SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 26, 1999
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COMMISSION FILE NUMBER 1-7182
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MERRILL LYNCH & CO., INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 13-2740599
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(State of incorporation) (I.R.S. Employer Identification No.)
WORLD FINANCIAL CENTER, NORTH TOWER,
NEW YORK, NEW YORK 10281-1332
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(Address of principal executive offices) (Zip Code)
(212) 449-1000
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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
- --
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
363,473,557 shares of Common Stock and 4,386,135 Exchangeable Shares as of the
close of business on April 30, 1999. The Exchangeable Shares, which were issued
by Merrill Lynch & Co., Canada Ltd. in connection with the merger with Midland
Walwyn Inc., are exchangeable at any time into Common Stock on a one-for-one
basis and entitle holders to dividend, voting, and other rights equivalent to
Common Stock.
PART I. FINANCIAL INFORMATION
------------------------------
ITEM 1. Financial Statements
--------------------
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
FOR THE THREE MONTHS ENDED
--------------------------
MARCH 26, MARCH 27,(1) PERCENT (2)
(dollars in millions, except per share amounts) 1999 1998 INC. (DEC.)
--------- ------------ -----------
REVENUES
Commissions $1,567 $1,463 7.1%
Interest and dividends 3,965 4,814 (17.6)
Principal transactions 1,444 1,171 23.3
Investment banking 633 831 (23.9)
Asset management and portfolio service fees 1,110 1,029 7.8
Other 132 80 65.9
------ ------
TOTAL REVENUES 8,851 9,388 (5.7)
Interest Expense 3,585 4,626 (22.5)
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NET REVENUES 5,266 4,762 10.6
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NON-INTEREST EXPENSES
Compensation and benefits 2,762 2,499 10.5
Communications and technology 480 392 22.5
Occupancy and related depreciation 227 201 12.5
Advertising and market development 152 177 (14.0)
Brokerage, clearing, and exchange fees 154 156 (1.2)
Professional fees 117 152 (22.7)
Goodwill amortization 57 55 2.9
Other 321 263 22.3
------ ------
Total Non-Interest Expenses 4,270 3,895 9.6
------ ------
EARNINGS BEFORE INCOME TAXES AND DIVIDENDS ON
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 996 867 14.8
INCOME TAX EXPENSE 338 330 2.5
Dividends on Preferred Securities Issued by Subsidiaries 49 23 110.1
------ ------
NET EARNINGS $ 609 $ 514 18.4%
====== ======
NET EARNINGS APPLICABLE TO COMMON STOCKHOLDERS $ 599 $ 504 18.8%
====== ======
EARNINGS PER COMMON SHARE
Basic $ 1.65 $1.44
====== ======
Diluted $ 1.44 $1.26
====== ======
DIVIDEND PAID PER COMMON SHARE $ .24 $ .20
====== ======
AVERAGE SHARES USED IN COMPUTING
EARNINGS PER COMMON SHARE
Basic 364.0 349.5
====== ======
Diluted 415.7 400.2
====== ======
- ---------------------------------------------------------------
(1) Amounts have been restated from that originally reported on Form 10-Q to
reflect the 1998 merger with Midland Walwyn Inc., accounted for as a
pooling-of-interests.
(2) Percentages are based on actual numbers before rounding.
See Notes to Consolidated Financial Statements
2
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
MARCH 26, DECEMBER 25,
(dollars in millions) 1999 1998
- ----------------------------------------------------------------------------------- ---------- ------------
ASSETS
CASH AND CASH EQUIVALENTS $ 10,761 $ 12,530
-------- --------
CASH AND SECURITIES SEGREGATED FOR REGULATORY PURPOSES
OR DEPOSITED WITH CLEARING ORGANIZATIONS 5,857 6,590
-------- --------
RECEIVABLES UNDER RESALE AGREEMENTS AND SECURITIES BORROWED TRANSACTIONS 101,719 87,713
-------- --------
MARKETABLE INVESTMENT SECURITIES 5,429 4,605
-------- --------
TRADING ASSETS, AT FAIR VALUE
Equities and convertible debentures 25,901 25,318
Contractual agreements 16,873 21,979
Corporate debt and preferred stock 20,718 21,166
U.S. Government and agencies 13,631 15,421
Non-U.S. governments and agencies 6,715 7,474
Mortgages, mortgage-backed, and asset-backed 9,968 7,023
Other 3,416 3,358
-------- --------
97,222 101,739
Securities received as collateral, net of securities pledged as collateral 8,556 6,106
-------- --------
Total 105,778 107,845
-------- --------
SECURITIES PLEDGED AS COLLATERAL 13,750 8,184
-------- --------
OTHER RECEIVABLES
Customers (net of allowance for doubtful accounts of $68 in 1999 and $48 in 1998) 31,120 29,559
Brokers and dealers 5,054 8,872
Interest and other 9,594 9,278
-------- --------
Total 45,768 47,709
-------- --------
INVESTMENTS OF INSURANCE SUBSIDIARIES 4,365 4,485
LOANS, NOTES, AND MORTGAGES (net of allowance for loan losses of $115 in 1999 and $124 in 1998) 8,463 7,687
OTHER INVESTMENTS 2,934 2,590
EQUIPMENT AND FACILITIES (net of accumulated depreciation and amortization
of $3,610 in 1999 and $3,482 in 1998) 2,801 2,761
GOODWILL (net of accumulated amortization of $374 in 1999 and $338 in 1998) 5,174 5,364
OTHER ASSETS 1,821 1,741
-------- --------
TOTAL ASSETS $314,620 $299,804
======== ========
See Notes to Consolidated Financial Statements
3
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
MARCH 26, DECEMBER 25,
(dollars in millions, except per share amount) 1999 1998
- -------------------------------------------------------------------- -------- ------------
LIABILITIES
PAYABLES UNDER REPURCHASE AGREEMENTS AND SECURITIES LOANED TRANSACTIONS $ 70,012 $ 67,127
-------- --------
COMMERCIAL PAPER AND OTHER SHORT-TERM BORROWINGS 11,431 18,679
-------- --------
DEMAND AND TIME DEPOSITS 13,553 13,744
-------- --------
TRADING LIABILITIES, AT FAIR VALUE
Contractual agreements 21,063 23,840
Equities and convertible debentures 21,328 21,558
U.S. Government and agencies 12,102 7,939
Non-U.S. governments and agencies 8,760 7,245
Corporate debt and preferred stock 2,968 2,878
Other 289 254
-------- --------
Total 66,510 63,714
-------- --------
OBLIGATION TO RETURN SECURITIES RECEIVED AS COLLATERAL 22,306 14,290
-------- --------
OTHER PAYABLES
Customers 18,103 20,972
Brokers and dealers 17,217 7,899
Interest and other 18,002 18,738
-------- --------
Total 53,322 47,609
-------- --------
LIABILITIES OF INSURANCE SUBSIDIARIES 4,260 4,319
LONG-TERM BORROWINGS 59,907 57,563
-------- --------
TOTAL LIABILITIES 301,301 287,045
-------- --------
PREFERRED SECURITIES ISSUED BY SUBSIDIARIES 2,627 2,627
-------- --------
STOCKHOLDERS' EQUITY
PREFERRED STOCKHOLDERS' EQUITY 425 425
-------- --------
COMMON STOCKHOLDERS' EQUITY
Shares exchangeable into common stock 65 66
Common stock, par value $1.33 1/3 per share; authorized: 1,000,000,000 shares;
issued: 1999 - 472,661,774; 1998 - 472,660,324 630 630
Paid-in capital 1,624 1,427
Accumulated other comprehensive loss (net of tax) (272) (122)
Retained earnings 10,986 10,475
-------- --------
13,033 12,476
Less: Treasury stock, at cost: 1999 - 111,326,144 shares; 1998 - 116,376,259 shares 1,957 2,101
Employee stock transactions 809 668
-------- --------
TOTAL COMMON STOCKHOLDERS' EQUITY 10,267 9,707
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TOTAL STOCKHOLDERS' EQUITY 10,692 10,132
-------- --------
TOTAL LIABILITIES, PREFERRED SECURITIES ISSUED BY SUBSIDIARIES,
AND STOCKHOLDERS' EQUITY $314,620 $299,804
======== ========
See Notes to Consolidated Financial Statements
4
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED
--------------------------
(dollars in millions) MARCH 26, MARCH 27,
1999 1998
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 609 $ 514
Noncash items included in earnings:
Depreciation and amortization 162 133
Policyholder reserves 54 58
Goodwill amortization 57 55
Other 133 281
(Increase) decrease in operating assets(a):
Trading assets 3,772 (14,763)
Cash and securities segregated for regulatory purposes
or deposited with clearing organizations 733 (785)
Receivables under resale agreements and securities borrowed transactions (14,006) (13,720)
Customer receivables (1,566) (2,826)
Brokers and dealers receivables 3,818 (957)
Other (861) (676)
Increase (decrease) in operating liabilities(a):
Trading liabilities 2,796 1,965
Payables under repurchase agreements and securities loaned transactions 2,885 17,955
Customer payables (2,869) 1,128
Brokers and dealers payables 9,318 4,604
Other (700) 1,626
-------- --------
CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES 4,335 (5,408)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from (payments for):
Maturities of available-for-sale securities 1,563 1,000
Sales of available-for-sale securities 951 659
Purchases of available-for-sale securities (2,533) (1,799)
Maturities of held-to-maturity securities 205 237
Purchases of held-to-maturity securities (222) (179)
Loans, notes, and mortgages (782) (1,331)
Acquisitions, net of cash acquired (20) (5,220)
Other investments and other assets (424) (435)
Equipment and facilities (202) (280)
-------- --------
CASH USED FOR INVESTING ACTIVITIES (1,464) (7,348)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments for):
Commercial paper and other short-term borrowings (7,248) 4,494
Demand and time deposits (191) 748
Issuance and resale of long-term borrowings 8,914 7,763
Settlement and repurchase of long-term borrowings (5,921) (3,144)
Issuance of subsidiaries' preferred securities - 750
Issuance of treasury stock 75 56
Other common stock transactions (171) (129)
Dividends (98) (79)
-------- --------
CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (4,640) 10,459
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (1,769) (2,297)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 12,530 12,072
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 10,761 $ 9,775
======== ========
(a) Net of effects of acquisitions.
