<PAGE> 1
________________________________________________________________________________
________________________________________________________________________________
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1994
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
FOR THE QUARTER ENDED JUNE 30, 1994
COMMISSION FILE NUMBER 1-6817
LEHMAN BROTHERS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 13-2518466
(STATE OR OTHER JURISDICTION OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
3 WORLD FINANCIAL CENTER
NEW YORK, NEW YORK 10285
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 526-7000
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 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.
AS OF AUGUST 12, 1994, 1,005 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE
$.10 PER SHARE, WERE ISSUED AND OUTSTANDING.
________________________________________________________________________________
________________________________________________________________________________
<PAGE> 2
LEHMAN BROTHERS INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1994
INDEX
<TABLE>
<CAPTION>
Part I. FINANCIAL INFORMATION Page Number
--------------------- -----------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Statement of
Operations - Three and Six Months Ended
June 30, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Balance Sheet -
June 30, 1994 and
December 31, 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Consolidated Statement of
Cash Flows - Six Months Ended
June 30, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Notes to Consolidated
Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 2. Management's Discussion and
Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Part II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . 28
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
EXHIBIT INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Exhibits
</TABLE>
2
<PAGE> 3
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Three Months Ended
June 30,
------------------
1994 1993
---- ----
<S> <C> <C>
Revenues
Market making and principal transactions $ 184 $ 414
Investment banking 94 226
Commissions 103 455
Interest and dividends 1,544 1,275
Other 14 188
----- -----
Total revenues 1,939 2,558
Interest expense 1,475 1,161
----- -----
Net revenues 464 1,397
----- -----
Non-interest expenses
Compensation and benefits 256 843
Brokerage, commissions and clearance fees 34 29
Communications 38 96
Professional services 33 42
Depreciation and amortization 28 41
Occupancy and equipment 25 66
Advertising and market development 25 34
Other 54 94
----- -----
Total non-interest expenses 493 1,245
----- -----
Income (loss) before taxes and preferred dividend of
subsidiary (29) 152
Provision for (benefit from) income taxes (22) 62
----- -----
Income (loss) before preferred dividend of subsidiary (7) 90
Preferred dividend of subsidiary (17) (17)
----- -----
Net income (loss) $ (24) $ 73
===== =====
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
------------------
1994 1993
---- ----
<S> <C> <C>
Revenues
Market making and principal transactions $ 467 $ 831
Investment banking 231 421
Commissions 224 925
Interest and dividends 2,897 2,501
Other 28 373
----- -----
Total revenues 3,847 5,051
Interest expense 2,729 2,278
----- -----
Net revenues 1,118 2,773
----- -----
Non-interest expenses
Compensation and benefits 592 1,715
Brokerage, commissions and clearance fees 77 56
Communications 75 183
Professional services 61 83
Depreciation and amortization 54 80
Occupancy and equipment 50 132
Advertising and market development 48 74
Other 98 170
Severance charge 27
Loss on sale of Shearson 535
Reserves for non-core businesses 141
----- -----
Total non-interest expenses 1,082 3,169
----- -----
Income (loss) from continuing operations before taxes,
cumulative effect of change in accounting principle and
preferred dividend of subsidiary 36 (396)
Provision for income taxes 2 163
----- -----
Income (loss) from continuing operations before cumulative
effect of change in accounting principle and preferred
dividend of subsidiary 34 (559)
Income from discontinued operations, net of taxes
Income from operations 24
Gain on disposal 165
----- -----
Net income from discontinued operations 189
----- -----
Income (loss) before cumulative effect of change in
accounting principle and preferred dividend of subsidiary 34 (370)
Cumulative effect of change in accounting principle (13)
Preferred dividend of subsidiary (34) (34)
----- -----
Net income (loss) $ (13) $ (404)
===== =====
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN MILLIONS)
ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
1994 1993
----------- ------------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 383 $ 316
Cash and securities segregated and on deposit
for regulatory and other purposes 1,395 867
Securities and other financial instruments owned 30,912 20,557
Collateralized short-term agreements:
Securities purchased under agreements to resell 31,078 23,175
Securities borrowed 8,716 4,276
Receivables:
Brokers and dealers 6,043 4,102
Customers 1,430 1,391
Other 1,785 2,138
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $393 in 1994 and $361 in 1993) 416 426
Deferred expenses and other assets 200 299
Excess of cost over fair value of net assets acquired
(net of accumulated amortization of $104 in 1994
and $99 in 1993) 245 267
------ ------
$82,603 $57,814
====== ======
</TABLE>
See notes to consolidated financial statements.
5
<PAGE> 6
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
(IN MILLIONS, EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
June 30, December 31,
1994 1993
----------- ------------
(unaudited)
<S> <C> <C>
Commercial paper and short-term debt $ 4,424 $ 2,635
Securities and other financial instruments sold
but not yet purchased 10,285 5,223
Advances from Holdings and other affiliates 5,890 5,063
Securities sold under agreements to repurchase 44,219 30,798
Securities loaned 3,287 772
Payables:
Brokers and dealers 3,727 2,021
Customers 2,282 2,322
Accrued liabilities and other payables 2,069 2,590
Senior notes 654 653
Subordinated indebtedness 3,303 3,053
------ ------
Total liabilities 80,140 55,130
------ ------
Preferred stock of subsidiary, $1 par value; 5,000 shares
authorized: 1,000 shares 9% Cumulative Preferred,
Series A, issued and outstanding 750 750
Less: Note receivable, Series A Preferred stock (750) (750)
Stockholder's equity:
Preferred stock, $.10 par value; 10,000 shares authorized;
none outstanding
Common stock, $.10 par value; 10,000 shares authorized;
1,005 shares issued and outstanding in 1994 and 1993
Additional paid-in capital 2,586 2,738
Foreign currency translation adjustment 3 2
Accumulated deficit (126) (56)
------
Total stockholder's equity 2,463 2,684
------ ------
$82,603 $57,814
====== ======
</TABLE>
See notes to consolidated financial statements.
6
<PAGE> 7
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------------
1994 1993
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Income (loss) from continuing operations before cumulative effect of
change in accounting principle and preferred dividend of subsidiary $ 34 $ (559)
Adjustments to reconcile income (loss) to net cash (used in) provided
by operating activities:
Depreciation and amortization 54 80
Provisions for losses and other reserves 43 42
Loss on sale of Shearson 535
Non-core business reserves 141
Other adjustments 10 9
Net change in:
Cash and securities segregated (528) (95)
Receivables from brokers and dealers (1,941) (1,363)
Receivables from customers (39) 414
Securities purchased under agreements to resell (7,903) 6,680
Securities borrowed (4,440) 877
Loans originated or purchased for resale (92)
Securities and other financial instruments owned (10,355) (2,675)
Payables to brokers and dealers 1,706 (371)
Payables to customers (40) (12)
Accrued liabilities and other payables (487) 679
Securities sold under agreements to repurchase 13,421 (397)
Securities loaned 2,515 854
Securities & other financial instruments sold but not yet purchased 5,062 (3,343)
Other operating assets and liabilities, net 487 (636)
------- -------
(2,401) 768
Net cash flows provided by operating activities of discontinued operations 428
------- -------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (2,401) 1,196
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments of senior notes (7) (15)
Proceeds from issuance of subordinated indebtedness 760 206
Principal payments of subordinated indebtedness (512) (315)
Proceeds from issuance of other indebtedness 827 715
Principal payments of other indebtedness (26) (639)
Increase (decrease) in commercial paper and short-term debt, net 1,815 (1,832)
Capital contributions 20
Proceeds from the issuance of common stock 430
Dividends and capital distributions paid (358) (300)
Net cash flows used in financing activities of discontinued operations (301)
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,499 (2,031)
------- -------
</TABLE>
See notes to consolidated financial statements.
