 30, 2002 and 2001.
On August 19, 2002, the Company filed a Current Report on Form 8-K, dated August
14, 2002, filing certain exhibits under Item 7 thereof relating to the offer and
sale of its Equity Linked Securities (ELKS) based on the common stocks of five
companies due August 20, 2003.
No other reports on Form 8-K were filed during the third quarter of 2002,
however:
On October 17, 2002, the Company filed a Current Report on Form 8-K, dated
October 15, 2002, reporting under Item 5 thereof the results of its operations
for the three- and nine-month periods ended September 30, 2002 and 2001.
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3.01 Restated Certificate of Incorporation of Salomon Smith Barney
Holdings Inc. (the "Company"), effective July 1, 1999,
incorporated by reference to Exhibit 3.2 to Post-Effective
Amendment No. 1 to the Company's Registration Statement on
Form S-3 (No. 333-38931).
3.02 By-Laws of the Company, incorporated by reference to Exhibit
3.3 to Post-Effective Amendment No. 1 to the Company's
Registration Statement on Form S-3 (No. 333-38931).
12.01+ Computation of ratio of earnings to fixed charges.
99.01+ Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.02+ Fourth paragraph under the caption "Legal Proceedings"
beginning on page 11 of the Annual Report on Form 10-K of the
Company for the year ended December 31, 2001 (File No.
1-4346).
- --------------------
+ Filed herewith.
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The total amount of securities authorized pursuant to any instrument defining
rights of holders of long-term debt of the Company does not exceed 10% of the
total assets of the Company and its consolidated subsidiaries. The Company will
furnish copies of any such instrument to the SEC upon request.
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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.
SALOMON SMITH BARNEY HOLDINGS INC.
(Registrant)
Date: November 14, 2002 By: /s/ William T. Bozarth
-----------------------------------
William T. Bozarth
Chief Financial Officer
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CERTIFICATIONS
I, Charles O. Prince, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Salomon Smith Barney
Holdings Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 14, 2002
By: /s/ Charles O. Prince, Chief Executive Officer
---------------------------------------------------
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I, William T. Bozarth, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Salomon Smith Barney
Holdings Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: November 14, 2002
By: /s/William T. Bozarth, Chief Financial Officer
---------------------------------------------------------
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