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes $ 111 $ 95
Interest 3,537 4,333
See Notes to Consolidated Financial Statements
5
MERRILL LYNCH & CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 26, 1999
(dollars in millions, except per share amounts)
================================================================================
NOTE 1. BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The Consolidated Financial Statements include the accounts of Merrill Lynch &
Co., Inc. ("ML & Co.") and subsidiaries (collectively, "Merrill Lynch"). All
material intercompany balances have been eliminated. The December 25, 1998
consolidated balance sheet was derived from the audited financial statements.
The interim consolidated financial statements for the three-month periods are
unaudited; however, in the opinion of Merrill Lynch management, all adjustments,
consisting only of normal recurring accruals, necessary for a fair statement of
the results of operations have been included.
These unaudited financial statements should be read in conjunction with the
audited financial statements included in Merrill Lynch's Annual Report included
as an exhibit to the Form 10-K for the year ended December 25, 1998. The nature
of Merrill Lynch's business is such that the results of any interim period are
not necessarily indicative of results for a full year. Prior period amounts
have been restated to reflect the 1998 merger of Midland Walwyn Inc. with
Merrill Lynch, which has been accounted for as a pooling-of-interests. Certain
reclassifications have also been made to prior period financial statements,
where appropriate, to conform to the current period presentation.
================================================================================
NOTE 2. SHORT-TERM BORROWINGS
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Short-term borrowings at March 26, 1999 and December 25, 1998 are presented
below:
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MARCH 26, DECEMBER 25,
1999 1998
--------- ------------
PAYABLES UNDER REPURCHASE AGREEMENTS
AND SECURITIES LOANED TRANSACTIONS
Repurchase agreements $62,275 $59,501
Securities loaned transactions 7,737 7,626
------- -------
Total $70,012 $67,127
======= =======
COMMERCIAL PAPER AND OTHER SHORT-TERM
BORROWINGS
Commercial paper $ 9,436 $16,758
Bank loans and other 1,995 1,921
------- -------
Total $11,431 $18,679
======= =======
DEMAND AND TIME DEPOSITS
Demand $ 3,964 $ 4,454
Time 9,589 9,290
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Total $13,553 $13,744
======= =======
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NOTE 3. COMMON STOCK
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In February 1999, ML & Co. issued 1,450 shares of Common Stock to certain non-
U.S. employees in connection with an employee incentive plan grant, thereby
increasing issued shares to 472,661,774.
6
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NOTE 4. SEGMENT INFORMATION
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In reporting to management, Merrill Lynch's operating results are categorized
into two business segments: Wealth Management and Corporate and Institutional
Client Group ("CICG"). For more information on these segments, see the 1998
Annual Report included as an exhibit to Form 10-K.
Operating results by business segment follow:
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WEALTH CORPORATE
MANAGEMENT CICG ITEMS TOTAL
---------- ---- --------- -----
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THREE MONTHS ENDED
MARCH 26, 1999
Net interest revenue (a) $ 280 $ 166 $ (66)(b) $ 380
All other revenues 2,774 2,112 - 4,886
------- -------- ------ --------
Net revenues 3,054 2,278 (66) 5,266
Non-interest expenses 2,551 1,662 57 (c) 4,270
------- -------- ------ --------
Earnings before income taxes 503 616 (123) 996
Income tax expense (benefit) 187 179 (28) 338
Dividends on preferred securities
issued by subsidiaries - - 49 49
------- -------- ------ --------
Net earnings $ 316 $ 437 $ (144) $ 609
======= ======== ====== ========
Total assets $48,596 $260,736 $5,288 $314,620
======= ======== ====== ========
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THREE MONTHS ENDED
MARCH 27, 1998
Net interest revenue (a) $ 253 $ 3 $ (68)(b) $ 188
All other revenues 2,552 2,022 - 4,574
------- -------- ------- -------
Net revenues 2,805 2,025 (68) 4,762
Non-interest expenses 2,302 1,538 55 (c) 3,895
------- -------- ------- -------
Earnings before income taxes 503 487 (123) 867
Income tax expense (benefit) 197 152 (19) 330
Dividends on preferred securities
issued by subsidiaries - - 23 23
------- -------- ------ --------
Net earnings $ 306 $ 335 $ (127) $ 514
======= ======== ====== ========
Total assets $40,084 $313,377 $5,435 $358,896
======= ======== ====== ========
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(a) Management views interest income net of interest expense in evaluating
results.
(b) Represents Mercury financing costs.
(c) Represents goodwill amortization from acquisitions.
7
===========================================================================
NOTE 5. COMPREHENSIVE INCOME
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The components of comprehensive income are as follows:
- ----------------------------------------------------------------------------
THREE MONTHS ENDED
----------------------
MARCH 26, MARCH 27,
1999 1998
--------- ---------
Net earnings $ 609 $ 514
-------- --------
Other comprehensive income (loss), net of tax:
Currency translation adjustment (117) 18
Net unrealized (losses) on investment
securities available-for-sale (33) (6)
-------- ---------
Total other comprehensive income (loss), net (150) 12
-------- ---------
Comprehensive income $ 459 $ 526
======== =========
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============================================================================
NOTE 6. EARNINGS PER COMMON SHARE
- ----------------------------------------------------------------------------
Information relating to earnings per common share computations follows:
- ----------------------------------------------------------------------------
THREE MONTHS ENDED
-----------------------
MARCH 26, MARCH 27,
1999 1998
--------- ---------
Net earnings $ 609 $ 514
Preferred stock dividends 10 10
-------- --------
Net earnings applicable to
common stockholders $ 599 $ 504
======== ========
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(shares in thousands)
Weighted-average shares outstanding 364,039 349,495
-------- --------
Effect of dilutive instruments(1) (2):
Employee stock options 29,833 29,338
FCCAAP shares 16,548 16,831
Restricted units 5,161 4,496
ESPP shares 81 89
-------- --------
Dilutive potential common shares 51,623 50,754
-------- --------
Total weighted-average diluted shares 415,662 400,249
======== ========
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Basic earnings per common share $ 1.65 $ 1.44
Diluted earnings per common share 1.44 1.26
- ---------------------------------------------------------------------------
(1) At March 26, 1999, there were 469 instruments that were considered
antidilutive and were not included in the above computations.
(2) See Note 10 to Consolidated Financial Statements in the 1998 Annual Report
included as an exhibit to Form 10-K for a description of these instruments.
8
================================================================================
NOTE 7. DERIVATIVES AND OTHER COMMITMENTS
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Merrill Lynch enters into various derivative contracts to meet clients' needs
and to manage its own market risks. Derivative contracts often involve future
commitments to exchange interest payment streams or currencies (such as interest
rate and currency swaps or foreign exchange forwards) or to purchase or sell
other financial instruments at specified terms on a specified date. Options,
for example, can be purchased or written on a wide range of financial
instruments such as securities, currencies, futures, and various market indices.