7
<PAGE> 8
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------------
1994 1993
---- ----
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and
leasehold improvements $ (24) $ (46)
Proceeds from the sale of The Boston Company 1,300
Other (7) 144
Net cash flows used in investing activities of
discontinued operations (85)
------- -------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (31) 1,313
------- -------
Net change in cash and cash equivalents
of discontinued operations 42
------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS 67 436
------- -------
Cash and cash equivalents at beginning of period 316 295
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 383 $ 731
======= =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS) (INCLUDING THE
BOSTON COMPANY IN 1993)
Interest paid (net of amount capitalized) totaled $2,813 and $2,377
in the first six months of 1994 and 1993, respectively. Income taxes paid
totaled $12 and $90 in the first six months of 1994 and 1993, respectively.
See notes to consolidated financial statements.
8
<PAGE> 9
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of Lehman
Brothers Inc., a registered broker-dealer ("LBI") and subsidiaries (LBI
together with its subsidiaries, the "Company"). LBI is a wholly-owned
subsidiary of Lehman Brothers Holdings Inc. ("Holdings"). Prior to May 31,
1994, American Express Company ("American Express") owned 100% of Holdings'
common stock, which represented approximately 93% of Holdings' voting stock.
Effective May 31, 1994, Holdings became an independent public company with its
common stock traded on the New York Stock Exchange, Inc. (See Note 2.)
The Company's financial statements have been prepared in accordance
with the rules and regulations of the Securities and Exchange Commission (the
"Commission") with respect to the Form 10-Q and reflect all normal recurring
adjustments which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods presented. Pursuant to
such rules and regulations, certain footnote disclosures which are normally
required under generally accepted accounting principles have been omitted. It
is recommended that these consolidated financial statements be read in
conjunction with the Company's most recent Annual Report on Form 10-K. As
described in Note 3, the Company completed the sale of The Boston Company, Inc.
("The Boston Company"), on May 21, 1993. The accompanying consolidated
financial statements and notes to consolidated financial statements reflect The
Boston Company as a discontinued operation at and for the six month period
ended June 30, 1993. The 1993 Consolidated Statement of Operations includes
the results of operations of Shearson and SLHMC, which were sold on July 31,
1993 and August 31, 1993, respectively. (See Notes 4 and 5 for definitions and
additional information concerning these sales.)
2. HOLDINGS:
Equity Investments and Distribution of Common Stock
On May 31, 1994 all of the shares of common stock of Holdings were
distributed (the "Distribution") to American Express common shareholders of
record on May 20, 1994 (the "Record Date") as a result of a special dividend
declared on April 29, 1994 by the Board of Directors of American Express.
Prior to the Distribution, an additional equity investment of approximately
$1.25 billion was made in Holdings, most significantly by American Express.
3. SALE OF THE BOSTON COMPANY:
On May 21, 1993, pursuant to a stock purchase agreement (the "Mellon
Agreement") between the Company and Mellon Bank Corporation ("Mellon Bank"),
LBI sold to Mellon Bank (the "Mellon Transaction") The Boston Company. Under
the terms of the Mellon Agreement, LBI received approximately $1.3 billion in
cash, 2,500,000 shares of Mellon Bank common stock and ten-year warrants to
purchase an additional 3,000,000 shares of Mellon Bank's common stock at an
exercise price of $50 per share. In June 1993, such shares and warrants were
sold by LBI to American Express for an aggregate purchase price of $169
million. After accounting for transaction costs and certain adjustments, the
Company recognized a 1993 first quarter after-tax gain of $165 million for the
Mellon Transaction. In connection with the completion of the Mellon
Transaction, the Company paid a $300 million dividend to Holdings.
9
<PAGE> 10
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of the Mellon Transaction, the Company treated The Boston
Company as a discontinued operation. Accordingly, the Company's financial
statements segregate the operating results of The Boston Company for the six
month period ended June 30, 1993.
Presented below are the results of operations and the gain on disposal
of The Boston Company included in income from discontinued operations (in
millions):
<TABLE>
<CAPTION>
Six Months ended
June 30, 1993
-----------------
<S> <C>
Discontinued operations:
Revenues $201
Expenses 159
---
Income before taxes 42
Provision for income taxes 18
---
Income from operations 24
Gain on disposal, net of taxes of $37 165
---
Income from discontinued operations, net of taxes $189
===
</TABLE>
4. SALE OF SHEARSON:
On July 31, 1993, pursuant to an asset purchase agreement (the
"Primerica Agreement"), the Company completed the sale (the "Primerica
Transaction") of LBI's domestic retail brokerage business (except for such
business conducted under the Lehman Brothers name) and substantially all of its
asset management business (collectively, "Shearson") to Primerica Corporation
(now known as The Travelers Corporation, "Travelers") and its subsidiary Smith
Barney, Harris Upham & Co. Incorporated ("Smith Barney"). Also included in the
Primerica Transaction were the operations and data processing functions that
support these businesses, as well as certain of the assets and liabilities
related to these operations.
LBI received approximately $1.2 billion in cash and a $586 million
interest bearing note from Smith Barney which was repaid in January 1994 (the
"Smith Barney Note"). The Smith Barney Note was issued as partial payment for
certain Shearson assets in excess of $600 million which were sold to Smith
Barney. The proceeds received at July 31, 1993, were based on the estimated
net assets of Shearson, which exceeded the minimum net assets of $600 million
prescribed in the Primerica Agreement. As further consideration for the sale
of Shearson, Smith Barney agreed to pay future contingent amounts based upon
the combined performance of Smith Barney and Shearson, consisting of up to $50
million per year for three years based on revenues, plus 10% of after-tax
profits in excess of $250 million per year over a five-year period (the
"Participation Rights"). All Participation Rights, including the first
payment, were assigned to American Express prior to the Distribution. As
further consideration for the sale of Shearson, the Company received 2,500,000
shares of 5.50% Convertible Preferred Stock, Series B, of Travelers and a
warrant to purchase 3,749,466 shares of common stock of Travelers at an
exercise price of $39 per share. In August 1993, American Express purchased
such preferred stock and warrant from LBI for aggregate consideration of $150
million.
The Company recognized a 1993 first quarter loss related to the
Primerica Transaction of approximately $630 million after-tax ($535 million
pre-tax), which amount includes a reduction in goodwill of $750 million and
transaction-related costs such as relocation, systems and operations
modifications and severance.
