<PAGE> 1
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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 AUGUST 31, 1994
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 1-6817
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 OCTOBER 11, 1994, 1,005 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR
VALUE $.10 PER SHARE, WERE ISSUED AND OUTSTANDING.
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<PAGE> 2
LEHMAN BROTHERS INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED AUGUST 31, 1994
INDEX
<TABLE>
<CAPTION>
Part I. FINANCIAL INFORMATION Page Number
--------------------- ----------
<S> <C>
Item 1. Financial Statements
Consolidated Statement of Operations -
Three and Eight Months Ended
August 31, 1994 and Three and Nine
Months Ended September 30, 199 . . . . . . . . . . . . . . . . . . . 33
Consolidated Balance Sheet -
August 31, 1994 and
December 31, 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Consolidated Statement of Cash Flows -
Eight Months Ended August 31, 1994 and
Nine Months Ended September 30, 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 . . . . . . . . . . . . . . . . . . . . 27
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
EXHIBIT INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
</TABLE>
Exhibits
2
<PAGE> 3
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Three months ended
------------------------------------
August 31, September 30,
1994 1993
---------- -------------
<S> <C> <C>
Revenues
Market making and principal transactions $ 180 $ 301
Investment banking 116 189
Commissions 98 229
Interest and dividends 1,790 1,292
Other 14 81
-------- ---------
Total revenues 2,198 2,092
Interest expense 1,695 1,170
-------- ---------
Net revenues 503 922
-------- ---------
Non-interest expenses
Compensation and benefits 265 502
Brokerage, commissions and clearance fees 45 50
Communications 39 54
Professional services 25 40
Depreciation and amortization 25 31
Advertising and market development 24 33
Occupancy and equipment 20 34
Management fees 38
Other 52 62
-------- ---------
Total non-interest expenses 533 806
-------- ---------
Income (loss) before taxes and preferred dividend
of subsidiary (30) 116
Provision for (benefit from) income taxes (28) 37
-------- ---------
Income (loss) before preferred dividend
of subsidiary (2) 79
Preferred dividend of subsidiary (17) (17)
-------- ---------
Net income (loss) $ (19) $ 62
======== =========
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Eight months ended Nine months ended
August 31, September 30,
1994 1993
------------------ -----------------
<S> <C> <C>
Revenues
Market making and principal transactions $ 616 $1,164
Investment banking 289 610
Commissions 288 1,154
Interest and dividends 4,128 3,793
Other 33 454
------- ------
Total revenues 5,354 7,175
Interest expense 3,889 3,448
------- ------
Net revenues 1,465 3,727
------- ------
Non-interest expenses
Compensation and benefits 753 2,217
Brokerage, commissions and clearance fees 143 138
Communications 101 237
Professional services 74 123
Depreciation and amortization 69 111
Advertising and market development 63 107
Occupancy and equipment 61 166
Management fees 38
Other 133 232
Severance charge 27
Loss on sale of Shearson 535
Reserves for non-core businesses 141
------
Total non-interest expenses 1,462 4,007
------- ------
Income (loss) from continuing operations before taxes,
cumulative effect of change in accounting principle and
preferred dividend of subsidiary 3 (280)
Provision for (benefit from) income taxes (24) 200
------- ------
Income (loss) from continuing operations before cumulative
effect of change in accounting principle and preferred
dividend of subsidiary 27 (480)
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 27 (291)
Cumulative effect of change in accounting principle (13)
Preferred dividend of subsidiary (45) (51)
------- ------
Net income (loss) $ (31) $ (342)
======= ======
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
LEHMAN BROTHERS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN MILLIONS)
ASSETS
<TABLE>
<CAPTION>
August 31, December 31,
1994 1993
---------- ------------
(unaudited)
<S> <C> <C>
Cash and cash equivalents $ 125 $316
Cash and securities segregated and on deposit
for regulatory and other purposes 1,233 867
Securities and other financial instruments owned 34,176 20,557
Collateralized short-term agreements:
Securities purchased under agreements to resell 33,943 23,175
Securities borrowed 7,924 4,276
Receivables:
Brokers and dealers 5,444 4,102
Customers 1,656 1,39
Other 2,009 2,138
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $406 in 1994 and $361 in 1993) 413 426
Deferred expenses and other assets 175 299
Excess of cost over fair value of net assets acquired
