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, 1996
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)
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)
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, 1996 1,006 shares of the Registrant's Common Stock, par value
$.10 per share, were issued and outstanding.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED AUGUST 31, 1996
INDEX
Part I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Operations -
Three and Nine Months Ended August 31, 1996
and 1995 3
Consolidated Statement of Financial Condition -
August 31, 1996 and November 30, 1995 5
Consolidated Statement of Cash Flows -
Nine Months Ended August 31, 1996
and 1995 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 6. Exhibits and Reports on Form 8-K 31
Signatures 32
EXHIBIT INDEX 33
Exhibits
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of OPERATIONS
(Unaudited)
(In millions)
Three months ended
August 31, August 31,
1996 1995
------------- -----------
Revenues
Principal transactions $ 85 $ 159
Investment banking 189 186
Commissions 65 100
Interest and dividends 2,717 2,634
Other 1 7
-------- --------
Total revenues 3,057 3,086
Interest expense 2,614 2,525
----- -----
Net revenues 443 561
------ -----
Non-interest expenses
Compensation and benefits 267 306
Brokerage, commissions and clearance fees 51 47
Communications 24 29
Occupancy and equipment 20 20
Business development 17 18
Professional services 16 17
Depreciation and amortization 13 15
Management fees 7 24
Other 38 24
------ -------
Total non-interest expenses 453 500
----- ------
Income (loss) before taxes (10) 61
Provision for (benefit from) income taxes (10) 22
----- ------
Net income (loss) $ 0 $ 39
======= ======
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of OPERATIONS
(Unaudited)
(In millions)
Nine months ended
August 31, August 31,
1996 1995
------------- ---------
Revenues
Principal transactions $ 671 $ 498
Investment banking 523 407
Commissions 223 300
Interest and dividends 7,800 7,623
Other 15 29
------ -------
Total revenues 9,232 8,857
Interest expense 7,567 7,358
----- -----
Net revenues 1,665 1,499
----- -----
Non-interest expenses
Compensation and benefits 884 753
Brokerage, commissions and clearance fees 150 146
Communications 74 93
Occupancy and equipment 57 64
Business development 55 61
Professional services 54 61
Depreciation and amortization 40 48
Management fees 51 124
Other 137 98
------ -------
Total non-interest expenses 1,502 1,448
----- -----
Income before taxes 163 51
Provision for income taxes 63 7
------- --------
Net income $ 100 $ 44
====== =======
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(Unaudited)
(In millions)
ASSETS
August 31, November 30,
1996 1995
Cash and cash equivalents $ 357 $ 287
Cash and securities segregated and on deposit
for regulatory and other purposes 828 785
Securities and other financial instruments owned:
Governments and agencies 17,748 14,038
Corporate obligations and other contractual
commitments 6,310 8,115
Certificates of deposit and other money market
instruments 2,575 2,958
Mortgages and mortgage-backed 2,338 3,182
Corporate stocks and options 2,589 2,856
------- -------
31,560 31,149
------ ------
Collateralized short-term agreements:
Securities purchased under agreements to resell 26,323 25,982
Securities borrowed 23,411 16,562
Receivables:
Brokers, dealers and clearing organizations 4,738 2,719
Customers 3,112 2,219
Others 6,835 2,175
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $492 in 1996 and $455 in 1995) 293 333
Deferred expenses and other assets 190 219
Excess of cost over fair value of net assets
acquired (net of accumulated amortization of $92
in 1996 and $86 in 1995) 168 174
---------- ---------
$97,815 $82,604
======= =======
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (Continued)
(Unaudited)
(In millions, except share data)
LIABILITIES AND STOCKHOLDER'S EQUITY
August 31, November 30,
1996 1995
----------- ----------
Commercial paper and short-term debt $ 4,844 $ 1,008
Securities and other financial instruments sold
but not yet purchased:
Governments and agencies 7,369 6,477
Corporate obligations and other contractual
commitments 3,104 3,403
Corporate stocks and options 2,245 1,195
------- -------
12,718 11,075
------ ------
Collateralized short-term financings:
Securities sold under agreements to repurchase 43,449 41,900
Securities loaned 9,508 2,649
Advances from Holdings and other affiliates 8,162 8,418
Payables:
Brokers, dealers and clearing organizations 4,413 4,467
Customers 6,760 5,733
Accrued liabilities and other payables 1,975 1,829
Long-term debt:
Senior notes 212 420
Subordinated indebtedness 3,793 3,077
------- ------
Total liabilities 95,834 80,576
------ ------
Commitments and contingencies
Stockholder's equity:
Preferred stock,$.10 par value; 10,000 shares
authorized; none outstanding
Common stock, $.10 par value; 10,000 shares
authorized; 1,006 shares issued and outstanding
in 1996 and 1995
Additional paid-in capital 2,206 2,353
Foreign currency translation adjustment 3 3
Accumulated deficit (228) (328)
-------- -------
Total stockholder's equity 1,981 2,028
-------- -------
Total liabilities and stockholder's equity $97,815 $82,604