10
<PAGE> 11
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Presented below are the results of operations and the loss on the sale
of Shearson (in millions):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, 1993 June 30, 1993
------------------- -----------------
<S> <C> <C>
Revenues $ 752 $1,544
Expenses 702 1,432
Loss on sale of Shearson 535
------ -----
Income (loss) before taxes 50 (423)
Provision for income taxes 24 146
------ -----
Net income (loss) $ 26 $ (569)
====== =====
</TABLE>
5. SALE OF SHEARSON LEHMAN HUTTON MORTGAGE CORPORATION:
The Company completed the sale of its wholly-owned subsidiary,
Shearson Lehman Hutton Mortgage Corporation ("SLHMC") to GE Capital Corporation
on August 31, 1993. The sales price, net of proceeds used to retire debt of
SLHMC, was approximately $70 million. During the first quarter of 1993, the
Company provided $120 million of pre-tax reserves in anticipation of the sale
of SLHMC, which reserves are included in the $141 million of pre-tax reserves
for non-core businesses on the Consolidated Statement of Operations. After
accounting for these reserves, the sale did not have a material effect on the
Company's results of operations.
6. SECURITIES AND OTHER FINANCIAL INSTRUMENTS:
Securities and other financial instruments owned and Securities and
other financial instruments sold but not yet purchased are summarized as
follows (in millions):
<TABLE>
<CAPTION>
June 30, December 31,
1994 1993
-------- -----------
<S> <C> <C>
Securities and other financial instruments owned:
Government and agency obligations $16,881 $12,579
Corporate obligations and other contractual commitments 6,625 3,780
Mortgage-backed 3,766 1,071
Certificates of deposit and other money market instruments 2,449 1,849
Corporate stocks and options 1,191 1,247
Spot commodities 31
------ ------
$30,912 $20,557
====== ======
Securities and other financial instruments sold but not yet purchased:
Government and agency obligations $ 6,675 $ 3,898
Corporate obligations and other contractual commitments 2,469 433
Corporate stocks and options 905 694
Spot commodities 236 198
------ ------
$10,285 $ 5,223
====== ======
</TABLE>
11
<PAGE> 12
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. PROVISION FOR INCOME TAXES:
The Company reported a tax benefit of $22 million for the second
quarter of 1994 compared to an expense of $62 million a year ago. For the
first six months of 1994, the Company reported a tax expense from continuing
operations of $2 million as compared to $163 million a year ago. The 1994
effective tax rate for the second quarter and first six months differs from the
statutory U.S. federal income tax rate primarily as a result of tax benefits
related to income subject to preferential tax treatment. The six months 1993
tax provision included expenses of (i) $109 million related to the operating
results of Shearson and the businesses that now comprise Lehman Brothers, (ii)
$95 million from the sale of Shearson (which resulted primarily from the
write-off of $750 million of goodwill which was not deductible for tax
purposes) and (iii) a benefit of $41 million related to the $120 million
reserve for non-core businesses recorded in anticipation of the sale of SLHMC.
8. CHANGE IN ACCOUNTING PRINCIPLES:
Postemployment Benefits. Effective January 1, 1994, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No. 112,
"Employers' Accounting for Postemployment Benefits". SFAS No. 112 requires the
accrual of obligations associated with services rendered to date for employee
benefits accumulated or vested for which payment is probable and can be
reasonably estimated. These benefits principally include the continuation of
salary, health care and life insurance costs for employees on service
disability leaves. The Company previously expensed the cost of these benefits
as they were incurred.
The cumulative effect of adopting SFAS No. 112 reduced net income for
the first quarter of 1994 by approximately $13 million after-tax (approximately
$23 million pre-tax). Excluding the cumulative effect of this accounting
change, the effect of this change on the 1994 results of operations was not
material.
Offsetting of Certain Receivables and Payables. During the first
quarter of 1994, the Company adopted Financial Accounting Standards Board
Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts"
("FIN No. 39"). FIN No. 39 restricts the historical industry practice of
offsetting certain receivables and payables. The increase in the Company's
gross assets and liabilities from December 31, 1993 to June 30, 1994 is
primarily due to the adoption of FIN No. 39. The Financial Accounting
Standards Board has instructed its staff to explore modifying FIN No. 39 to
create certain exceptions, which, if enacted, would substantially mitigate the
increase in the Company's gross assets and liabilities resulting from the
implementation of FIN No. 39.
9. BORROWINGS:
For the six months ended June 30, 1994, the Company issued
approximately $760 million of subordinated indebtedness, with maturities
ranging from 1997 to 2003. Of this amount, approximately $240 million were
fixed rate with contractual interest rates ranging from 7.00% to 7.36%. The
Company entered into interest rate swap contracts which effectively converted
$200 million of its fixed rate debt issuances to floating rates based on the
London Interbank Offered Rate. The remaining $520 million were subordinated
borrowings from Holdings and a subsidiary of Holdings, on which the interest
rate was 6.82% as of June 30, 1994.
12
<PAGE> 13
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The holders of approximately $40 million of the subordinated debt
issued during the first six months of 1994 have the option to cause the Company
to repurchase such notes at par in 1996 rather than at their contractual
maturity in 2003.
The proceeds of the Company's debt issuances for the first six months
of 1994 were used to provide additional liquidity and to refinance maturing
long-term debt. During this period, approximately $519 million of long-term
debt matured, of which approximately $368 million was related party
subordinated indebtedness.
10. CAPITAL REQUIREMENTS:
As registered broker-dealers, LBI and certain of its subsidiaries are
subject to the Net Capital Rule (Rule 15c3-1, the "Rule") promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The New
York Stock Exchange, Inc. and the National Association of Securities Dealers,
Inc. monitor the application of the Rule by LBI and such subsidiaries, as the
case may be. LBI and such subsidiaries compute net capital under the
alternative method of the Rule which requires the maintenance of minimum net
capital, as defined. A broker-dealer may be required to reduce its business if
net capital is less than 4% of aggregate debit balances or 6% of the funds
required to be segregated pursuant to the Commodity Exchange Act (the
"Commodity Act") and the regulations thereunder, if greater. A broker-dealer
may also be prohibited from expanding its business or paying cash dividends if
resulting net capital would be less than 5% of aggregate debit balances or 7%
of the funds required to be segregated pursuant to the Commodity Act and the
regulations thereunder, if greater. In addition, the
13
<PAGE> 14
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Rule does not allow withdrawal of subordinated capital if net capital would be
less than 5% of such debit balances or 7% of the funds required to be
segregated pursuant to the Commodity Act and the regulations, thereunder, if
greater.
The Rule also limits the ability of broker-dealers to transfer large
amounts of capital to parent companies and other affiliates. Under the Rule,
equity capital cannot be withdrawn from a broker-dealer without the prior
approval of the Commission when net capital after the withdrawal would be less
than 25% of its securities positions haircuts (which are deductions from
capital of certain specified percentages of the market value of securities to
reflect the possibility of a market decline prior to disposition). In
addition, the Rule requires broker-dealers to notify the Commission and the
appropriate self-regulatory organization two business days before the
withdrawal of excess net capital if the withdrawal would exceed the greater of
$500,000 or 30% of the broker-dealer's excess net capital, and two business
days after a withdrawal that exceeds the greater of $500,000 or 20% of excess
net capital.