(net of accumulated amortization of $106 in 1994
and $99 in 1993) 237 267
------- -------
$87,335 $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>
August 31, December 31,
1994 1993
---------- ------------
(unaudited)
<S> <C> <C>
Commercial paper and short-term debt $ 3,693 $ 2,635
Securities and other financial instruments sold
but not yet purchased 10,489 5,223
Advances from Holdings and other affiliates 5,890 5,063
Securities sold under agreements to repurchase 52,404 30,798
Securities loaned 1,075 772
Payables:
Brokers and dealers 3,037 2,021
Customers 2,124 2,322
Accrued liabilities and other payables 2,011 2,590
Senior notes 647 653
Subordinated indebtedness 3,552 3,053
------- -------
Total liabilities 84,922 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 (176) (56)
------- -------
Total stockholder's equity 2,413 2,684
------- -------
$87,335 $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>
Eight months ended Nine months ended
August 31, September 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 $27 $ (480)
Adjustments to reconcile income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization 69 111
Provisions for losses and other reserves 45 65
Loss on sale of Shearson 535
Non-core business reserves 141
Other adjustments 11 99
Net change in:
Cash and securities segregated (366) 255
Receivables from brokers and dealers (1,342) (736)
Receivables from customers (265) 995
Securities purchased under agreements to resell (10,768) 1,663
Securities borrowed (3,648) 4,667
Loans originated or purchased for resale (62)
Securities and other financial instruments owned (13,619) (3,008)
Payables to brokers and dealers 1,016 (393)
Payables to customers (198) (1,257)
Accrued liabilities and other payables (616) 822
Securities sold under agreements to repurchase 21,606 3,163
Securities loaned 303 (2,500)
Securities and other financial instruments sold but
not yet purchased 5,266 (3,344)
Other operating assets and liabilities, net 344 (858)
--------
(2,135) (122)
Net cash flows provided by operating activities of
discontinued operations 428
-------- -------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES $ (2,135) $ 306
-------- -------
</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>
Eight months ended Nine months ended
August 31, September 30,
1994 1993
------------------ -----------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments of senior notes $ (16) $ (578)
Proceeds from issuance of subordinated indebtedness 1,060 206
Principal payments of subordinated indebtedness (562) (602)
Proceeds from issuance of other indebtedness 827 725
Principal payments of other indebtedness (26) (954)
Increase (decrease) in commercial paper
and short-term debt, net 1,084 (1,569)
Capital contributions 20
Proceeds from the issuance of common stock 430
Dividends and capital distributions paid (390) (300)
Net cash flows used in financing activities of
discontinued operations (301)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,977 (2,923)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and
leasehold improvements (33) (73)
Proceeds from the sale of The Boston Company 1,300
Proceeds from the sale of Shearson 1,200
Proceeds from sale of SLHMC 70
Other 271
Net cash flows used in investing activities of
discontinued operations (85)
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (33) 2,683
------- -------
Net change in cash and cash equivalents
of discontinued operations 42
--
NET CHANGE IN CASH AND CASH EQUIVALENTS (191) 24
------- -------
Cash and cash equivalents at beginning of period 316 295
-------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 125 $ 319
======= =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS) (INCLUDING THE
BOSTON COMPANY)
Interest paid (net of amount capitalized) totaled $3,858 and $3,577 in
the first eight months of 1994 and nine months of 1993, respectively. Income
taxes paid totaled $13 and $89 in the first eight months of 1994 and nine
months of 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 a widely held 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 for the nine month period ended
September 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.)
Certain amounts reflect reclassifications to conform to the current
period's presentation.
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.
9
<PAGE> 10
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with the completion of the Mellon Transaction, the
Company paid a $300 million dividend to Holdings.
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 nine
month period ended September 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>
Nine months ended
September 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.