======= =======
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In millions)
Nine months ended
August 31, August 31,
1996 1995
------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 100 $ 44
Adjustments to reconcile income to net cash (used in)
provided by operating activities:
Depreciation and amortization 40 48
Provisions for losses and other reserves 30 22
Other adjustments 15 13
Net change in:
Cash and securities segregated (43) 626
Receivables from brokers, dealers and clearing
organizations (2,019) 1,058
Receivables from customers (893) (1,032)
Securities purchased under agreements to resell (341) 2,388
Securities borrowed (6,849) (8,900)
Securities and other financial instruments owned (411) 249
Payables to brokers, dealers and clearing
organizations (54) (260)
Payables to customers 1,027 3,675
Accrued liabilities and other payables 109 (109)
Securities sold under agreements to repurchase 1,549 375
Securities loaned 6,859 3,575
Securities and other financial instruments sold but
not yet purchased 1,643 2,684
Other operating assets and liabilities, net (4,625) 1,063
------ ----
Net cash (used in) provided by operating activities $(3,863) $5,519
-------- ------
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS -- (Continued)
(Unaudited)
(In millions)
Nine months ended
August 31, August 31,
996 1995
----------------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments of senior notes $ (210) $ (97)
Proceeds from issuance of subordinated indebtedness 975 250
Principal payments of subordinated indebtedness (261) (64)
Net proceeds from (payments for) commercial paper and
short-term debt 3,835 (500)
Decrease in advances from Holdings
and other affiliates (256) (3,808)
Capital contributions 4
Dividends and capital distributions paid (151) (475)
------ ------
Net cash provided by (used in) financing activities 3,936 (4,694)
----- ------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and
leasehold improvements (3) (16)
-------- ------
Net cash used in investing activities (3) (16)
-------- ------
Net change in cash and cash equivalents 70 809
------- ------
Cash and cash equivalents, beginning of period 287 361
------ ------
Cash and cash equivalents, end of period $ 357 $1,170
====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $7,569 and $7,400 for the nine months ended
August 31, 1996 and 1995, respectively. Income taxes paid totaled $22 and $11
for the nine months ended August 31, 1996 and 1995, respectively.
See notes to consolidated financial statements.
<PAGE>
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"). LBI is one of the leading global
investment banks serving institutional, corporate, government and high-net-worth
individual clients and customers. The Company's worldwide headquarters in New
York are complemented by offices in additional locations in North America,
Europe, the Middle East, Latin and South America and the Asia Pacific region.
Holdings provides investment banking and capital markets services in Europe and
Asia. The Company is engaged primarily in providing financial services. The
Company also operates a commodities trading and sales operation in London. All
material intercompany accounts and transactions have been eliminated in
consolidation. The Company's financial statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission (the "SEC") 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. The
Consolidated Statement of Financial Condition at November 30, 1995 was derived
from the audited financial statements. It is recommended that these financial
statements be read in conjunction with the audited consolidated financial
statements included in the Company's Annual Report on Form 10-K for the twelve
months ended November 30, 1995 (the "Form 10-K").
The nature of the Company's business is such that the results of any
interim period may vary significantly from quarter to quarter and may not be
indicative of the results to be expected for the fiscal year. Certain amounts
reflect reclassifications to conform to the current period's presentation.
2. Long-Term Debt:
During the nine months ended August 31, 1996, the Company issued $975
million of fixed-rate subordinated indebtedness with maturities ranging from
2001 to 2026. These issuances have been effectively converted to floating rate
obligations, based on the London Interbank Offered Rates ("LIBOR") through the
use of interest rate swaps. In addition, $471 million of long-term debt matured
during the nine months ended August 31, 1996.
3. Capital Requirements:
As a registered broker-dealer, LBI is subject to SEC Rule 15c3-1, the
Net Capital Rule, which requires LBI to maintain net capital of not less than
the greater of 2% of aggregate debit items arising from customer transactions,
as defined, or 4% of funds required to be segregated for customers' regulated
commodity accounts, as defined. At August 31, 1996, LBI's regulatory net
capital, as defined, of $1,708 million exceeded the minimum requirement by
$1,616 million. The Company's triple-A rated derivatives subsidiary, Lehman
Brothers Financial Products Inc., has established certain capital and operating
restrictions which are reviewed by various rating agencies.