Finally, the Rule authorizes the Commission to order a freeze on the
transfer of capital if a broker-dealer plans a withdrawal of more than 30% of
its excess net capital and the Commission believes that such a withdrawal would
be detrimental to the financial integrity of the Company or would jeopardize
the broker-dealers ability to pay its customers. At June 24, 1994, LBI's net
capital aggregated $1,233 million and was $1,175 million in excess of the
minimum requirement. Also at June 30, 1994, Lehman Government Securities Inc.,
a wholly-owned subsidiary of LBI, had net capital which aggregated $346 million
and was $317 million in excess of the minimum requirement.
The Company is subject to other domestic and international regulatory
requirements. As of June 30, 1994, the Company believes it is in material
compliance with all such requirements.
11. OTHER CHARGES:
Reduction in Personnel
During the first quarter of 1994, the Company completed a review of
personnel needs, which resulted in the termination of certain personnel. The
Company recorded a severance charge of $27 million pre-tax ($15 million
after-tax) in the first quarter of 1994.
Reserves for Non-Core Businesses
During the first quarter of 1993, the Company provided $141 million
pre-tax ($93 million after-tax) of non-core business reserves. Of this amount,
$21 million pre-tax ($13 million after-tax) related to certain non-core
partnership syndication activities in which the Company is no longer actively
engaged. The remaining $120 million pre-tax ($79 million after-tax) related to
reserves recorded in anticipation of the sale of SLHMC. Such sale was
completed during the third quarter of 1993.
12. RELATED PARTY TRANSACTIONS:
A wholly-owned subsidiary of the Company has outstanding 1,000 shares
of its 9% Cumulative Preferred Stock, Series A (the "Preferred Stock"), which
it issued for an aggregate purchase price of $750,000,000, to a wholly-owned
subsidiary of Holdings, for $1,000 in cash and a promissory note of
14
<PAGE> 15
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$749,999,000, bearing interest at a rate equal to the holder's cost of funds
(the "Note"). Interest income from the Note was approximately $8 million and
$7 million for the three months ended June 30, 1994 and 1993, respectively, and
approximately $15 million and $14 million for the six months ended June 30,
1994 and 1993, respectively. The dividend requirement on the Preferred Stock,
as reflected on the Company's Consolidated Statement of Operations, amounted to
approximately $17 million for each of the three months ended June 30, 1994 and
1993 and approximately $34 million for each of the six months ended June 30,
1994 and 1993.
Effective June 10, 1994, Lehman Special Securities Inc., a
wholly-owned subsidiary of Holdings was merged into a subsidiary of the Company
resulting in an increase in stockholder's equity in LBI and LGSI of
approximately $149 million. During the second quarter of 1994, the Company
paid $336 million to Holdings, $300 million as a return of capital and $36
million as a dividend.
13. CHANGE OF FISCAL YEAR-END:
On March 28, 1994, the Board of Directors of Holdings approved,
subject to the Distribution, a change in the Company's fiscal year-end from
December 31 to November 30. Such a change to a non-calendar cycle will shift
certain year-end administrative activities to a time period that conflicts less
with the business needs of the Company's institutional customers. The Company
expects to file its third quarter Form 10-Q for the three month period ended
August 31, 1994. Also in conjunction with its decision to change its fiscal
year-end, the Company anticipates that its financial statements for the
transition period ending November 30, 1994, will be contained in a report on
Form 10-K which is expected to be filed with the Commission on or about
February 28, 1995.
15
<PAGE> 16
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
During 1993, the Company completed the sale of three businesses: The
Boston Company, Shearson, and SLHMC which were completed on May 21, July 31,
and August 31, 1993, respectively. The Company's 1993 operating results
reflect The Boston Company as a discontinued operation, while the operating
results of Shearson and SLHMC are included in the Company's 1993 results from
continuing operations. Because of the significant sale transactions completed
during 1993, the Company's 1993 historical financial statements are not fully
comparable with the results of 1994. To facilitate an understanding of the
Company's results, the following table separates the Company's 1993 results
into three categories. These categories are as follows:
- - - Historical Results: the results of the businesses that now comprise Lehman
Brothers; the results of Shearson and SLHMC through their respective sale
dates; the loss on the sale of Shearson; the reserves for non-core
businesses; and the results of The Boston Company (accounted for as a
discontinued operation).
- - - The Lehman Businesses: the results of the businesses that now comprise
Lehman Brothers.
- - - Businesses Sold: the results of Shearson and SLHMC; the loss on the sale
of Shearson; and the reserves for non-core businesses related to the sale
of SLHMC.
<TABLE>
<CAPTION>
Three Months Ended June 30,
-------------------------------------------------------
1994 1993
---------- --------------------------------------
(UNAUDITED) Lehman Lehman Businesses
(IN MILLIONS) Businesses Businesses Sold Historical
---------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Revenues:
Market making and principal transactions $ 184 $ 287 $ 127
Investment banking 94 166 60
Commissions 103 109 346
Interest and dividends 1,544 1,205 70
Other 14 14 174
----- ----- -----
Total revenues 1,939 1,781 777
Interest expense 1,475 1,098 63
----- ----- -----
Net revenues 464 683 714 $1,397
----- ----- ----- -----
Non-interest expenses:
Compensation and benefits 256 368 475
Other expenses 237 213 189
----- ----- -----
Total non-interest expenses 493 581 664 1,245
----- ----- ----- -----
Income (loss) before taxes and preferred dividend
of subsidiary (29) 102 50 152
Provision for (benefit from) income taxes (22) 38 24 62
----- ----- ----- -----
Income (loss) before preferred dividend of
subsidiary (7) 64 26 90
Preferred dividend of subsidiary (17) (17) (17)
----- ----- ----- -----
Net income (loss) $ (24) $ 47 $ 26 $ 73
===== ===== ===== =====
</TABLE>
16
<PAGE> 17
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------------------------------------
1994 1993
---------- --------------------------------------
(UNAUDITED) Lehman Lehman Businesses
(IN MILLIONS) Businesses Businesses Sold Historical
---------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Revenues:
Market making and principal transactions $ 467 $ 549 $ 282
Investment banking 231 297 124
Commissions 224 215 710
Interest and dividends 2,897 2,365 136
Other 28 28 345
----- ----- -----
Total revenues 3,847 3,454 1,597
Interest expense 2,729 2,153 125
----- ----- -----
Net revenues 1,118 1,301 1,472 $2,773
----- ----- ----- -----
Non-interest expenses:
Compensation and benefits 592 731 984
Other expenses 463 402 376
Loss on sale of Shearson 535
Reserves and other charges 27 21 120
----- ----- -----
Total non-interest expenses 1,082 1,154 2,015 3,169
----- ----- ----- -----
Income (loss) from continuing operations before taxes,
cumulative effect of change in accounting principle
and preferred dividend of subsidiary 36 147 (543) (396)
Provision for income taxes 2 58 105 163
----- ----- ----- -----
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle and preferred dividend of subsidiary 34 89 (648) (559)
----- ----- ----- -----
Income from discontinued operations, net of taxes 189 189
----- ----- ----- -----
Income (loss) before cumulative effect of change in
accounting principle and preferred dividend of
subsidiary 34 89 (459) (370)
Cumulative effect of change in accounting principle (13)
Preferred dividend of subsidiary (34) (34) (34)
----- ----- ----- -----
Net income (loss) $ (13) $ 55 $ (459) $ (404)
===== ===== ===== ======
</TABLE>
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 1994 AND 1993
The Company reported a net loss of $24 million for the second quarter
of 1994 as compared to net income of $73 million for the second quarter of
1993. The 1993 net income of $73 million was comprised of net income from the
Lehman Businesses of $47 million and net income from Businesses Sold of $26
million.