The notional or contractual amounts of derivatives provide only a measure of
involvement in these types of transactions and represent neither the amounts
subject to the various types of market risk nor the future cash requirements
under these instruments. The notional or contractual amounts of derivatives
used for trading purposes and included in trading inventory by type of risk
follow:
- --------------------------------------------------------------------------------
INTEREST EQUITY COMMODITY
RATE CURRENCY PRICE PRICE
(in billions) RISK (1)(2) RISK (3) RISK RISK
- --------------------------------------------------------------------------------
MARCH 26, 1999
- --------------
Swap agreements $1,956 $174 $25 $8
Forward contracts 77 232 1 3
Futures contracts 158 1 12 2
Options purchased 329 100 69 5
Options written 186 105 62 6
DECEMBER 25, 1998
- -----------------
Swap agreements $2,006 $170 $19 $5
Forward contracts 62 229 - 6
Futures contracts 184 2 10 3
Options purchased 254 93 71 4
Options written 192 96 58 6
- --------------------------------------------------------------------------------
(1) Certain derivatives subject to interest rate risk are also exposed to the
credit spread risk of the underlying financial instrument.
(2) Forward contracts subject to interest rate risk principally represent "To
Be Announced" mortgage pools that bear interest rate as well as principal
prepayment risk.
(3) Included in the currency risk category are certain contracts that are also
subject to interest rate risk.
- --------------------------------------------------------------------------------
The notional or contractual amounts of derivatives at March 26, 1999 and
December 25, 1998 used to hedge all other exposures, primarily borrowings,
follow:
- --------------------------------------------------------------------------------
MARCH 26, DECEMBER 25,
(in billions) 1999 1998
--------- ------------
Interest rate derivatives (1) $ 69 $ 71
Currency derivatives (1) 22 19
Equity derivatives 5 5
- --------------------------------------------------------------------------------
(1) Includes swap contracts totaling $2 billion in notional amounts that contain
embedded options hedging callable debt at March 26, 1999 and December 25,
1998.
9
Most of these derivatives are entered into with Merrill Lynch's derivative
dealer subsidiaries, which intermediate interest rate, currency, and equity
risks with third parties.
In the normal course of business, Merrill Lynch enters into underwriting
commitments and commitments to extend credit. Settlement of these commitments
as of March 26, 1999 would not have a material effect on the consolidated
financial condition of Merrill Lynch.
Subsequent to quarter-end, Merrill Lynch extended a $3,675 loan commitment to an
investment grade company in connection with a proposed acquisition transaction.
Merrill Lynch intends to syndicate a significant portion of this loan
commitment.
As disclosed in the 1998 Annual Report included as an exhibit to Form 10-K,
Merrill Lynch has agreed to pay $400 and $17 in settlement of the Orange County
action and the related Irvine Ranch Water District action, respectively. At
March 26, 1999, Merrill Lynch has remaining liabilities of these amounts plus
interest.
================================================================================
NOTE 8. REGULATORY REQUIREMENTS
- --------------------------------------------------------------------------------
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S"), a registered
broker-dealer, is subject to the net capital requirements of Rule 15c3-1 under
the Securities Exchange Act of 1934. Under the alternative method permitted by
this rule, the minimum required net capital, as defined, shall not be less than
2% of aggregate debit items arising from customer transactions. At March 26,
1999, MLPF&S's regulatory net capital of $3,887 was 17% of aggregate debit
items, and its regulatory net capital in excess of the minimum required was
$3,438.
Merrill Lynch International ("MLI"), a U.K. registered broker-dealer, is subject
to the capital requirements of the Financial Services Authority ("FSA").
Financial resources, as defined, must exceed the total financial resources
requirement of the FSA. At March 26, 1999, MLI's financial resources were
$3,555 and exceeded the minimum requirement by $1,125.
Merrill Lynch Government Securities Inc. ("MLGSI"), a primary dealer in U.S.
Government securities, is subject to the capital adequacy requirements of the
Government Securities Act of 1986. This rule requires dealers to maintain
liquid capital in excess of market and credit risk, as defined, by 20% (a 1.2-
to-1 capital-to-risk standard). At March 26, 1999, MLGSI's liquid capital of
$1,488 was 282% of its total market and credit risk, and liquid capital in
excess of the minimum required was $855.
10
INDEPENDENT ACCOUNTANTS' REPORT
- -------------------------------
To the Board of Directors and Stockholders of
Merrill Lynch & Co., Inc.:
We have reviewed the accompanying condensed consolidated balance sheet of
Merrill Lynch & Co., Inc. and subsidiaries ("Merrill Lynch") as of March 26,
1999, and the related condensed consolidated statements of earnings and cash
flows for the three-month periods ended March 26, 1999 and March 27, 1998. These
financial statements are the responsibility of Merrill Lynch's management. The
unaudited interim condensed consolidated financial information for the three-
month period ended March 27, 1998 gives retroactive effect to the 1998 merger of
Merrill Lynch and Midland Walwyn Inc., which has been accounted for as a
pooling-of-interests, as disclosed in Note 1 to the condensed consolidated
financial statements.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Merrill Lynch as of December 25,
1998, and the related consolidated statements of earnings, changes in
stockholders' equity, comprehensive income, and cash flows for the year then
ended (not presented herein); and in our report dated February 22, 1999, we
expressed an unqualified opinion and included an explanatory paragraph for the
change in accounting method for certain internal-use software development costs
to conform with Statement of Position 98-1. In our opinion, the information set
forth in the accompanying condensed consolidated balance sheets as of December
25, 1998 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
/s/ Deloitte & Touche LLP
New York, New York
May 7, 1999
11
- --------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Merrill Lynch & Co., Inc. ("ML & Co." and, together with its subsidiaries and
affiliates, "Merrill Lynch") is a holding company that, through its subsidiaries
and affiliates, provides investment, financing, advisory, insurance, and related
services worldwide. Merrill Lynch conducts its businesses in global financial
markets that are influenced by numerous unpredictable factors including economic
conditions, monetary policies, liquidity, international and regional political
events, regulatory developments, the competitive environment, and investor
sentiment. These conditions or events can significantly affect the volatility
of financial markets. While greater volatility increases risk, it may also
increase order flow in businesses such as trading and brokerage. Revenues and
net earnings may vary significantly from period to period due to these
unpredictable factors and the resulting market volatility.
The financial services industry continues to be affected by the intensifying
competitive environment, as demonstrated by consolidation through mergers and
acquisitions, as well as diminishing margins in many mature products and
services. In addition, the relaxation of banks' barriers to entry into the
securities industry and expansion by insurance companies into traditional
brokerage products, coupled with the potential repeal of the laws separating
commercial and investment banking activities in the future, have increased the
number of companies competing for a similar customer base.
In addition to providing historical information, Merrill Lynch may make or
publish forward-looking statements about management expectations, strategic
objectives, business prospects, anticipated financial performance, and other
similar matters. A variety of factors, many of which are beyond its control,
affect the operations, performance, business strategy, and results of Merrill
Lynch and could cause actual results and experience to differ materially from
the expectations expressed in these statements. These factors include, but are
not limited to, the factors listed in the previous paragraphs, as well as:
. actions and initiatives taken by both current and potential competitors,
. the impact of current and future legislation and regulation throughout the
world, and
. the other risks and uncertainties detailed in the following sections.
MERRILL LYNCH UNDERTAKES NO RESPONSIBILITY TO UPDATE PUBLICLY OR REVISE ANY
FORWARD-LOOKING STATEMENTS.
================================================================================
BUSINESS ENVIRONMENT
- --------------------------------------------------------------------------------
Global financial markets, which experienced significant volatility during the
latter half of 1998, stabilized during the 1999 first quarter as market
conditions generally improved. Markets continued to benefit from credit spread
tightening, increased investor demand, liquidity in debt markets, and record
highs on many equity indices. These conditions contributed to strong trading,
commissions, and asset management revenues industrywide during the 1999 first
quarter. Several emerging markets, including Japan and Korea, showed signs of
improvement during the 1999 first quarter, while European markets generally
continued their strong performance.
Long-term U.S. interest rates, as measured by the yield on 30-year U.S. Treasury
bonds, rose during the 1999 first quarter, as favorable market conditions
increased investor demand for higher-yielding securities and equities. Long-
term U.S. rates, however, were lower compared to the year-ago period. European
rates, following the U.S. trend, generally increased during the 1999 first
quarter and were lower compared to the 1998 first quarter. In Japan, rates
increased substantially in January, but gradually fell in February and March,
ending the quarter down from year-end 1998 and up slightly from a year ago.
International Monetary Fund support, as well as a reduction in interest rates,
helped Brazilian markets recover from the devaluation of its currency in
January.
12
Credit spreads, which represent the risk premium over the risk-free rate paid by
an issuer based on the issuer's credit rating or perceived creditworthiness,
tightened significantly during the 1999 first quarter relative to the 1998
fourth quarter, indicative of restored liquidity in credit markets. Credit
spreads also tightened more in the 1999 first quarter compared with the year-ago
period, driving trading revenues to record levels.