Repayment of subordinated indebtedness and certain advances and
dividend payments by LBI are restricted by the regulations of the SEC and other
regulatory agencies. In addition, certain instruments governing the indebtedness
of LBI contractually limit its ability to pay dividends.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Derivative Financial Instruments:
In the normal course of business, the Company enters into derivative
transactions both in a trading capacity and as an end user. Acting in a trading
capacity, the Company enters into derivative transactions to satisfy the needs
of its clients and to manage the Company's own exposure to market and credit
risks resulting from its trading activities in cash instruments (collectively,
"Trading Related Derivative Activities"). For a further discussion of the
Company's derivative related activities, refer to "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Off-Balance Sheet
Financial Instruments and Derivatives" and Note 13 to the Consolidated Financial
Statements, included in the Form 10-K.
Trading-Related Derivative Activities
The Company records its Trading-Related Derivative Activities on a
mark-to-market basis with realized and unrealized gains (losses) recognized in
principal transactions in the Consolidated Statement of Operations. The Company
records unrealized gains and losses on derivative contracts on a net basis in
the Consolidated Statement of Financial Condition for those transactions with
counterparties executed under a legally enforceable master netting agreement.
Listed in the following table is the fair value and average fair value of the
Company's Trading Related Derivative Activities (in millions):
Average Fair Value*
Fair Value* Nine Months Ended
August 31, 1996 August 31, 1996
--------------- ---------------
Assets Liabilities Assets Liabilities
- -------------------------------------------------------------------------------
Interest rate and currency swaps and options
(including caps, collars and floors) $3,527 $1,693 $3,258 $1,675
Foreign exchange forward contracts and options 451 667 632 943
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 325 282 242 227
Equity contracts (including equity swaps,
warrants and options) 41 31 52 37
Commodity contracts (including swaps, forwards,
and options) 43 38 40 46
---------------------------------
Total $4,387 $2,711 $4,224 $2,928
---------------------------------
* Amounts represent carrying value (exclusive of collateral) and do not include
receivables or payables related to exchange traded futures contracts.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Twelve Months Ended
November 30, 1995 November 30, 1995
----------------- -----------------
Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $2,672 $2,248 $2,692 $2,060
Foreign exchange forward contracts and options 893 1,171 1,173 1,226
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 188 151 182 172
Equity contracts (including equity swaps, warrants
and options) 40 31 42 17
Commodity contracts (including swaps, forwards,
and options) 39 51 67 60
------------------------------------------------------
Total $3,832 $3,652 $4,156 $3,535
-----------------------------------------------------
</TABLE>
* Amounts represent carrying value (exclusive of collateral) and do not include
receivables or payables related to exchange traded futures contracts.
Assets included in the table above represent the Company's unrealized
gains, net of unrealized losses for which the Company has a master netting
agreement. Therefore, the fair value of assets related to derivative contracts
at August 31, 1996 represents the Company's net receivable for derivative
financial instruments before consideration of collateral. Included within this
amount was $4,346 million and $41 million, respectively, related to OTC and
exchange-traded contracts.
With respect to OTC contracts, the Company's views its net credit
exposure to be $3,222 million at August 31, 1996, representing the fair value of
the Company's OTC contracts in an unrealized gain position, after consideration
of collateral of $1,124 million. Presented below is an analysis of the Company's
net credit exposure for OTC contracts based upon internal designations of
counterparty credit quality.
Counterparty S&P/Moody's August 31, 1996
Risk Rating Equivalent Net Credit
Exposure
1 AAA/Aaa 19%
2 AA-/Aa3 or higher 23%
3 A-/A3 or higher 46%
4 BBB-/Baa3 or higher 9%
5 BB-/Ba3 or higher 2%
6 B+/B1 or lower 1%
- --------------------------------------------------------------------------------
These designations are based on actual ratings made by external rating
agencies or by equivalent ratings established and utilized by the Company's
Corporate Credit Department.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company is also subject to credit risk related to its exchange
traded derivative contracts. Echange traded contracts are translated directly on
the exchange. To protect against the potential for a default, all exchange
clearing houses impose net capital requirements for their membership.