THE LEHMAN BUSINESSES
FOR THE THREE MONTHS ENDED JUNE 30, 1994 AND 1993
Summary. Net income for the Lehman Businesses was a loss of $24
million for the second quarter of 1994 as compared to net income of $47 million
in the second quarter of 1993. The Company's second quarter results were
affected by the difficult market environment. Lower syndicate volumes in both
equities and fixed income had an adverse effect on the Company's business.
Market volatility
17
<PAGE> 18
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
also impaired the profitability of the Company's customer flow activity in
certain areas, resulting in a less favorable business mix. Net revenues from
the Lehman Businesses decreased 32% to $464 million in the second quarter of
1994 from $683 million in the prior year. Total non-interest expenses
decreased 15% to $493 million in the second quarter of 1994 from $581 million
in the second quarter of 1993, primarily due to decreased compensation and
benefits expense.
Market Making and Principal Transactions. Market making and principal
transactions include the results of the Company's market making and trading
related to customer activities, as well as proprietary trading for the
Company's own account. Revenues from these activities encompass net realized
and mark-to-market gains and losses on securities and other financial
instruments owned, as well as securities and other financial instruments sold
but not yet purchased. The Company utilizes various hedging strategies as it
deems appropriate to minimize its exposure to significant movements in interest
and foreign exchange rates and the equity markets. Market making and principal
transactions revenues decreased 36% to $184 million for the second quarter of
1994 from $287 million in the second quarter of 1993. The second quarter 1994
results were adversely affected by market conditions, resulting in reduced
profitability from the Company's customer flow business in certain areas and
proprietary trading activities, partially offset by increased net revenues from
derivative products.
Investment Banking. Investment banking revenues decreased 43% to $94
million for the second quarter of 1994 from $166 million in the prior year
period, principally due to decreased underwriting revenues. The decrease in
underwriting revenues was due to a significantly reduced syndicate calender in
both equities and fixed income. Partially offsetting this decrease were
increased financial advisory fees as compared to the second quarter of 1993.
Commissions. Commission revenues decreased slightly to $103 million
in the second quarter of 1994 from $109 million in the second quarter of 1993,
with relatively sustained volumes of customer trading in listed securities.
Commission revenues are generated from the Company's agency activities on
behalf of corporations, institutions and high net worth individuals.
Interest and Dividends. Interest and dividend revenues increased 28%
to $1,544 million in the second quarter of 1994 from $1,205 million in the
second quarter of 1993. However, net interest and dividend income decreased to
$69 million in the second quarter of 1994 from $107 million in the second
quarter of 1993. Net interest and dividend revenue amounts are closely related
to the Company's trading activities. The Company evaluates its trading
strategies on an overall profitability basis which includes both market making
and principal transactions and net interest. Therefore, changes in net
interest and dividend revenue from period to period should not be viewed in
isolation but should be viewed in conjunction with revenues from market making
and principal transactions. Net interest and dividend revenue is impacted by
the balance sheet size and mix of assets, the amount and mix of short and
long-term funding sources, as well as the prevailing level, term structure and
volatility of interest rates. The 1994 decrease in net interest and dividend
revenue was due in part to reduced spreads on fixed income products, increased
funding cost to the Company as a result of the higher domestic interest rate
environment and changes in financial instruments used for hedging.
Non-interest Expenses. Compensation and benefits expense decreased
30% to $256 million in the second quarter of 1994 from $368 million in the
second quarter of 1993, consistent with the lower level
18
<PAGE> 19
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
of business activity in the second quarter. Compensation and benefits expense
as a percentage of net revenues increased to 55.2% in the second quarter of
1994 from 53.8% in the second quarter of 1993.
Non-interest expenses were $493 million in the second quarter of 1994,
as compared to $581 million in the second quarter of 1993. Excluding
compensation and benefits, non-interest expenses increased 11% to $237 million
in the second quarter of 1994. This increase was due to higher levels of
professional services, depreciation and amortization and other expenses,
primarily reflecting ongoing investments in systems and technology.
The Company achieved its goal of reducing its costs by $170 million on
an annual basis. The Company's expense structure for the first half of 1993,
adjusted for changes in the volume and mix of revenues, as well as for
additional costs due to external factors such as inflation or new legislation,
was the basis against which these goals were measured. However, other factors
including the Company's ongoing investments in systems have resulted in
increased non-compensation expense levels year over year. The Company remains
committed to its expense reduction efforts and the ongoing review of its
expense structure in order to achieve greater operating efficiencies.
Income Taxes. For the second quarter of 1994, the Lehman Businesses
had an income tax benefit of $22 million as compared to an income tax
provision of $38 million a year ago. The effective tax rate for the second
quarter differs from the statutory U.S. federal income tax rate primarily as a
result of tax benefits related to income subject to preferential tax treatment.
As of June 30, 1994, the Company had approximately $130 million of tax
NOLs available to offset future taxable income, the benefits of which have not
yet been reflected in the financial statements. Although the benefit related
to these NOLs does not currently meet the recognition criteria of SFAS No. 109,
strategies are being implemented to increase the likelihood of realization.
Approximately $15 million of NOLs were transferred to American Express during
the second quarter in connection with the Distribution.
RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1994 AND 1993
The Company reported a net loss of $13 million for the first six
months of 1994 as compared to a net loss of $404 million for first six months
of 1993. The 1994 results included a $13 million charge for the cumulative
effect of a change in accounting for postemployment benefits as a result of the
adoption of SFAS No. 112 and a $15 million severance charge. The 1993 net loss
of $404 million was comprised of net income from the Lehman Businesses of $55
million, net income of $189 million from the discontinued operations of The
Boston Company, including a $165 million after-tax gain on the sale and
after-tax earnings of $24 million, and a net loss from the Businesses Sold of
$648 million, which included an after-tax loss on the sale of Shearson of $630
million, an after-tax charge of $79 million related to a reserve for non-core
businesses recognized in anticipation of the sale of SLHMC, and operating
earnings from Shearson of $61 million. The loss on the sale of Shearson
included a reduction in goodwill of $750 million and transaction-related costs
such as relocation, systems and operations modifications and severance.