U.S. equity indices, which posted significant gains during 1998, continued to
advance during the 1999 first quarter, due to low interest rates and renewed
investor confidence. Although the Dow Jones Industrial Average rose 6.6% from
year-end 1998 and 11.2% from a year ago, the majority of the advance during the
1999 first quarter resulted from increases in a small number of large
capitalization stocks, as well as those in the Internet, technology, and
financial services sector. In addition, both the Nasdaq and S&P 500 reached
record highs during the 1999 first quarter, and were up 12.3% and 4.6% from
year-end 1998 and 34.1% and 16.8% from the end of the 1998 first quarter.
Global equity markets rose 2.8% during the 1999 first quarter and 9.0% from the
end of the 1998 first quarter, as measured by the Dow Jones World Index.
Prospects of corporate restructuring and increased consumer spending led many
Asian equity markets, including Japan, South Korea, and Hong Kong, to rebound
during the 1999 first quarter. Many other emerging market indices, particularly
in Brazil, produced favorable gains during the 1999 first quarter aided by a
reduction in interest rates. European market indices were generally up during
the 1999 first quarter, despite the euro's 8% year-to-date drop against the U.S.
dollar. For the 1999 first quarter, equity prices in certain countries, when
measured in local currency terms, were up more than U.S. equity prices; however,
in U.S. dollar terms, only a few of these increases exceeded the U.S. advance
due to the overall strengthening of the U.S. dollar versus many local
currencies.
Global underwriting volume reached near-record levels during the 1999 first
quarter, driven by a strong economy and renewed stability in the bond market.
Total underwriting revenues were down 23%, however, from the 1998 first quarter,
as equity offerings, which typically yield higher fees than debt issuances,
declined industrywide.
Strategic services activities remained strong during the 1999 first quarter,
reflecting a continuation of the high level of merger and acquisition activity
experienced in 1998. U.S. and global announced mergers and acquisitions reached
new highs during the 1999 first quarter, up 58% and 75%, respectively, from 1998
first quarter volume. For the first time since the 1996 first quarter, non-U.S.
strategic services activity dominated the quarter, with Europe representing 40%
of total announced merger and acquisition activity.
Due to the volatility of the financial services industry, Merrill Lynch
continually evaluates its businesses across varying market conditions for
profitability and alignment with long-term strategic objectives. Merrill Lynch
seeks to mitigate the effects of market downturns by selectively expanding its
global presence in non-U.S. markets, developing and maintaining long-term client
relationships, monitoring costs and risks, and continuing to diversify revenue
sources.
13
===============================================================================
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
FOR THE THREE MONTHS ENDED
---------------------------------- INCREASE (DECREASE)
1Q99 VERSUS
MARCH 26, DECEMBER 25, MARCH 27, ------------------
(dollars in millions, except per share amounts) 1999 1998 1998 4Q98 1Q98
- -------------------------------------------------------------------------------------------------------------------------
Total revenues $8,851 $8,172 $9,388 8.3% (5.7)%
Net revenues 5,266 4,081 4,762 29.0 10.6
Pre-tax earnings 996 519 867 91.9 14.8
Net earnings 609 359 514 69.7 18.4
Net earnings applicable
to common stockholders 599 349 504 71.6 18.8
Earnings per common share
Basic 1.65 .97 1.44 70.1 14.6
Diluted 1.44 .86 1.26 67.4 14.3
Annualized return on average common
stockholders' equity 24.6% 14.8% 24.0%
Effective tax rate 34.0 22.8 38.1
- -------------------------------------------------------------------------------------------------------------------------
The following discussion compares the first quarters of 1999 and 1998 and, where
appropriate, contrasts the 1999 first quarter and 1998 fourth quarter.
Merrill Lynch's net earnings were a record $609 million, up 18% and 70% from the
$514 million and $359 million reported in the 1998 first and fourth quarters,
respectively. These results also surpassed the previous quarterly record of
$549 million set in the 1998 second quarter. Record revenues were achieved in
commissions, principal transactions, asset management and portfolio service
fees, and net interest. Overall results also benefited from continued cost
management, including lower advertising and market development expense and
professional fees, partially offset by higher costs primarily related to
compensation and benefits and communications and technology.
Net revenues were a record, up 11% and 29% from the 1998 first and fourth
quarters, respectively, to $5.3 billion in the 1999 first quarter. Non-U.S. net
revenues also grew, representing 36% of total net revenues in the 1999 first
quarter, up from 30% in the 1998 first quarter.
Commissions revenues are summarized as follows:
- --------------------------------------------------------------------------------
THREE MONTHS ENDED
--------------------
MARCH 26, MARCH 27, %
(in millions) 1999 1998 INC.
- --------------------------------------------------------------------------------
Listed and over-the-counter $ 882 $ 805 10%
Mutual funds 483 479 1
Other 202 179 13
------ ------
Total $1,567 $1,463 7
====== ======
- --------------------------------------------------------------------------------
Commissions revenues reached record levels primarily due to higher fees from
global listed and over-the-counter securities transactions. Listed securities
revenues benefited from increased trading volumes on most European and U.S.
stock exchanges. Higher fees from Nasdaq retail equities led to an increase in
over-the-counter securities transactions.
14
Significant components of interest and dividend revenues and interest expense
follow:
- --------------------------------------------------------------------------------
THREE MONTHS ENDED
-------------------
MARCH 26, MARCH 27,
(in millions) 1999 1998
- --------------------------------------------------------------------------------
INTEREST AND DIVIDEND REVENUES
Resale agreements and securities borrowed transactions $1,651 $2,300
Trading assets 1,030 1,322
Margin lending 683 667
Other 601 525
------ ------
Total 3,965 4,814
------ ------
INTEREST EXPENSE
Repurchase agreements and securities loaned transactions 1,521 2,071
Borrowings 1,111 1,361
Trading liabilities 526 769
Other 427 425
------ ------
Total 3,585 4,626
------ ------
NET INTEREST AND DIVIDEND PROFIT $ 380 $ 188
====== ======
- -------------------------------------------------------------------------------
Interest and dividend revenues and expenses are a function of the level and mix
of interest-earning assets and interest-bearing liabilities and the prevailing
level, term structure, and volatility of interest rates. Net interest and
dividend profit more than doubled from the 1998 first quarter, primarily due to
changes in asset composition and lower funding costs triggered by a decline in
interest rates.
Merrill Lynch hedges certain of its long- and short-term borrowings, primarily
with interest rate and currency swaps, to better match the interest rate and
currency characteristics of the borrowings to the assets funded by borrowing
proceeds. The effect of this hedging activity, which is included in
"Borrowings" above, decreased interest expense by $62 million and $14 million
for the 1999 and 1998 first quarters, respectively.
15
The following table provides information on aggregate trading revenues,
including related net interest. Interest revenue and expense amounts are based
on management's assessment of the cost to finance trading positions, after
consideration of the underlying liquidity of these positions.
Trading and related hedging and financing activities affect the recognition of
both principal transactions revenues and net interest and dividend revenues. In
assessing the profitability of its trading activities, Merrill Lynch aggregates
net interest and principal transactions revenues. For financial reporting
purposes, however, realized and unrealized gains and losses on trading
positions, including hedges, are recorded in principal transactions revenues.
The net interest carry (i.e., the spread representing interest earned less
financing costs) for trading positions, including hedges, is recorded either as
principal transactions revenues or net interest revenues, depending on the
nature of the specific instruments. Changes in the composition of trading
inventories and hedge positions can cause the recognition of revenues within
these categories to fluctuate.
- -------------------------------------------------------------------------------
PRINCIPAL NET NET
TRANSACTIONS INTEREST TRADING
(in millions) REVENUES REVENUES REVENUES
- -------------------------------------------------------------------------------
1999 FIRST QUARTER
- ------------------
Equities and equity derivatives $ 671 $ 33 $ 704
Debt derivatives 223 22 245
Government and agency obligations 200 18 218
Corporate debt and preferred stock 168 (3) 165
Mortgages and municipals 124 75 199
Foreign exchange 58 (1) 57
------ ---- ------
Total $1,444 $144 $1,588
====== ==== ======
1998 FIRST QUARTER
- ------------------
Equities and equity derivatives $ 474 $ 1 $ 475
Debt derivatives 320 (53) 267
Government and agency obligations 82 23 105
Corporate debt and preferred stock 172 (39) 133
Mortgages and municipals 77 58 135
Foreign exchange 46 (1) 45
------ ---- ------
Total $1,171 $(11) $1,160
====== ==== ======
- -------------------------------------------------------------------------------
Net trading revenues were a record $1.6 billion in the 1999 first quarter, up
37% from the 1998 first quarter and up over $1 billion from the weak 1998 fourth
quarter. Increases in equities and equity derivatives, government and agency
obligations, corporate debt and preferred stock, mortgages and municipals, and
foreign exchange revenues were partially offset by a modest decrease in debt
derivatives compared with the 1998 first quarter.