10
<PAGE> 11
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Presented below are the results of operations and the loss on the sale
of Shearson (in millions):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, 1993 September 30, 1993
------------------ ------------------
<S> <C> <C>
Revenues $ 282 $1,825
Expenses 277 1,708
Loss on sale of Shearson 535
------- ------
Income (loss) before taxes 5 (418)
Provision for income taxes 3 149
------- ------
Net income (loss) $ 2 $ (567)
======= ======
</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>
August 31, December 31,
1994 1993
---------- ------------
<S> <C> <C>
Securities and other financial instruments owned:
Government and agency obligations $22,656 $12,579
Corporate obligations and other contractual commitments 5,498 3,780
Mortgage-backed 2,346 1,071
Certificates of deposit and other money market instruments 2,431 1,849
Corporate stocks and options 1,209 1,247
Spot commodities 36 31
------- -------
$34,176 $20,557
======= =======
Securities and other financial instruments sold but not yet purchased:
Government and agency obligations $ 6,577 $ 3,898
Corporate obligations and other contractual commitments 2,189 433
Corporate stocks and options 1,501 694
Spot commodities 222 198
------- -------
$10,489 $ 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 $28 million for the third
quarter of 1994 compared to an expense of $37 million a year ago. For the
first eight months of 1994, the Company reported a tax benefit from continuing
operations of $24 million and tax expense of $200 million for the first nine
months of 1993. The 1994 quarter and year-to-date tax benefit reflects lower
pre-tax earnings and tax benefits related to income subject to preferential tax
treatment. The nine months 1993 tax provision included expenses of (i) $146
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 $13 million after-tax ($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. A substantial portion of the
increase in the Company's gross assets and liabilities from December 31, 1993
to August 31, 1994 is due to the adoption of FIN No. 39. On September 30,
1994, the Financial Accounting Standards Board issued a draft modification to
FIN No. 39 which, if enacted, will substantially mitigate the increase in
the Company's gross assets and liabilities resulting from the implementation of
FIN No. 39.
9. BORROWINGS:
For the eight months ended August 31, 1994, the Company issued $1,060
million of subordinated indebtedness, with maturities ranging from 1997 to
2003. Of this amount, $540 million was fixed rate with contractual interest
rates ranging from 7.00% to 7.625%. The Company entered into interest rate
swap contracts which effectively converted $450 million of its fixed rate debt
issuances to floating rates based on the London Interbank Offered Rate. The
remaining $520 million of subordinated debt issuances were borrowings from
Holdings and a subsidiary of Holdings, on which the interest rate was 6.89% as
of August 31, 1994.
12
<PAGE> 13
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The holders of $40 million of the subordinated debt issued during the
first eight 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 eight
months of 1994 have been used to provide additional liquidity and to refinance
maturing long-term debt. During this period, $578 million of long-term debt
matured, of which $377 million was related party debt.
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 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 August 31, 1994, LBI's net
capital aggregated $1,263 million and was $1,205 million in excess of the
minimum requirement. Also at August 31, 1994, Lehman Government Securities
Inc. ("LGSI"), a wholly owned subsidiary of LBI, had net capital which
aggregated $364 million and was $345 million in excess of the minimum
requirement.
The Company is subject to other domestic and international regulatory
requirements. As of August 31, 1994, the Company believes it is in material
compliance with all such requirements.
13
<PAGE> 14
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
In the normal course of business, the Company engages in various
securities trading, investment banking and financing activities with Holdings
and many of its affiliates (the "Related Parties"). In addition, various
charges, such as compensation, occupancy, administration and computer
processing are allocated among the Related Parties, based upon specific
identification and allocation methods.
During the third quarter of 1994, Holdings acquired additional space
in the World Financial Center and also began occupying its leased facility at
101 Hudson Street in Jersey City, New Jersey. In addition, certain employees
of the Company who perform administrative and corporate functions were
transferred to Holdings. Accordingly, Holdings has allocated the cost of
these new facilities and services provided by employees transferred to its
appropriate subsidiaries. These charges, which are classified in the
Consolidated Statement of Operations as management fees, are primarily
comprised of compensation, occupancy and computer processing. The result of
these allocations was to reduce expenses incurred directly by the Company in
previous periods with an offsetting increase in management fees.
LBI Group, a wholly owned subsidiary of the Company ("Group") 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 LB Funding Corp. a wholly owned subsidiary of Holdings
("Funding"), for $1,000 in cash and a promissory note of $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 $9 million and $7 million for the three
months ended August 31, 1994 and September 30, 1993, respectively, and
approximately $22 million and $21 million for the eight months ended August 31,
1994 and nine months ended September 30, 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 the three
months ended August 31, 1994 and September 30, 1993 and approximately $45
million for the eight months ended August 31, 1994 and $51 million for the nine
months ended September 30, 1993. It is anticipated that in the fourth quarter
of 1994 Funding will be merged into Group. In connection with such merger the
Preferred Stock will be cancelled with no impact on the Company's consolidated
equity.