19
<PAGE> 20
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THE LEHMAN BUSINESSES
FOR THE SIX MONTHS ENDED JUNE 30, 1994 AND 1993
Summary. Income from continuing operations before the cumulative
effect of change in accounting principle and preferred dividend of subsidiary
for the Lehman Businesses decreased 62% to $34 million for the first six months
of 1994 from net income of $89 million in the first six months of 1993. Net
income for 1994 included a $15 million ($27 million pre-tax) severance charge
while net income for 1993 included a $13 million ($21 million pre-tax) reserve
for certain non-core partnership syndication activities in which the Company is
no longer actively engaged. Excluding these charges, net income from
continuing operations before the cumulative effect of change in accounting
principle and preferred dividend of subsidiary for the Lehman Businesses was
$49 million in the first six months of 1994 as compared to $102 million in the
first six months of 1993. Net revenues from the Lehman Businesses decreased
14% to $1,118 million in the first six months of 1994 from $1,301 million in
the prior year reflecting a difficult market environment. Total non-interest
expenses decreased 6% to $1,082 million in the first six months of 1994 from
$1,154 million in the first six months of 1993.
Market Making and Principal Transactions. Market making and principal
transactions revenues decreased 15% to $467 million for the first six months of
1994 from $549 million in the first six months of 1993. The Company's 1994
trading results were adversely affected by market conditions resulting in
reduced profitability from fixed income and equity products, partially offset by
increased net revenues from derivative products.
Investment Banking. Investment banking revenues decreased 22% to $231
million for the first six months of 1994 from $297 million in the prior year
period, due to decreased underwriting revenues resulting from a significantly
reduced syndicate calender in both equities and fixed income. Partially
offsetting this decrease was increased financial advisory fees.
Commissions. Commission revenues increased 4% to $224 million in the
first six months of 1994 from $215 million in the first six months of 1993,
primarily as a result of higher volumes of customer trading of securities and
commodities on exchanges. Commission revenues are generated from the Company's
agency activities on behalf of corporations, institutions and high net worth
individuals.
Interest and Dividends. Interest and dividend revenues increased 22%
to $2,897 million in the first six months of 1994 from $2,365 million in the
first six months of 1993. Net interest and dividend income decreased to $168
million in the first six months of 1994 from $212 million in the first six
months of 1993. The Company's net interest revenue was adversely impacted by
the combination of reduced spreads on fixed income products, higher funding
cost and changes in financial instruments used for hedging.
Non-interest Expenses. Compensation and benefits expense decreased to
$592 million in the first six months of 1994 from $731 million in the first six
months of 1993, reflecting reduced business activity in 1994. Compensation and
benefits expense as a percentage of net revenues decreased to 53.0% in the
first six months of 1994 from 56.1% in the first six months of 1993.
20
<PAGE> 21
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Non-interest expenses decreased 6% to $1,082 million for the first six
months of 1994 from $1,154 million in the first six months of 1993. Excluding
compensation and benefits expense, non-interest expenses increased 16% to $490
million in the first six months of 1994 from $423 million in the comparable
period in 1993. Included within the 1994 results was a severance charge of $27
million recognized as a result of a review of personnel needs and on-going cost
reduction efforts. The 1993 results included a $21 million charge related to
certain non-core partnership syndication activities in which the Company is no
longer actively engaged. Excluding these charges, other non-interest expenses
were $463 million and $402 million for the first six months of 1994 and 1993,
respectively. This increase was due to higher levels of professional services,
depreciation and amortization and other expenses, primarily reflecting ongoing
investments in systems and technology.
Income Taxes. For the first six months of 1994, the Lehman Businesses
had an income tax provision of $2 million as compared to $58 million a year
ago. The effective tax rate for the first six months of 1994 differs from the
statutory U.S. federal income tax rate primarily as a result of tax benefits
related to income subject to preferential tax treatment.
21
<PAGE> 22
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
Total assets increased to $82.6 billion at June 30, 1994 from $57.8
billion at December 31, 1993. The primary reason for this increase was the
adoption of FIN No. 39, which restricts the historical industry practice of
offsetting certain receivables and payables. (See Note 8.)
The Company's asset base consists primarily of cash and cash
equivalents, and assets which can be sold within one year, including securities
and other financial instruments owned, collateralized short-term agreements and
receivables. Long-term assets consist primarily of other receivables, property,
equipment and leasehold improvements, deferred expenses and other assets, and
excess of cost over fair value of net assets acquired.
The Company finances its short-term assets primarily on a secured
basis through the use of securities sold under agreements to repurchase,
securities loaned, securities and other financial instruments sold but not yet
purchased, advances from Holdings and other affiliates and other collateralized
liability structures.
The Company uses short-term unsecured borrowing sources to fund
short-term assets not financed on a secured basis. The Company's primary
sources of short-term, unsecured general purpose funding include commercial
paper and short-term debt, including master notes and bank borrowings under
uncommitted lines of credit. Commercial paper and short-term debt outstanding
totaled $4.4 billion at June 30, 1994, compared to $2.6 billion at December 31,
1993. Of these amounts, commercial paper outstanding totaled approximately
$300 million at June 30, 1994, compared to approximately $400 million at
December 31, 1993.
The Company's uncommitted lines of credit provide an additional source
of short-term financing. At June 30, 1994, the Company had $5.6 billion in
uncommitted lines of credit compared to $5.7 billion at December 31, 1993.
Uncommitted lines consist of facilities that the Company has been advised are
available but for which no contractual lending obligation exists.
Long-term assets are financed with a combination of long-term debt and
equity. The Company's long-term unsecured funding sources are senior notes and
subordinated indebtedness. The Company maintains long-term debt in excess of
its long-term assets to provide additional liquidity, which the Company uses to
meet its short-term funding requirements and to reduce its reliance on
commercial paper and short-term debt. During the second quarter of 1994, the
Company paid $336 million to Holdings, $300 million as a return of capital and
$36 million as a dividend.
For the six months ended June 30, 1994, the Company issued
approximately $760 million of subordinated indebtedness, of which approximately
$240 million were fixed rate. The Company entered into interest rate swap
contracts which effectively converted $200 million of its 1994 fixed rate debt
issuances to floating rates based on the London Interbank Offered Rate. The
remaining $520 million of 1994 subordinated debt issuances were borrowings from
Holdings and a subsidiary of Holdings. The proceeds of the Company's issuances
for the first six months of 1994 were used to provide additional liquidity and
to refinance long-term debt maturing in 1994. At June 30, 1994, the Company
had long-term debt outstanding of $4.0 billion compared to $3.7 billion
outstanding at December 31, 1993.
22
<PAGE> 23
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
At June 30, 1994, the Company had approximately $800 million available
for issuance under its shelf registration.
Pursuant to a clearing agreement (the "Clearing Agreement"), Smith
Barney carries and clears, on a fully disclosed basis, all accounts introduced
to it by the Company, and performs clearing and settlement functions for
equities, municipal securities and corporate debt securities. The Clearing
Agreement expires on December 31, 1994, but may be extended for up to an
additional six months. The Company is currently negotiating an agreement with
another financial institution to take effect upon the expiration of the
Clearing Agreement. Under that agreement it is currently contemplated that such
financial institution would provide to the Company transaction support services
to enable the Company to clear the transactions currently cleared by Smith
Barney in a manner which would result in the accounts currently carried by
Smith Barney being carried on the Company's books. Although no definitive
agreement has been reached, it is anticipated that this new arrangement will
take efect during the first half of 1995.