Equities and equity derivatives trading revenues were $704 million, up 48% from
the 1998 first quarter as a result of sharply higher revenues from global equity
derivatives and consistent strength in U.S. and European equities. Global equity
derivatives benefited in part from higher revenues from certain emerging market
positions. U.S. equities increased primarily due to higher demand for technology
securities.
Debt derivatives revenues decreased 8% to $245 million in the 1999 first
quarter, resulting from declines in currency trading in Latin American and Asian
debt, compared with the corresponding 1998 period. A favorable U.S. interest
rate environment and increased volume in Japanese markets led to a 108% gain in
government and agency obligations revenues, which were $218 million in the 1999
first quarter. Corporate debt and preferred stock revenues were up 24% to $165
million, primarily due to the tightening of credit spreads and the general
strengthening in investment grade markets.
16
Mortgages and municipals revenues were up 47% from last year's first quarter to
$199 million in the 1999 first quarter attributable to increased customer demand
driven by a low interest rate environment and realized losses in the 1998 first
quarter. Foreign exchange revenues increased 27% to $57 million in the 1999
first quarter due to fluctuations in the U.S. dollar versus various currencies,
including the Japanese yen.
Investment banking revenues declined 24% from the 1998 first quarter to $633
million in the 1999 first quarter, primarily due to a decrease in equity
underwriting revenues and slightly lower fees from strategic services
activities. A summary of Merrill Lynch's investment banking revenues follows:
- -----------------------------------------------------------------
THREE MONTHS ENDED
------------------------
MARCH 26, MARCH 27, %
(in millions) 1999 1998 (Dec.)
- -----------------------------------------------------------------
Underwriting $427 $616 (31)%
Strategic services 206 215 (4)
---- ----
Total $633 $831 (24)
==== ====
- -----------------------------------------------------------------
Merrill Lynch remained the leading underwriter of total debt issuances and
total debt and equity offerings during the 1999 first quarter. An industrywide
decline in equity issuances, in addition to lower convertible and high-yield
revenues, however, led to a 31% reduction in underwriting revenues compared with
the 1998 first quarter. Merrill Lynch's underwriting market share information
based on transaction value follows:
- ---------------------------------------------------------------
THREE MONTHS ENDED
--------------------------------
MARCH 26, 1999 MARCH 27, 1998
-------------- --------------
MARKET MARKET
SHARE RANK SHARE RANK
- ---------------------------------------------------------------
U.S. PROCEEDS
Debt 15.5% 1 14.2% 1
Equity 16.8 2 13.7 2
Debt and Equity 16.0 1 14.7 1
GLOBAL PROCEEDS
Debt 11.4 1 11.9 1
Equity 10.6 3 12.2 2
Debt and Equity 11.7 1 12.4 1
- ---------------------------------------------------------------
Source: Securities Data Co. ("SDC") statistics based on full credit to book
manager.
17
Strategic services fees fell 4% to $206 million in the 1999 first quarter due to
a slight decline industrywide in the number of completed merger and acquisition
transactions compared with the 1998 first quarter. Deal flow remains strong,
however, as evidenced by Merrill Lynch's 22.5% first quarter market share in
U.S. announced transactions. Merrill Lynch's merger and acquisition market
share information for the 1999 and 1998 first quarter based on transaction value
follows:
- ------------------------------------------------------------------------------------
THREE MONTHS ENDED
---------------------------------------------
MARCH 26, 1999 MARCH 27, 1998
------------------- ---------------
MARKET MARKET
SHARE RANK SHARE RANK
- ------------------------------------------------------------------------------------
COMPLETED TRANSACTIONS
U.S. 37.1% 3 36.5% 1
Global 28.0 3 23.8 2
ANNOUNCED TRANSACTIONS
U.S. 22.5 4 22.3 3
Global 21.7 4 23.5 1
- ------------------------------------------------------------------------------------
Source: SDC statistics based on full credit to both target and acquiring companies' advisors.
Merrill Lynch's asset management and portfolio service fees are summarized below:
- --------------------------------------------------------------------------------------------
THREE MONTHS ENDED
-------------------------
MARCH 26, MARCH 27, %
(in millions) 1999 1998 INC. (DEC.)
- --------------------------------------------------------------------------------------------
Asset management fees $ 526 $ 521 1%
Portfolio service fees 333 252 32
Account fees 127 116 9
Other fees 124 140 (12)
------ ------
Total $1,110 $1,029 8
====== ======
- --------------------------------------------------------------------------------------------
Total assets in client accounts or under management and assets under management
increased $122 billion and $25 billion, respectively, from the end of the 1998
first quarter to $1.5 trillion and $515 billion at the end of the 1999 first
quarter. The changes in these balances are noted as follows:
- ----------------------------------------------------------------------------------------------------------------------
NET CHANGES DUE TO
-------------------------
MARCH 27, NEW ASSET MARCH 26,
(in billions) 1998 MONEY(1) APPRECIATION 1999
- ----------------------------------------------------------------------------------------------------------------------
Total assets in client accounts or
under management $1,356 $68 $54 $1,478
Total assets under management 490 21 4 515
- ----------------------------------------------------------------------------------------------------------------------
(1) Includes reinvested dividends of $11 billion.
Asset management fees increased slightly from the 1998 first quarter due to
growth in assets under management attributable to a net inflow of customer
assets and asset appreciation. Portfolio service fees were up 32% from the
corresponding 1998 period due to increased revenues from various fee-based
products, including Merrill Lynch Consults (Registered Trademark), Financial
Advantage (Service Mark), Asset Power (Service Mark), and Mutual Fund Advisor
(Service Mark). Account fees rose due in part to record Cash Management Account
fees resulting from an increase in the number of customer accounts. Other fee-
based revenues were down primarily due to lower revenues from mortgage-related
activities, attributable in part to the 1998 third quarter sale of a majority
interest in Lender's Service, Inc., a residential real estate services provider.
This decrease was partially offset by higher transfer agency fees.
18
Other revenues were up 66% from the 1998 first quarter to $132 million in the
1999 first quarter attributable in part to higher net realized investment gains,
income from partnership investments, and consulting revenues from Howard
Johnson & Co., a 1998 fourth quarter acquisition.
Merrill Lynch's non-interest expenses are summarized below.
- ------------------------------------------------------------------------------
THREE MONTHS ENDED
--------------------
MARCH 26, MARCH 27,
(in millions) 1999 1998
- ------------------------------------------------------------------------------
Compensation and benefits $2,762 $2,499
------ ------
Non-interest expenses,
excluding compensation and benefits:
Communications and technology 480 392
Occupancy and related depreciation 227 201
Advertising and market development 152 177
Brokerage, clearing, and exchange fees 154 156
Professional fees 117 152
Goodwill amortization 57 55
Other 321 263
------ ------
Total non-interest expenses,
excluding compensation and benefits 1,508 1,396
------ ------
Total non-interest expenses $4,270 $3,895
====== ======
Compensation and benefits
as a percentage of net revenues 52.4% 52.5%
Compensation and benefits as a percentage of
pre-tax earnings before compensation and benefits 73.5% 74.2%
- ------------------------------------------------------------------------------
In terms of its cost base, Merrill Lynch has achieved its objectives in
repositioning resources consistent with market opportunities and strategic
investment for future growth. Non-interest expenses were up 10% from the 1998
first quarter to $4.3 billion, as higher compensation and benefits expense and
increases in technology costs more than offset cost savings in professional fees
and advertising and market development. Non-interest expenses were up only 7%
excluding the impact of Merrill Lynch Japan Securities ("MLJS"). Fixed and
semi-fixed costs, however, were down 8%, or $186 million, from peak levels of
the 1998 third quarter.
Compensation and benefits, the largest expense category, was up 11% from the
1998 first quarter to $2.8 billion, due to higher incentive and production-
related compensation and increased headcount versus the year-ago period.
However, non-producer salary expense and total headcount were both down slightly
from the 1998 fourth quarter. The percentage of non-interest expenses,
excluding compensation and benefits costs and goodwill amortization, to net
revenues was 27.6% in the 1999 first quarter, the lowest in ten quarters.
Communications and technology expense was $480 million, up 22% from the 1998
first quarter because of increased systems consulting costs related in part to
the Year 2000 initiative and higher technology-related depreciation. Occupancy
and related depreciation advanced 13% to $227 million due to continued global
expansion. MLJS accounted for nearly two-thirds of the increase.
Advertising and market development expense was down 14% to $152 million as a
result of reductions in travel and entertainment and sales promotion costs.
Brokerage, clearing, and exchange fees were $154 million, relatively unchanged
from a year ago. Professional fees decreased 23% to $117 million, primarily due
to lower legal and consulting costs. Goodwill amortization was $57 million,
in line with the 1998 first quarter expense. Other expenses increased 22% to
$321 million due in part to higher loss provisions related to various business
and legal matters.