Additionally, the exchange clearing house requires counterparties to futures
contracts to post margin upon the origination of the contract and for any
changes in the market value of the contract on a daily basis (certain foreign
exchanges extend settlement to three days). Therefore, the potential for losses
from exchange-traded products is limited.
5. Other Commitments and Contingencies:
In the normal course of its business, the Company has been named a
defendant in a number of lawsuits and other legal proceedings. After considering
all relevant facts, available insurance coverage and the advice of outside
counsel, in the opinion of the Company such litigation will not, in the
aggregate, have a material adverse effect on the Company's consolidated
financial position or results of operations.
As a leading global investment bank, risk is an inherent part of all of
the Company's businesses and activities. The extent to which the Company
properly and effectively identifies, assesses, monitors and manages each of the
various types of risks involved in its trading (including derivatives),
brokerage, and investment banking activities is critical to the success and
profitability of the Company. The principal types of risks involved in the
Company's activities are market risk, credit or counterparty risk, and
transaction risk. Management has developed a control infrastructure to monitor
and manage each type of risk on a global basis throughout the Company. For
further discussion of these matters, refer to Note 15 to the Consolidated
Financial Statements, in the Form 10-K.
6. 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 nine months ended August 31, 1996, the Company paid $151
million to Holdings as a return of capital.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Incentive Plans:
In June 1996, the Compensation and Benefits Committee of the Board of
Directors of Holdings (the "Compensation Committee") approved the 1996 Stock
Award Program (the "1996 Program"), pursuant to the Lehman Brothers Holdings
Inc. Employee Incentive Plan ("EIP"). Under the 1996 Program, eligible employees
of Holdings and the Company are to receive, subject to vesting provisions and
transfer restrictions, approximately five million restricted stock units
("RSUs"). These RSUs will vest 80% on July 1, 1997 and 20% on July 1, 2001. A
total of 20 million shares of common stock may be subject to awards under the
EIP. Through August 31, 1996, approximately eleven million shares have been
awarded, consisting of approximately seven million RSUs for both the 1996
Program and for new hires as part of Holdings and the Company's recruitment
efforts, 1.4 million options granted in 1995 and approximately 2.7 million
options granted in 1996 to certain senior officers. The Company controls the
dilutive impact of these awards through open market purchases.
In addition, members of the Corporate Management Committee ("CMC") and
certain senior officers are eligible to receive RSUs based on the achievement of
1996 performance goals, with approximately one million RSUs expected to be
awarded in total under the 1996 Management Ownership Plan (the "1996 Plan") and
the EIP. The 1996 Plan was approved by shareholders of Holdings on April 10,
1996.
In the second quarter of 1996, Holdings granted approximately 0.8
million options under the 1996 Plan to members of the Corporate Management
Committee ("CMC") at an average market price on the dates of grant of $24.06
(the "1996 Options"). The 1996 Options become exercisable in four and one half
years and expire five years after grant date; exercisability is accelerated
ratably in one-third increments at such time as the closing price of the common
stock meets, or exceeds, $28.00, $30.00 and $32.00 for 30 consecutive trading
days. If a minimum target price is not reached and maintained for the specified
period in the four and one half year period following issuance, the award
recipients may then exercise all of their options thereafter. Also, in the
second quarter, Holdings granted approximately 2.7 million options under the EIP
to certain senior officers (as previously mentioned in the 1996 Program
discussion above) at an average market price on the dates of grant of $24.19,
with provisions similar to the 1996 Options. No compensation expense has been
recognized for any of these stock options as all have been issued at the market
price of the common stock on the date of the respective grant.
Also in the second quarter of 1996, Holdings awarded performance stock
units ("PSUs") under the 1996 Plan to members of the CMC and under the EIP to
certain senior officers as part of a four-year long-term incentive award. The
number of PSUs which may be earned, if any, is dependent upon achievement of
certain performance levels within a two-year period. At the end of the
performance period, any PSUs earned will convert one-for-one to RSUs which then
vest at the end of the fourth year. The compensation cost for the estimated
number of RSUs that may eventually become payable in satisfaction of PSUs is
accrued over the combined performance and vesting period and added to common
stock issuable.
<PAGE>
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 economic
and political trends and industry competition. As a result, revenues and
earnings may vary significantly from quarter to quarter and from year to year.
The favorable market environment experienced during the second half of
1995 continued into 1996. The U.S. bond market rallied, as expectations for
additional easing by the U.S. Federal Reserve Bank and the possibility of a
deficit reduction package positively impacted the industry as a whole.