SPECIFIC BUSINESS ACTIVITIES AND TRANSACTIONS
The following sections include information on specific business
activities of the Company which affect overall liquidity and capital resources:
Westinghouse. In May 1993, the Company and Westinghouse Electric
Corporation ("Westinghouse") entered into a partnership to facilitate the
disposition of Westinghouse's commercial real estate portfolio valued at
approximately $1.1 billion, which will be accomplished substantially by
securitizations and asset sales. The Company invested approximately $154
million in the partnership, and also made collateralized loans to the
partnership of $752 million. During the third quarter of 1993, Lennar Inc. was
appointed portfolio servicer and purchased a 10% limited partnership interest
from the Company and Westinghouse.
At June 30, 1994, the carrying value of the Company's investment in the
partnership was $170 million and the outstanding balance of the collateralized
loans, including accrued interest, was $191 million. The remaining loan
balance is expected to be repaid in 1994 through a combination of mortgage
remittances, securitizations, asset sales and refinancings by third parties.
High Yield Securities. The Company underwrites, trades, invests and
makes markets in high yield corporate debt securities. The Company also
syndicates, trades and invests in loans to below investment grade companies.
For purposes of this discussion, high yield debt securities are defined as
securities or loans to companies rated below BBB- by Standard & Poor's
Corporation and below Baa3 by Moody's Investor Services, Inc., as well as
non-rated securities or loans which, in the opinion of management, are non-
investment grade. High yield debt securities are carried at market value and
unrealized gains or losses for these securities are reflected in the Company's
Consolidated Statement of Operations. The Company's portfolio of such
securities at June 30, 1994 and December 31, 1993 included long positions with
an aggregate market value of approximately $660 million and $661 million,
respectively, and short positions with an aggregate market value of
approximately $59 million and $75 million, respectively. The portfolio may
from time to time contain concentrated holdings of selected issues. The
Company's two largest high yield positions were $42 million and $33 million at
June 30, 1994 and $61 million and $56 million at December 31, 1993.
Change in Facilities. In 1993, Holdings agreed to lease approximately
392,000 square feet of office space located at 101 Hudson Street in Jersey
City, New Jersey (the "Operations Center"). The lease term will commence in
August 1994 and provides for minimum rental payments of approximately $87
million over its 16-year term. Concurrently, Holdings announced it would
relocate certain administrative employees to five additional floors at 3 World
Financial Center in New York, New York. Effective August 1, 1994 Holdings
purchased these floors from American Express for approximately $44 million
through an assumption of a portion of the existing debt related to the World
Financial Center. In connection with the relocation of the Operations Center
and the acquisition of additional space at the World Financial Center, Holdings
anticipates remaining fixed asset additions of approximately $78 million which
is expected to be funded from the issuance of long-term debt. The relocation
is expected to be
23
<PAGE> 24
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
completed by the third quarter of 1994. A substantial portion of the lease and
depreciation charges will be allocated to the Company based upon Holding's
method of allocating certain intercompany charges.
Non-Core Activities and Investments. In March 1990, the Company
discontinued the origination of partnerships (the assets of which are primarily
real estate) and investments in real estate. Currently, the Company acts as a
general partner for approximately $4.2 billion of partnership investment
capital and manages a real estate investment portfolio with an aggregate
investment basis of approximately $114 million. At June 30, 1994, the Company
had remaining net exposure to these investments (defined as the remaining
unreserved investment balance plus outstanding commitments and contingent
liabilities under guarantees and credit enhancements) of $86 million. In
certain circumstances, the Company provides financial and other support and
assistance to such investments to maintain investment values. Except as
described above, there is no contractual requirement that the Company continue
to provide this support. Although a decline in the real estate market or the
economy in general or a change in the Company's disposition strategy could
result in additional real estate reserves, the Company believes that it is
adequately reserved.
SPIN-OFF OF HOLDINGS
On May 31, 1994, American Express effected a special dividend
to its common shareholders of record on May 20, 1994, representing
approximately 98.3 million shares of Lehman Brothers Holdings Inc. Common
Stock. (See Note 2.) As a result of the Distribution, Holdings became a
public corporation with its Common Stock traded on the New York Stock Exchange,
Inc.
24
<PAGE> 25
LEHMAN BROTHERS INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The Company is involved in a number of judicial, regulatory and
arbitration proceedings concerning matters arising in connection with the
conduct of its business. Such proceedings include actions brought against LBI
and others with respect to transactions in which LBI acted as an underwriter or
financial advisor, actions arising out of LBI's activities as a broker or
dealer in securities and commodities and actions brought on behalf of various
classes of claimants against many securities and commodities firms of which LBI
is one.
Although there can be no assurance as to the ultimate outcome, the
Company has denied, or believes it has meritorious defenses and will deny,
liability in all significant cases pending against it including the matters
described below, and intends to defend vigorously each such case. Although
there can be no assurance as to the ultimate outcome, based on information
currently available and established reserves, the Company believes that the
eventual outcome of the actions against it, including the matters described
below, will not, in the aggregate, have a material adverse effect on its
business or consolidated financial condition.
BAMAODAH V. E.F. HUTTON & COMPANY INC. (Reported in LBI's Annual Report on Form
10-K and First Quarter Report on Form 10-Q)
The Company has appealed the judgment of the Dubai Court of Appeals to
the Court of Cassation.
RALPH MAJESKI, ET AL. V. BALCOR ENTERTAINMENT COMPANY, LTD, ET AL.; ROBERT
ECKSTEIN, ET AL. V. BALCOR FILM INVESTORS, ET AL. (Reported in LBI's Annual
Report on Form 10-K and First Quarter Report on Form 10-Q)
The United States District Court for the Eastern District of Wisconsin
has set a trial date of October 4, 1994.
PAUL WILLIAMS AND BEVERLY KENNEDY, ET AL. V. BALCOR PENSION INVESTORS ET AL.
(Reported in LBI's Annual Report on Form 10-K and First Quarter Report on Form
10-Q)
The United States District Court for the Northern District of Illinois
granted plaintiffs' motion for class certification, but invited defendants to
move for reconsideration.
<PAGE> 26
GLYNWIL INVESTMENT, LTD, V. SHEARSON LEHMAN BROTHERS INC. (Reported in LBI's
Annual Report on Form 10-K and First Quarter Report on Form 10-Q)
Discovery is expected to be completed by September 16, 1994.
CC&F MEDFORD III INVESTMENT COMPANY V. THE BOSTON COMPANY, INC. AND
WELLINGTON-MEDFORD III PROPERTIES, INC. (Reported in LBI's Annual Report on
Form 10-K and First Quarter Report on Form 10-Q)
The parties have settled all disputes among them and a Stipulation of
Dismissal has been filed in the Superior Court of the Commonwealth of
Massachusetts.