14
<PAGE> 15
LEHMAN BROTHERS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective June 10, 1994, Lehman Special Securities Inc., a wholly
owned subsidiary of Holdings, was merged into LGSI resulting in an increase
in stockholders' equity in LBI and LGSI of approximately $149 million. During
the first eight months of 1994, the Company paid $390 million to Holdings, $300
million as a return of capital and $90 million as dividends.
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. In
conjunction with the decision to change its year-end, the Company is reporting
its third quarter results on the basis of its new fiscal year for the three
months ended August 31, 1994. As such, the results for the month of June have
been reflected in both the second and third quarters of 1994. With the
decision to change its year-end, the Company anticipates that its financial
statements for the eleven month 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
BUSINESS ENVIRONMENT
The Company's principal business activities, investment banking and
securities trading and sales, are by their nature subject to volatility,
primarily due to changes in interest and foreign exchange rates, global and
economic political trends and industry competition. As a result, revenues and
earnings may vary significantly from quarter to quarter and from year to year.
Interest rate uncertainties and inflationary concerns continued to
dampen the activities of both issuers and investors, contributing to an overall
softness in net revenues in 1994. Interest rates continued to rise creating an
unfavorable climate for both debt and equity new issues. Concerns over
increasing interest rates and anticipated Federal Reserve actions had a
negative effect on customer activity. Customers concentrated on short-term,
high quality products in the fixed income area which typically provide reduced
profit margins. Equity investors were equally defensive in posture. During
1993, the Company's operating results were achieved in a more favorable
environment which was characterized by declining interest rates. The 1993
environment resulted in record levels of debt and equity issuances
industrywide, along with record operating profits for companies in the
industry.
The Company believes market conditions experienced during the first
eight months of 1994 will continue throughout the fourth quarter, resulting in
lower revenues, profit margins and profits as compared to the prior year.
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.
16
<PAGE> 17
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three months ended
--------------------------------------------------------------------
August 31, 1994 September 30, 1993
--------------- ------------------------------------------------
(UNAUDITED) Lehman Lehman Businesses
(IN MILLIONS) Businesses Businesses Sold Historical
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Market making and principal
transactions $ 180 $ 260 $ 41
Investment banking 116 142 47
Commissions 98 111 118
Interest and dividends 1,790 1,267 25
Other 14 14 67
------ ------ ----
Total revenues 2,198 1,794 298
Interest expense 1,695 1,152 18
------ ------
Net revenues 503 642 280 $922
------ ------ ---- ----
Non-interest expenses:
Compensation and benefits 265 322 180
Other expenses 268 209 95
------ ------
Total non-interest expenses 533 531 275 806
------ ------ ---- ----
Income (loss) before taxes and preferred
dividend of subsidiary (30) 111 5 116
Provision for (benefit from) income taxes (28) 34 3 37
------ ------ ----
Income (loss) before preferred dividend
of subsidiary (2) 77 2 79
Preferred dividend of subsidiary (17) (17) (17)
Net income (loss) $ (19) $ 60 $ 2 $ 62
====== ====== ==== ====
<CAPTION>
Eight months ended Nine months ended
August 31, 1994 September 30, 1993
------------------- ------------------------------------------------
(UNAUDITED) Lehman Lehman Businesses
(IN MILLIONS) Businesses Businesses Sold Historical
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Market making and principal transactions $ 616 $ 841 $ 323
Investment banking 289 439 171
Commissions 288 326 828
Interest and dividends 4,128 3,632 161
Other 33 42 412
------ ------ ------
Total revenues 5,354 5,280 1,895
Interest expense 3,889 3,305 143
------ ------
Net revenues 1,465 1,975 1,752 $3,727
------ ------ ------ ------
Non-interest expenses:
Compensation and benefits 753 1,053 1,164
Other expenses 682 643 471
Loss on sale of Shearson 535
Reserves and other charges 27 21 120
------ ------ ---
Total non-interest expenses 1,462 1,717 2,290 4,007
------ ------ ------ ------
Income (loss) from continuing
operations before taxes,
cumulative effect of change in
accounting principle
and preferred dividend of subsidiary 3 258 (538) (280)
Provision for (benefit from) income taxes (24) 92 108 200
------ ------ ------ ------
Income (loss) from continuing operations
before cumulative effect of change in
accounting principle and preferred
dividend of subsidiary 27 166 (646) (480)
------ ------ ------
Income from discontinued operations, net
of taxes 189 189
------ ------ ------ ------
Income (loss) before cumulative effect
of change in accounting principle and
preferred dividend of subsidiary 27 166 (457) (291)
Cumulative effect of change in
accounting principle (13)
Preferred dividend of subsidiary (45) (51) (51)
------
Net income (loss) $ (31) $ 115 $ (457) $ (342)
====== ====== ====== ======
</TABLE>
17
<PAGE> 18
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED AUGUST 31, 1994 AND SEPTEMBER 30, 1993
- - -----------------------------------------------------------------
The Company reported a net loss of $19 million for the third quarter
ended August 31, 1994 as compared to net income of $62 million for the third
quarter ended September 30, 1993. The 1993 net income of $62 million was
comprised of net income from the Lehman Businesses of $60 million and net
income from the Businesses Sold of $2 million.