19
The effective tax rate was 34.0% in the 1999 first quarter, down from 38.1% in
the 1998 first quarter, due to additional tax-advantaged financing and higher
tax-exempt and non-U.S. income. The 1999 first quarter effective tax rate was
virtually unchanged from the full-year 1998 rate.
- --------------------------------------------------------------------------------
BUSINESS SEGMENTS
- --------------------------------------------------------------------------------
Merrill Lynch reports the results of its four strategic business priorities
within two business segments: Wealth Management and Corporate and Institutional
Client. Wealth Management is comprised of Merrill Lynch's U.S. Private Client,
International Private Client, and Asset Management strategic priorities, all of
which provide services related to the accumulation and management of wealth.
Although managed by separate individuals, these strategic priorities serve
largely the same customer base, provide similar products and services, utilize
comparable distribution channels to deliver those products and services, operate
in a highly regulated environment, and accordingly, are managed and evaluated on
an aggregate basis. The Corporate and Institutional Client Group ("CICG"),
Merrill Lynch's other strategic priority, is reported as a separate business
segment due to the distinct nature of the products it provides and the clients
it serves. CICG's activities predominantly involve providing equity and debt
trading, origination and strategic advisory services, and other capital markets
services to corporate, institutional, and governmental clients throughout the
world. For further information on services provided to clients within these
segments, see the 1998 Annual Report included as an exhibit to Form 10-K.
The segment operating results exclude certain corporate items, which reduced net
earnings for the 1999 and 1998 first quarters by $144 million and $127 million,
respectively (see Note 4 to Consolidated Financial Statements - Unaudited).
- --------------------------------------------------------------------------------
WEALTH MANAGEMENT
- ------------------------------------------------
THREE MONTHS ENDED
-------------------------
MARCH 26, MARCH 27,
(in millions) 1999 1998
- ------------------------------------------------
Net revenues $3,054 $2,805
Net earnings 316 306
- ------------------------------------------------
Net revenues and net earnings for Wealth Management were $3.1 billion and $316
million, respectively, in the 1999 first quarter, up 9% and 3% from $2.8 billion
and $306 million in the 1998 first quarter. Increased trading volumes on global
exchanges and the continued growth in fee-based revenues, resulting from market
appreciation and net inflows of assets, led to record revenues in brokerage,
which includes commissions, and asset management and portfolio service fees.
In the U.S., total assets in client accounts or under management were $1.2
trillion at March 26, 1999, which included $309 billion in assets under
management. Outside the U.S., total assets in client accounts or under
management were approximately $300 billion. Non-U.S. assets under management
were $206 billion at quarter end. Total assets in client accounts or under
management have benefited from the successful integration of Mercury Asset
Management, which introduced two new mutual funds to U.S. investors during the
quarter, resulting in $810 million of new money. Merrill Lynch Canada and MLJS
client assets have also steadily increased, with $34 billion in total assets at
quarter end. In addition, during the quarter, Merrill Lynch advanced its on-line
trading efforts by purchasing the financial technology assets of D.E. Shaw
Financial Technology, a developer of Internet technology for financial
institutions, which is expected to benefit the Wealth Management segment.
20
- --------------------------------------------------------------------------------
CICG
THREE MONTHS ENDED
------------------------
MARCH 26, MARCH 27,
(in millions) 1999 1998
- ------------------------------------------------
Net revenues $2,278 $2,025
Net earnings 437 335
- ------------------------------------------------
CICG net revenues were $2.3 billion in the 1999 first quarter, up 12% from the
1998 first quarter. CICG net earnings also increased, up 30% from the 1998
first quarter to $437 million due to record revenues in both debt and equity
businesses. Debt trading revenues benefited from improved results in both
liquidity and credit products and were up across the board from the 1998 fourth
quarter as credit spreads tightened, emerging markets stabilized, and general
market conditions improved. Equities and equity derivatives trading revenues
also rose sharply from both the 1998 first and fourth quarters, primarily due to
growth from equity derivatives and continued strength in secondary trading,
particularly in the U.S. and Europe.
Merrill Lynch remained the leading underwriter of total debt and equity
securities in the 1999 first quarter, with U.S. and global market shares of
16.0% and 11.7%, respectively, according to SDC. Equity issuance volume was down
from the 1998 first quarter, which contributed to a decline in origination
revenues. Revenues from strategic service fees were down slightly from last
year's first quarter.
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY AND LIQUIDITY
- --------------------------------------------------------------------------------
The primary objectives of Merrill Lynch's capital structure and funding policies
are to:
1. Ensure sufficient equity capital to absorb losses,
2. Support the business strategies, and
3. Assure liquidity at all times, across market cycles, and through periods of
financial stress.
These objectives and Merrill Lynch's capital structure and funding policies are
discussed more fully in the 1998 Annual Report included as an exhibit to Form
10-K.
Among U.S. institutions engaged primarily in the global securities business,
Merrill Lynch is one of the most highly capitalized, with $10.3 billion in
common equity, $425 million in preferred stock, and $2.6 billion of preferred
securities issued by subsidiaries at March 26, 1999. Preferred securities issued
by subsidiaries consist primarily of Trust Originated Preferred Securities
(Service Mark) ("TOPrS" (Service Mark)). Based on various analyses and
criteria, management believes that Merrill Lynch's equity capital base of $13.3
billion is adequate.
21
Merrill Lynch's leverage ratios were as follows:
- --------------------------------------------------------------
Adjusted
Leverage Leverage
Ratio (1) Ratio (2)
- --------------------------------------------------------------
PERIOD-END
March 26, 1999 23.6x 14.3x
December 25, 1998 23.5x 15.5x
AVERAGE (3)
Quarter ended March 26, 1999 24.4x 15.4x
Year ended December 25, 1998 32.9x 19.2x
- --------------------------------------------------------------
(1) Total assets to total stockholders' equity and preferred securities issued
by subsidiaries.
(2) Total assets less (a) securities received as collateral, net of securities
pledged as collateral, (b) securities pledged as collateral, and (c)
receivables under resale agreements and securities borrowed transactions, to
total stockholders' equity and preferred securities issued by subsidiaries.
(3) Computed using month-end balances.
An asset-to-equity leverage ratio does not reflect the risk profile of assets,
hedging strategies, or off-balance sheet exposures. Thus, Merrill Lynch does
not rely on overall leverage ratios to assess risk-based capital adequacy.
Commercial paper decreased from $16.8 billion at year-end 1998 to $9.4 billion
at March 26, 1999 in order to reduce Merrill Lynch's use of short-term unsecured
funding. Commercial paper represented 3% and 6% of total assets at March 26,
1999 and year-end 1998, respectively. Outstanding long-term borrowings increased
to $59.9 billion at March 26, 1999 from $57.6 billion at December 25, 1998.
Major components of the change in long-term borrowings during the 1999 first
quarter follow:
- ------------------------------------------------
(in billions)
- ------------------------------------------------
Balance at December 25, 1998 $57.6
Issuances 8.9
Maturities (5.9)
Other, net (.7)
-----
Balance at March 26, 1999 (1) $59.9
=====
- ------------------------------------------------
(1) At the end of the 1999 first quarter, $47.1 billion of long-term
borrowings had maturity dates beyond one year.
In addition to equity capital sources, Merrill Lynch views long-term debt as a
stable funding source for its core balance sheet assets. Other sources of
liquidity are unsecured bank credit facilities that, at March 26, 1999, totaled
$7.2 billion and were not drawn upon. Additionally, Merrill Lynch maintains
access to significant uncommitted credit lines, both secured and unsecured, from
a large group of banks.
The cost and availability of unsecured financing generally are dependent on
credit ratings. Merrill Lynch's senior long-term debt, preferred stock, and
TOPrS were rated by several recognized credit rating agencies at March 26, 1999
as follows:
- ----------------------------------------------------------------------------------------------------------
SENIOR PREFERRED STOCK
DEBT AND TOPRS
RATING AGENCY RATINGS RATINGS
- ----------------------------------------------------------------------------------------------------------
Duff & Phelps Credit Rating Co. AA AA-
Fitch IBCA, Inc. AA AA-
Japan Rating & Investment Information, Inc. AA Not Rated
Moody's Investors Service, Inc. Aa3 aa3
Standard & Poor's AA- A
Thomson BankWatch, Inc. AA+ Not Rated
- ----------------------------------------------------------------------------------------------------------
22
- --------------------------------------------------------------------------------
CAPITAL PROJECTS AND EXPENDITURES
- --------------------------------------------------------------------------------
Merrill Lynch continually prepares for the future by expanding its operations
and investing in new technology to improve service to clients. For more
information, see the 1998 Annual Report included as an exhibit to Form 10-K.