ACTIONS RELATING TO NATIONAL ASSOCIATION OF SECURITIES DEALERS AUTOMATED
QUOTATIONS SYSTEM ("NASDAQ") MARKET MAKER ANTITRUST AND SECURITIES LITIGATION.
Since May 1994, at least 15 class actions have been filed in
various state and federal courts against various broker-dealers making markets
in NASDAQ securities. To date, LBI has been named specifically as a defendant
in ten of these actions. Plaintiffs in these cases have alleged violations of
the antitrust laws, securities laws and have pled a variety of other statutory
and common law claims. All of these actions are based on the theory that
because odd-eighth quotes occur less often than quarter quotes, NASDAQ market
makers must be colluding wrongfully to maintain a wider spread. At this time,
it is premature to express an opinion as the ultimate outcome of these actions,
although LBI believes that it has meritorious defenses to these claims, which
it intends to pursue vigorously.
Actions In Which LBI Is Named As A Defendant
Federal Court Actions. During a period commencing on or about July 6,
1994 and ending on or about July 12, 1994, seven separate class actions
entitled SILVERMAN V. AlEX BROWN & SONS ET AL.; FRANGIOSA V. ALEX BROWN & SONS
ET AL.; KRUM V. ALEX BROWN & SONS ET AL.; SACHS V. ALEX BROWN & SONS ET AL.;
HENNESSEY V. ALEX BROWN & SONS ET AL.; LUTZ V. ALEX BROWN & SONS ET AL. and
TOLCHIN V. ALEX BROWN & SONS ET AL., were instituted in the United States
District Court for the District of Columbia. On or about July 1, 1994, a class
action entitled DERDEL V. ALEX BROWN & SONS ET AL. was instituted in the United
States District Court for the District of Maryland. On or about July 29, 1994,
a class action entitled JOHNSON V. ALEX BROWN & SONS ET AL. was instituted in
the United States District Court for the District of Minnesota. All of the
aforementioned complaints were filed on behalf of customers of any defendant or
any affiliate of any defendant who purchased or sold securities through NASDAQ
within four years of the filing of the respective complaints. The
<PAGE> 27
complaints specifically name 24 broker-dealers as defendants, including LBI.
The allegations in these complaints are similar, and each alleges violations of
the antitrust laws and seeks treble damages, costs and attorneys' fees and
injunctive relief.
By a series of motions, all of the above mentioned federal actions are
before the Judicial Panel on Multidistrict Litigation (the "Judicial Panel")
for transfer and coordination or consolidation in a single district court. LBI
has taken the position before the Judicial Panel that all of these cases should
be transferred to the Southern District of New York. LBI anticipates that the
Judicial Panel will issue a ruling in the early fall. Pending that ruling, the
plaintiffs have agreed that LBI need not respond to any of the complaints.
State Court Action. On or about May 27, 1994, a class action entitled
ABEL ET AL. V. MERRILL LYNCH ET AL. was instituted in the Superior Court of the
State of California, County of San Diego. This complaint was filed on behalf
of all residents of California who, within the last four years, purchased or
sold any security listed on the NASDAQ. The complaint specifically named
13 broker-dealers as defendants, including LBI. The complaint generally
alleges violations of the California Business and Professions Code -
specifically the Cartwright Act and the Unfair Competition Act - and seeks
treble damages, cost and attorneys' fees, restitution, and injunctive relief.
Actions In Which LBI Is Not Specifically Named As A Defendant
To date, LBI is aware of five actions with allegations similar to
those in the above mentioned cases, but in which LBI is not specifically named
as a defendant: three actions commenced in the Southern District of New York
(ROBINSON V. HERZOG, HEINE, GEDULD ET AL.; KAYE AND DESAI V. HERZOG, HEINE,
GEDULD ET AL.; AND DAMPF V. HERZOG, HEINE, GEDULD ET AL.); one action in the
Southern District of California (PERLMAN V. HERZOG, HEINE, GEDULD ET AL.); and
one action in the Northern District of Illinois (DOLINAR V. SHERWOOD SECURITIES
CORP, ET AL.). It is possible that LBI will be named as a defendant in one or
more of these actions; however, as with the above described federal court
actions in which LBI has been named, motions are pending before the Judicial
Panel for transfer to a single district court.
<PAGE> 28
EXHIBITS AND REPORTS ON FORM 8-K
The following exhibits and reports on Form 8-K are filed as part of this
Quarterly Report, or where indicated, were heretofore filed and are hereby
incorporated by reference:
(a) Exhibits:
12. Computation in Support of Ratio of Earnings to Fixed Charges.
(b) Reports on Form 8-K:
1. Form 8-K dated June 15, 1994, Item 8.
2. Form 8-K dated July 27, 1994, Items 5 and 7.
<PAGE> 29
SIGNATURES
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.
LEHMAN BROTHERS INC.
---------------------------
(Registrant)
Date: August 15, 1994 By /s/ Richard S. Fuld, Jr.
---------------------------
Richard S. Fuld, Jr.
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: August 15, 1994 By /s/ Robert Matza
---------------------------
Robert Matza
Chief Financial Officer
(Principal Financial Officer)
<PAGE> 30
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
12. Computation in Support of Ratio of Earnings to Fixed Charges.
<PAGE> 1
Exhibit 12
<PAGE> 2
LEHMAN BROTHERS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN MILLIONS)
(UNAUDITED)
<TABLE>
<CAPTION>
For the
Six Months
Ended
For the Year Ended December 31, June 30,
------------------------------------------------------- --------
1989 1990 1991 1992 1993 1994
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Fixed charges:
Interest expense:
Subordinated indebtedness $ 341 $ 277 $ 231 $ 210 $ 192 $ 94
Bank loans and other
borrowings* 4,325 3,753 4,068 4,363 4,393 2,635
Interest component of rentals
of office and equipment 63 57 64 64 62 15
Other adjustments** 152 73 88 127 101 37
----- ----- ----- ----- ----- -----
TOTAL (A) $4,881 $4,160 $4,451 $4,764 $4,748 $2,781
===== ===== ===== ===== ===== =====
Earnings:
Pre-tax income (loss) from
continuing operations $ 202 $ (501) $ 283 $ 319 $ (146) $ 36
Fixed charges 4,881 4,160 4,451 4,764 4,748 2,781
Other adjustments*** (95) (68) (69) (68) (68) (35)
----- ----- ----- ----- ----- -----
TOTAL (B) $4,988 $3,591 $4,665 $5,015 $4,534 $2,782
===== ===== ===== ===== ===== =====
(B / A) 1.02 **** 1.05 1.05 **** 1.00
</TABLE>
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest costs and amortization
of capitalized interest and preferred stock dividends of a wholly-owned
subsidiary.
*** Other adjustments include adding the net loss of affiliates accounted
for at equity whose debt is not guaranteed by the Company and
subtracting capitalized interest costs and undistributed net income of
affiliates accounted for at equity and preferred stock dividends of a
wholly-owned subsidiary.
**** Earnings were inadequate to cover fixed charges and would have had to
increase approximately $569 million in 1990 and $214 million in 1993 in
order to cover the deficiency.