THE LEHMAN BUSINESSES
FOR THE THREE MONTHS ENDED AUGUST 31, 1994 AND SEPTEMBER 30, 1993
- - -----------------------------------------------------------------
Summary. The Lehman Businesses reported a net loss of $19 million for
the third quarter of 1994 as compared to net income of $60 million in the third
quarter of 1993. Net revenues from the Lehman Businesses decreased 22% to $503
million in the third quarter of 1994 from $642 million in the prior year.
Total non-interest expenses were $533 million for the third quarter of 1994,
virtually unchanged from the prior year.
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. Market making and principal transactions revenues
decreased 31% to $180 million for the third quarter of 1994 from $260 million
in the third quarter of 1993. The third quarter 1994 results were affected by
market uncertainties which reduced the levels of customer flow activity and, in
turn, resulted in lower revenues across most major product lines.
Investment Banking. Investment banking revenues decreased 18% to $116
million for the third quarter of 1994 from $142 million in the prior year
period, due to lower origination volumes partially offset by improved results
from strategic advisory activities.
Commissions. Commission revenues decreased 12% to $98 million in the
third quarter of 1994 from $111 million in the third quarter of 1993,
reflecting lower 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 41%
to $1,790 million in the third quarter of 1994 from $1,267 million in the third
quarter of 1993. However, net interest and dividend income decreased 17% to
$95 million in the third quarter of 1994 from $115 million in the third 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
18
<PAGE> 19
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 and increased funding costs to the Company as a result of the
higher interest rate environment.
Non-interest Expenses. Total non-interest expenses were $533 million
in the third quarter of 1994 as compared to $531 million for the third quarter
of 1993. Excluding compensation and benefits expense, non-interest expenses
increased 28% to $268 million in the third quarter of 1994 from $209 million in
the third quarter of 1993. During the third quarter of 1994, Holdings acquired
additional facilities and certain employees of the Company who perform
administrative and corporate functions were transferred to Holdings. The cost
of these new facilities and services provided by employees transferred has been
allocated by Holdings to the Company. For the third quarter of 1994, the
allocated charges totaled $38 million and are shown as management fees in the
Company's Consolidated Statement of Operations. The result of these
allocations was to reduce expenses incurred directly by the Company in previous
periods with an offsetting increase in management fees. The increase in
non-interest expenses excluding compensation and benefits is primarily related
to these management fees along with other allocations between affiliated
entities.
Compensation and benefits expense decreased 18% to $265 million in the
third quarter of 1994 from $322 million in the third quarter of 1993,
consistent with lower levels of business activities in the third quarter. A
portion of the decrease in compensation and benefits expense is also due to the
transfer of certain employees in July 1994 to Holdings. The Company continued
to receive charges for the services of these employees, which are included in
management fees. Compensation and benefits expense as a percentage of net
revenues increased to 52.8% in the third quarter of 1994 from 50.2% in the
third quarter of 1993.
Income Taxes. For the third quarter of 1994, the Lehman Businesses had
an income tax benefit of $28 million as compared to an income tax provision of
$34 million a year ago. The 1994 results reflect the pre-tax loss and benefits
related to income subject to preferential tax treatment.