- --------------------------------------------------------------------------------
YEAR 2000 COMPLIANCE
As the Year 2000 approaches, Merrill Lynch has undertaken initiatives to address
the Year 2000 problem (the "Y2K problem"), as more fully described in the 1998
Annual Report. The failure of Merrill Lynch's technology systems relating to a
Y2K problem would likely have a material adverse effect on the company's
business, results of operations, and financial condition. This effect could
include disruption of normal business transactions, such as the settlement,
execution, processing, and recording of trades in securities, commodities,
currencies, and other assets. The Y2K problem could also increase Merrill
Lynch's exposure to risk and legal liability and its need for liquidity.
The renovation phase of Merrill Lynch's Year 2000 efforts, as described in the
1998 Annual Report, was approximately 99.7% completed as of April 16, 1999, and
production testing was approximately 99.1% completed as of that date. In March
and April 1999, Merrill Lynch continued its participation in U.S. industrywide
testing sponsored by the Securities Industry Association. These tests involved
an expanded number of firms, transactions, and conditions compared with those
previously conducted.
In light of the interdependency of the parties in or serving the financial
markets, there can be no assurance that all Y2K problems will be identified and
remedied on a timely basis or that all remediation will be successful.
Disruption or suspension of activity in the world's financial markets is also
possible. In some non-U.S. markets in which Merrill Lynch does business, the
level of awareness and remediation efforts relating to the Y2K problem are
thought to be less advanced than in the U.S. Management is unable at this
point to ascertain whether all significant third parties will successfully
address the Y2K problem. Merrill Lynch will continue to monitor third parties'
Year 2000 readiness to determine if additional or alternative measures are
necessary. The failure of exchanges, clearing organizations, vendors, service
providers, clients and counterparties, regulators, or others to resolve their
own processing issues in a timely manner could have a material adverse effect on
Merrill Lynch's business, results of operations, and financial condition.
As of March 26, 1999, the total estimated expenditures for the Year 2000
compliance initiative are approximately $520 million. This estimate includes
$104 million of occupancy, communications, and other related overhead
expenditures as Merrill Lynch is applying a fully costed pricing methodology for
this project. Of the total estimated expenditures, approximately $157 million
remains to be spent, primarily on continued testing, contingency planning, and
risk management. There can be no assurance that the costs associated with
remediation efforts will not exceed those currently anticipated by Merrill
Lynch, or that the possible failure of such remediation efforts will not have a
material adverse effect on Merrill Lynch's business, results of operations, or
financial condition.
- --------------------------------------------------------------------------------
AVERAGE ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
Merrill Lynch monitors changes in its balance sheet using average daily balances
that are determined on a settlement date basis and reported for management
information purposes. Financial statement balances are recorded on a trade date
basis as required under generally accepted accounting principles. The following
discussion compares changes in settlement date average daily balances.
23
For the first three months of 1999, average total assets were $322 billion, down
6% from $342 billion for the 1998 fourth quarter. Average total liabilities
decreased 6% to $309 billion from $329 billion for the 1998 fourth quarter. The
major components in the decline in average total assets and liabilities for the
first three months of 1999 are summarized as follows:
- -------------------------------------------------------------------------------------------
(in millions) INCREASE (DECREASE) CHANGE
- -------------------------------------------------------------------------------------------
AVERAGE ASSETS
Trading assets $(12,140) (10)%
Securities pledged as collateral (3,648) (27)
Receivables under resale agreements
and securities borrowed transactions (2,010) (2)
- -------------------------------------------------------------------------------------------
AVERAGE LIABILITIES
Payables under repurchase agreements
and securities loaned transactions $(14,755) (14)%
Commercial paper and other short-term borrowings (9,183) (27)
Obligation to return securities received as collateral (2,708) (13)
Trading liabilities 4,360 7
Long-term borrowings 3,175 6
- -------------------------------------------------------------------------------------------
Merrill Lynch strategically reduced its balance sheet levels during the 1998
fourth quarter. Average balances in the 1999 first quarter were lower in
comparison due to continued strategic reductions in debt trading assets and
related funding, primarily repurchase agreements. Lower matched-book activity
also contributed to the decrease in payables under repurchase agreements and
securities loaned transactions, and resulted in a decline in securities pledged
as collateral, receivables under resale agreements and securities borrowed
transactions, and obligation to return securities received as collateral. The
decrease in commercial paper and other short-term borrowings resulted from a
shift towards longer-term borrowings and reductions in non-trading assets.
Trading liabilities rose in connection with an increase in equity trading
activities.
- --------------------------------------------------------------------------------
NON-INVESTMENT GRADE HOLDINGS
- --------------------------------------------------------------------------------
Non-investment grade holdings, which include transactions with highly leveraged
counterparties involve risks related to the creditworthiness of the issuers or
counterparties, and the liquidity of the market for such investments. Merrill
Lynch recognizes these risks and, whenever possible, employs strategies to
mitigate exposures. The specific components and overall level of non-investment
grade positions may vary significantly from period to period as a result of
inventory turnover, investment sales, and asset redeployment.
In the normal course of business, Merrill Lynch underwrites, trades, and holds
non-investment grade cash instruments in connection with its investment banking,
market-making, and derivative structuring activities. Non-investment grade
trading inventories have increased in recent years to satisfy growing client
demand for higher-yielding investments, including emerging market and other non-
U.S. securities. During the second half of 1998 and the first quarter of 1999,
however, these exposures were strategically reduced as a result of market
volatility. Non-investment grade holdings have been defined as debt and
preferred equity securities rated as BB+ or lower, or equivalent ratings by
recognized credit rating agencies, sovereign debt in emerging markets, amounts
due under derivative contracts from non-investment grade counterparties, and
other instruments that, in the opinion of management, are non-investment grade.
24
Derivatives may also expose Merrill Lynch to credit risk related to the
underlying security where a derivative contract can either synthesize ownership
of the underlying security (e.g., long total return swap) or potentially force
ownership of the underlying security (e.g., short put option). In addition,
derivatives may subject Merrill Lynch to credit spread or issuer default risk,
in that changes in credit spreads or in the credit quality of the underlying
securities may adversely affect the derivatives' fair values. Merrill Lynch
engages in various hedging strategies to reduce its exposure associated with
non-investment grade positions, such as purchasing an option to sell the related
security or entering into other offsetting derivative contracts.
In addition to engaging in business involving non-investment grade positions,
Merrill Lynch provides financing and advisory services to, and invests in,
companies entering into leveraged transactions, which may include leveraged
buyouts, recapitalizations, and mergers and acquisitions. Merrill Lynch
provides extensions of credit to leveraged companies in the form of senior and
subordinated debt, as well as bridge financing on a select basis. In addition,
Merrill Lynch syndicates loans for non-investment grade companies or in
connection with highly leveraged transactions and may retain a residual portion
of these loans.
Merrill Lynch holds direct equity investments in leveraged companies and
interests in partnerships that invest in leveraged transactions. Merrill Lynch
has also committed to participate in limited partnerships that invest in
leveraged transactions. Future commitments to participate in limited
partnerships and other direct equity investments will be made on a select basis.
- -----------------------------------------------------------------------------
TRADING EXPOSURES
The following table summarizes Merrill Lynch's non-investment grade trading
exposures:
- -----------------------------------------------------------------------------
March 26, December 25,
(in millions) 1999 1998
- -----------------------------------------------------------------------------
Trading assets
Cash instruments $ 6,687 $ 8,024
Derivatives 4,020 4,675
Trading liabilities
Cash instruments (994) (920)
Collateral on derivative assets (1,324) (2,192)
------- -------
Net trading asset exposure 8,389 9,587
Derivatives notionals with credit 1,777 1,631
exposure (1)
Derivatives notionals that hedge credit (3,956) (4,663)
exposure(1) ------- -------
Net exposure $ 6,210 $ 6,555
======= =======
- -----------------------------------------------------------------------------
(1) Represents amount subject to strike or reference price.
Included in the preceding table are debt and equity securities and bank loans of
companies in various stages of bankruptcy proceedings or in default. At March
26, 1999, the carrying value of such debt and equity securities totaled $91
million, of which 66% resulted from Merrill Lynch's market-making activities in
such securities. This compared with $74 million at December 25, 1998, of which
84% related to market-making activities. Also included are distressed bank loans
totaling $247 million and $156 million at March 26, 1999 and December 25, 1998,
respectively.
25
- --------------------------------------------------------------------------------
NON-TRADING EXPOSURES
The following table summarizes Merrill Lynch's non-investment grade non-trading
exposures:
- ----------------------------------------------------------------------------
March 26, December 25,
(in millions) 1999 1998
- ----------------------------------------------------------------------------
Marketable investment securities $ 16 $ 39
Investments of insurance subsidiaries 129 148
Loans (net of allowance for loan
losses):
Bridge loans 62 66
Other loans (1) 848 1,058
Other investments:
Partnership interests (2) 1,095 852
Other equity investments (3) 365 459
- ----------------------------------------------------------------------------
(1) Represented outstanding loans to 102 and 80 companies at March 26, 1999 and
December 25, 1998, respectively.