RESULTS OF OPERATIONS
FOR THE EIGHT MONTHS ENDED AUGUST 31, 1994 AND NINE MONTHS ENDED SEPTEMBER 30,
- - ------------------------------------------------------------------------------
1993
- - ----
The Company reported a net loss of $31 million for the first eight
months of 1994. The 1994 results included a $13 million after-tax 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 after-tax severance
charge. In 1993, the Company reported a net loss of $342 million comprised of
net income from the Lehman Businesses of $115 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 $646 million, which included an
after-tax loss on the sale of Shearson of $630 million ($535 million pre-tax),
an after-tax charge of $79 million ($120 million pre-tax) related to a reserve
for non-core businesses recognized in anticipation of the sale of SLHMC, and
operating earnings from Shearson of $63 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 EIGHT MONTHS ENDED AUGUST 31, 1994 AND NINE MONTHS ENDED SEPTEMBER 30,
- - ------------------------------------------------------------------------------
1993
- - ----
Summary. The Lehman Businesses reported a net loss of $31 million for
the first eight months of 1994 and net income of $115 million for the first
nine months of 1993. Included in the 1994 results were a $13 million ($23
million pre-tax) charge for the cumulative effect of a change in accounting
principle and a $15 million ($27 million pre-tax) severance charge. Excluding
these charges and the preferred dividend of subsidiary, net income for the
Lehman Businesses would have been $42 million. Net income for the first nine
months of 1993 was $166 million before recognition of the preferred dividend of
subsidiary. The 1993 net income 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 this charge, net income
before the preferred dividend of subsidiary, for the first nine months of 1993
was $179 million. Net revenues were $1,465 million for the first eight months
of 1994 and $1,975 million for the first nine months of 1993.
Market Making and Principal Transactions. Market making and principal
transactions revenues were $616 million for the first eight months of 1994 and
$841 million for the first nine months of 1993. Ongoing market uncertainties
lowered the levels of customer flow activity resulting in lower revenues across
most major product lines.
Investment Banking. Investment banking revenues were $289 million for
the first eight months of 1994 and $439 million for the first nine months of
1993. Investment banking revenues in 1994 were adversely affected by lower
origination volumes and a significantly reduced syndicate calendar in both
equities and fixed income, partially offset by improved results from strategic
advisory activities.
Commissions. Commission revenues were $288 million for the first
eight months of 1994 and $326 million for the first nine months of 1993.
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 were $4,128
million for the first eight months of 1994 and $3,632 million for the first
nine months of 1993. Net interest and dividend income was $239 million for the
first eight months of 1994 and $327 million for the first nine months of 1993.
Net interest and dividend revenues for the current year were adversely affected
by reduced spreads on fixed income products and increased funding costs to the
Company as a result of the higher interest rate environment.
Non-Interest Expenses. Total non-interest expenses were $1,462 million
for the first eight months of 1994 and $1,717 million for the first nine months
of 1993. Excluding compensation and benefits expense, non-interest expenses
were $709 million for the eight months ended August 31, 1994 and $664 million
for the nine months ended September 30, 1993. Included in the 1994 results was
a severance charge of $27 million. 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 and
compensation and benefits, non-interest expenses were $682 million for the
first eight months of 1994 and $643 million for the first nine months of 1993.
As discussed previously, included within non-interest expenses in 1994 are
management fees totaling $38 million which have been allocated by Holdings
20
<PAGE> 21
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
to the Company. The increase in non-interest expenses excluding compensation
and benefits is primarily related to these management fees along with other
allocations between affiliated entities.
Compensation and benefits expense was $753 million for the eight
months ended August 31, 1994 and $1,053 million for the nine months ended
September 30, 1993. Compensation and benefits expense for 1994 has been
affected by lower levels of business activities. In addition, the 1994
compensation and benefits expense has been affected by the transfer of certain
employees in July 1994 to Holdings. The Company continued to receive charges
for the services of these employees, which are included in management fees.
Compensation and benefits expense as a percentage of net revenues was 51.4% for
the first eight months of 1994 and 53.3% for the first nine months of 1993.
The Company remains committed to its expense reduction efforts and the
ongoing review of its expense structure. Throughout 1994, the Company has
taken actions to reduce its headcount and will continue to review its expense
base in order to be proactive in reducing costs in the current environment.
Income Taxes. For the first eight months of 1994, the Lehman
Businesses had an income tax benefit of $24 million and an expense of $92
million for the first nine months of 1993. The 1994 results reflect lower
pre-tax earnings and benefits related to income subject to preferential tax
treatment.
As of August 31, 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. It is anticipated that a
portion of these benefits will be recognized in the fourth quarter of 1994.
The benefits, when recognized, will be reflected as a reduction to goodwill.
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 $87.3 billion at August 31, 1994 from $57.8
billion at December 31, 1993. A substantial portion of this increase was due to
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 $3.7
billion at August 31, 1994, compared to $2.6 billion at December 31, 1993.
The Company had no commercial paper outstanding at August 31, 1994, compared to
$400 million at December 31, 1993.
The Company's uncommitted lines of credit provide an additional source of
short-term financing. At August 31, 1994, the Company had $5.3 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 first eight months of 1994,
the Company paid $390 million to Holdings, $300 million as a return of capital
and $90 million as dividends.
For the eight months ended August 31, 1994, the Company issued
approximately $1.1 billion of subordinated indebtedness, of which $540 million
was fixed rate. The Company entered into interest rate swap contracts which
effectively converted $450 million of these fixed rate issuances to floating
rates based on the London Interbank Offered Rate. The remaining $520 million
of 1994 subordinated issuances were borrowings from Holdings and a subsidiary
of Holdings. The proceeds of the Company's issuances for the first eight
months of 1994 have been used to provide additional liquidity and to refinance
long-term debt maturing in 1994. At August 31, 1994, the Company had long-term
debt outstanding of $4.2 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 August 31, 1994, the Company had $525 million available for
issuance under its shelf registration.
On September 21, 1994, Standard & Poor's (S&P) affirmed the short and
long-term ratings of the Company. However, in light of weaker market
conditions resulting from interest rate uncertainties and inflationary
concerns, S&P has revised the long-term debt outlook of the Company from stable
to negative. Furthermore, S&P indicated that weak or volatile earnings over
the next few quarters could lead to a rating downgrade. Other rating agencies
either took no action or affirmed the Company's existing ratings. In the event
of a downgrade, there would be a negative impact on the Company's funding costs
and a potential for reduced access to borrowings.
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. On October 12, 1994, the Company and Bear Stearns
Securities Corp. ("BSSC") entered into an agreement pursuant to which BSSC has
agreed to 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 (the "BSSC Agreement"). The BSSC Agreement is
currently anticipated to take effect during the first half of 1995 and will run
for a term of five years. At August 31, 1994 the balance sheet would have
increased by approximately $12 billion had this arrangement been in effect.
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 through
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 August 31, 1994, the carrying value of the Company's investment in
the partnership was $172 million and the outstanding balance of the
collateralized loans, including accrued interest, was $175 million. The
remaining loan balance is expected to be recovered during the fourth quarter of
1994 and the related investment should be fully recovered by the second half of
1995 through a combination of securitizations, asset sales, mortgage
remittances 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
23
<PAGE> 24
LEHMAN BROTHERS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
loans to companies rated below BBB- by S&P 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 August 31, 1994 and December 31, 1993 included
long positions with an aggregate market value of approximately $628 million and
$661 million, respectively, and short positions with an aggregate market value
of approximately $76 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 $36 million and $28 million at
August 31, 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 commenced in August
1994 and provides for minimum rental payments of approximately $87 million over
its 16-year term. Concurrently, Holdings relocated certain administrative
employees to five additional floors at 3 World Financial Center in New York,
New York. These floors were purchased from American Express for approximately
$44 million through an assumption of a portion of the existing debt related to
the World Financial Center. 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 the remaining real estate investment portfolio. At August
31, 1994, the Company had net exposure to these investments (defined as the
remaining unreserved investment balance plus outstanding commitments and
contingent liabilities under guarantees and credit enhancements) of $55
million. In certain circumstances, the Company provides financial and other
support and assistance to such investments to maintain investment values.
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
widely held 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.
General Acquisition, Inc. et al. v. GenCorp, Inc. et al. (Reported in LBI's
Annual Report on Form 10-K and First and Second Quarter Reports on Form 10-Q)
The parties have settled all actions among them.
Bamaodah v. E.F. Hutton & Company Inc. (Reported in LBI's Annual Report on Form
10-K and First and Second Quarter Reports on Form 10-Q)
The Company has appealed the judgment of the Dubai Court of Appeals to
the Court of Cassation. The appeal is expected to be argued on October 23,
1994.
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 and Second Quarter Reports on Form 10-Q)
On August 31, 1994, the Wisconsin District Court granted the
defendants' motions for summary judgment and dismissed both the Majeski and
Eckstein cases with prejudice.
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 and Second Quarter
Reports on Form 10-Q)
The United States District Court for the Northern District of Illinois
granted plaintiffs' motion for class certification and defendants moved for
reconsideration.