(2) Included is $449 and $279 million in investments at March 26, 1999 and
December 25, 1998, respectively, related to deferred compensation plans, for
which the default risk of the investments generally rests with the
participating employees.
(3) Invested in 92 and 89 enterprises at March 26, 1999 and December 25, 1998,
respectively.
The following table summarizes Merrill Lynch's commitments with exposure to non-
investment grade counterparties:
- --------------------------------------------------------------------------
March 26, December 25,
(in millions) 1999 1998
- -------------------------------------------------------------------------
Additional commitments to invest in $ 221 $ 227
partnerships
Unutilized revolving lines of credit
and other lending commitments 896 1,678
- --------------------------------------------------------------------------
At March 26, 1999, the largest industry exposure was to the financial services
sector, which accounted for 36% of total non-investment grade positions.
26
- -------------------------------------------------------------------------------------------------
STATISTICAL DATA
- -------------------------------------------------------------------------------------------------
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. 1ST QTR.
1998 1998 1998 1998 1999
-------- -------- -------- -------- --------
CLIENT ACCOUNTS (in billions):
U.S. Client Assets $ 1,086 $ 1,110 $ 1,065 $ 1,164 $ 1,186
Non-U.S. Client Assets 270 270 254 278 292
-------- -------- -------- -------- --------
Total Assets in Client Accounts or
Under Management $ 1,356 $ 1,380 $ 1,319 $ 1,442 $ 1,478
======== ======== ======== ======== ========
ASSETS UNDER MANAGEMENT: $ 490 $ 491 $ 467 $ 501 $ 515
Retail 263 263 255 258 267
Institutional 227 228 212 243 248
Equity 271 266 238 262 267
Fixed-Income/Other 219 225 229 239 248
U.S 285 292 279 298 309
Non-U.S. 205 199 188 203 206
FEE-BASED PROGRAM ASSETS(a) $ 54 $ 58 $ 55 $ 64 $ 70
- -------------------------------------------------------------------------------------------------
UNDERWRITING:
Global Debt and Equity:
Volume (in billions) $ 102 $ 120 $ 82 $ 88 $ 112
Market Share 12.4% 14.6% 13.6% 13.9% 11.7%
U.S. Debt and Equity:
Volume (in billions) $ 88 $ 107 $ 69 $ 74 $ 97
Market Share 14.7% 16.9% 15.0% 15.5% 16.0%
- -------------------------------------------------------------------------------------------------
FULL-TIME EMPLOYEES:
U.S. 46,100 47,100 47,700 46,700 46,300
Non-U.S. 14,200 16,500 17,900 17,100 16,800
------ ------ ------ ------ ------
Total 60,300 63,600 65,600 63,800 63,100
====== ====== ====== ====== ======
Financial Consultants and
Other Investment Professionals 16,600 17,600 18,100 18,200 18,200
- -------------------------------------------------------------------------------------------------
INCOME STATEMENT:
Net Earnings (Loss) (in millions) $ 514 $ 549 $ (163) $ 359 $ 609
Economic Profit 238 244 (485) 43 275
Annualized Return on Average
Common Stockholders' Equity 24.0% 23.6% (7.3)% 14.8% 24.6%
Earnings (Loss) per Common Share:
Basic $ 1.44 $ 1.52 $ (.48) $ .97 $ 1.65
Diluted 1.26 1.31 (.48) .86 1.44
- -------------------------------------------------------------------------------------------------
BALANCE SHEET (in millions):
Total Assets $358,896 $370,571 $353,391 $299,804 $314,620
Total Stockholders' Equity 9,209 9,897 9,779 10,132 10,692
Book Value Per Common Share 24.88 26.62 26.12 26.89 28.05
- -------------------------------------------------------------------------------------------------
SHARE INFORMATION (in thousands):
Weighted Average Shares Outstanding:
Basic 349,495 355,289 357,620 359,864 364,039
Diluted 400,249 411,385 357,620 404,872 415,662
Common Shares Outstanding 353,680 356,280 358,492 361,209 366,168
- -------------------------------------------------------------------------------------------------
(a) Includes Merrill Lynch Consults (Registered Trademark), Mutual Fund
Advisor (Service Mark), Asset Power (Service Mark), Global Funds
Advisor (Service Mark), and Financial Advantage (Service Mark).
27
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
-----------------
The following events have occurred since the filing of the 1998 Form 10-K. The
court in Miller v. Peters, et al. has issued an order discontinuing the action
with the parties' consent.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
On April 14, 1999, ML & Co. held its Annual Meeting of Stockholders, at which
86.4% of the shares of Common Stock, par value $1.33 1/3 per share (the "Common
Stock"), outstanding and eligible to vote, either in person or by proxy, were
represented, constituting a quorum. At this Annual Meeting, the following
matters were voted upon: (i) the election of five directors to the Board of
Directors to hold office for a term of three years; and (ii) a stockholder
proposal concerning cumulative voting in the election of directors. Proxies for
the Annual Meeting of Stockholders were solicited by the Board of Directors
pursuant to Regulation 14A of the Securities Exchange Act of 1934.
The stockholders elected all five nominees to three-year terms as members of the
Board of Directors as set forth in ML & Co.'s Proxy Statement. There was no
solicitation in opposition to such nominees. The votes cast for or withheld
from the election of directors were as follows: Jill K. Conway received
310,681,518 votes in favor and 4,074,955 votes were withheld; George B. Harvey
received 311,469,460 votes in favor and 3,287,013 votes were withheld; David H.
Komansky received 310,999,540 votes in favor and 3,756,933 votes were withheld;
John L. Steffens received 310,806,489 votes in favor and 3,949,984 votes were
withheld; and William L. Weiss received 311,414,878 votes in favor and 3,341,595
votes were withheld.
The stockholders did not approve the stockholder proposal concerning cumulative
voting in election of directors. The votes cast for and against, as well as the
number of abstentions and broker non-votes for this proposal were as follows:
74,975,991 votes in favor, 158,342,060 votes against, 3,660,552 shares
abstained, and 77,777,870 shares represented broker non-votes.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(4) Instruments defining the rights of security holders, including
indentures:
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, ML & Co.
hereby undertakes to furnish to the Securities and Exchange
Commission, upon request, copies of the instruments defining the
rights of holders of long-term debt securities of ML & Co. that
authorize an amount of securities constituting 10% or less of
the total assets of ML & Co. and its subsidiaries on a
consolidated basis.
(11) Statement re: computation of per share earnings
(12) Statement re: computation of ratios
(15) Letter re: unaudited interim financial information
28
(27) Financial Data Schedule
(b) Reports on Form 8-K
The following Current Reports on Form 8-K were filed by ML & Co. with the
Securities and Exchange Commission during the quarterly period covered by
this Report:
(i) Current Report dated December 28, 1998 for the purpose of filing the
form of ML & Co.'s Nikkei 225 Market Index Target-Term Securities
(Registered Trademark) due September 21, 2005.
(ii) Current Report dated January 19, 1999 for the purpose of filing ML &
Co.'s Preliminary Unaudited Earnings Summary for the three months
and the year ended December 25, 1998.
(iii) Current Report dated February 17, 1999 for the purpose of filing the
form of ML & Co.'s 6% Notes due February 17, 2009.
(iv) Current Report dated February 18, 1999 for the purpose of filing the
form of ML & Co.'s Energy Select Sector SPDRs* Fund Market Index
Target-Term Securities (Registered Trademark) due February 21, 2006.
(v) Current Report dated February 22, 1999 for the purpose of filing ML
& Co.'s Preliminary Unaudited Consolidated Balance Sheet as of
December 25, 1998.
(vi) Current Report dated February 23, 1999 for the purpose of filing the
form of ML & Co.'s 5 1/4% Stock Return Income Debt Securities
(Service Mark) due August 23, 2000.
(vii) Current Report dated March 26, 1999 for the purpose of filing the
form of ML & Co.'s S&P 500 Market Index Target-Term Securities
(Registered Trademark) due March 27, 2006.
_____________
* SPDRs is a registered trademark of The McGraw-Hill Companies, Inc. and has
been licensed for use in connection with the listing and trading of Select
Sector SPDRs on the American Stock Exchange.
29
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 hereunto duly authorized.
MERRILL LYNCH & CO., INC.
-------------------------
(Registrant)
Date: May 7, 1999 By: /s/ E. Stanley O'Neal
-------------------------------------
E. Stanley O'Neal
Executive Vice President and
Chief Financial Officer
30
INDEX TO EXHIBITS
Exhibits
11 Statement re: computation of per share earnings
12 Statement re: computation of ratios
15 Letter re: unaudited interim financial information
27 Financial Data Schedule