Glynwil Investment, Ltd. v. Shearson Lehman Brothers Inc. (Reported in LBI's
Annual Report on Form 10-K and First and Second Quarter Reports on Form 10-Q)
25
<PAGE> 26
LEHMAN BROTHERS INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS (CONTINUED)
------------------
LBI has moved for summary judgment. The New York court has set a
trial date of October 31, 1994.
Actions Relating to First Capital Holdings Inc. (Reported in LBI's Annual
Report on Form 10-K)
The Bankruptcy Court Action. A trial of limited issues specified by
the court commenced September 22, 1994 and is continuing.
26
<PAGE> 27
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.
27. Financial Data Schedule BD.
(b) Reports on Form 8-K:
1. Form 8-K filed September 30, 1994, Items 5 & 7.
27
<PAGE> 28
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: October 17, 1994 By /s/ Richard S. Fuld, Jr.
---------------------------
Richard S. Fuld, Jr.
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: October 17, 1994 By /s/ Robert Matza
--------------------------
Robert Matza
Chief Financial Officer
(Principal Financial Officer)
28
<PAGE> 29
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT PAGE NO.
- - ----------- ------- --------
<S> <C> <C>
Exhibit 12 Computation in Support of Ratio of Earnings to Fixed Charges.
Eshibit 27 Financial Data Schedule BD.
</TABLE>
29
<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
Eight Months
Ended
For the Year Ended December 31, August 31,
---------------------------------------------- ------------
1989 1990 1991 1992 1993 1994
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Fixed charges:
Interest expense:
Subordinated indebtedness $ 341 $ 277 $ 231 $ 210 $ 192 $ 129
Bank loans and other
borrowings* 4,325 3,753 4,068 4,363 4,393 3,760
Interest component of rentals
of office and equipment 63 57 64 64 62 19
Other adjustments** 152 73 88 127 101 48
------ ------ ------ ------ ------ ------
TOTAL (A) $4,881 $4,160 $4,451 $4,764 $4,748 $3,956
====== ====== ====== ====== ====== ======
Earnings:
Pre-tax income (loss) from
continuing operations $ 202 $ (501) $ 283 $ 319 $ (146) $ 3
Fixed charges 4,881 4,160 4,451 4,764 4,748 3,956
Other adjustments*** (95) (68) (69) (68) (68) (47)
------- ------ ------- ------- ------ ------
TOTAL (B) $4,988 $3,591 $4,665 $5,015 $4,534 $3,912
====== ====== ====== ====== ====== ======
(B / A) 1.02 **** 1.05 1.05 **** ****
</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, $214 million in
1993 and $44 million in the first eight months of 1994 in order to
cover the deficiency.
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
LEHMAN BROTHERS INC.
This schedule contains summary financial information extracted from the
Consolidated Balance Sheet at August 31, 1994 (Unaudited) and the Consolidated
Statement of Operations for the eight months ended August 31, 1994 (Unaudited)
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 8-MOS
<FISCAL-YEAR-END> NOV-30-1994
<PERIOD-START> JAN-01-1994
<PERIOD-END> AUG-31-1994
<CASH> $1,358
<RECEIVABLES> $9,109
<SECURITIES-RESALE> $33,943
<SECURITIES-BORROWED> $7,924
<INSTRUMENTS-OWNED> $34,176
<PP&E> $413
<TOTAL-ASSETS> $87,335
<SHORT-TERM> $3,693
<PAYABLES> $5,161
<REPOS-SOLD> $52,404
<SECURITIES-LOANED> $1,075
<INSTRUMENTS-SOLD> $10,489
<LONG-TERM> $4,199
<COMMON> $0
$0
$0
<OTHER-SE> $2,413
<TOTAL-LIABILITY-AND-EQUITY> $87,335
<TRADING-REVENUE> $616
<INTEREST-DIVIDENDS> $4,128
<COMMISSIONS> $288
<INVESTMENT-BANKING-REVENUES> $289
<FEE-REVENUE> $0
<INTEREST-EXPENSE> $3,889
<COMPENSATION> $753
<INCOME-PRETAX> $3
<INCOME-PRE-EXTRAORDINARY> $27
<EXTRAORDINARY> $0
<CHANGES> $(13)
<NET-INCOME> $(31)
<EPS-PRIMARY> $0.00
<EPS-DILUTED> $0.00
</TABLE>