Internationally, weakness in the major European economies produced a round of
interest rate cuts from a number of central banks in an effort to promote
stronger economic growth. These actions led to more positive market conditions
in Europe. The favorable worldwide trend in interest rates also supported strong
performance in global equity markets. All of these factors led to continued
strength in debt and equity underwriting volumes.
By mid February, 1996, investor concerns about stronger economic data,
raising the possibility of no further interest rate reductions by the U.S.
Federal Reserve Bank, caused a significant correction in the U.S. fixed income
market and a general increase in interest rates. Despite this change in interest
rates, the overall market environment in the second quarter remained reasonably
favorable. Investors were active in purchasing new issue products that offered a
spread to Treasuries, such as corporate, asset-backed and mortgage-backed bonds,
in order to achieve their performance benchmarks. The increase in investor
demand created a high level of customer volume in the U.S. debt market, while
strong customer demand and favorable spreads drove more issuers into the market,
resulting in an extremely high level of debt syndicate activity.
Late in the second quarter of 1996, the tone in the U.S. fixed income
market became decidedly more negative. Recent strength in the U.S. economy
created a more volatile market environment in terms of heightened inflationary
expectations and a general increase in interest rates. Investors reflected the
uncertainty of a possible Federal Reserve tightening by becoming less active in
general and more defensive. Fixed income underwriting continued at a reasonable
pace as issuers accelerated financing in anticipation of higher interest rates
later in the year. The equity market, meanwhile, continued to exhibit strength
as positive cash flows into mutual funds provided a strong underpinning for both
trading and syndicate activity. The second quarter realized record levels of
merger and acquisition activity, reflecting strategic purchases, restructurings,
spin-offs and growth in cross-border transactions.
Investor defensiveness continued into the third quarter of 1996,
particularly in the months of June and July. August experienced a more typical
seasonal slowdown in capital markets' activity. The U.S. market continued to
reflect concerns over higher inflation, tighter labor markets, possible wage
pressures and higher commodity prices. A series of indicators on employment,
price levels and growth in the economy provided mixed signals to the market
place, adding to the uncertainty with regard to the direction of interest rates.
Bond investors reacted to this volatility by becoming cautious and less active.
The equity markets were also impacted by the interest rate volatility, as the
stock market moved lower over concerns about weaker corporate earnings. Equity
trading volumes were lower as flows into mutual funds slowed; and the pace of
equity underwriting slowed as less liquidity in the marketplace caused issuers
to postpone transactions into the fourth quarter.
Early in the fourth quarter, market dynamics strengthened as concerns
over inflation and economic growth diminished. Customer activity in the bond
markets increased, and the enhanced liquidity encouraged higher underwriting
volumes. Similarly, in the U.S. equity markets, renewed strength in mutual fund
flows also produced higher customer trading activity, while improved valuations
prompted increased equity syndicate activity. In the major global markets,
prospects for lower interest rates to offset tighter fiscal policies and to
encourage stronger economic growth created a favorable market environment.
Note: Except for the historical information contained herein, the Business
Environment and Specific Business Activities and Transactions sections of
this Management's Discussion and Analysis of Financial Condition and
Results of Operations contain forward-looking statements that discuss the
risks and uncertainties involved in the Company's business.
<PAGE>
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, 1996 and August 31, 1995
The Company reported a net loss of approximately $264 thousand for the
third quarter ended August 31, 1996 and net income of $39 million for the third
quarter ended August 31, 1995. The results for 1996 reflect the effects of the
difficult market conditions throughout the third quarter of 1996, particularly
in the equity markets.
Net revenues decreased to $443 million for the third quarter of 1996
from $561 million for the third quarter of 1995 and $615 million for the second
quarter of 1996. The decrease in net revenues reflected reduced customer flow
activities in governments, NASDAQ and equity listed businesses partially offset
by more favorable results from fixed income derivatives and mortgages.
As part of its market-making activities, the Company maintains
inventory positions of varying amounts across a broad range of financial
instruments which are marked-to-market on a daily basis and along with the
Company's proprietary trading positions, give rise to principal transactions
revenues. The Company utilizes various hedging strategies to minimize its
exposure to significant movements in interest and foreign exchange rates and the
equity markets.
Net revenues from the Company's market-making and trading activities in
fixed income and equity products are recognized as either principal transactions
or net interest revenues depending upon the method of financing and/or hedging
related to specific inventory positions. The Company evaluates its trading
strategies on an overall profitability basis which includes both principal
transactions revenues and net interest. Therefore, changes in net interest
should not be viewed in isolation but should be viewed in conjunction with
revenues from principal transactions. Net interest revenues were $103 million
for the third quarter of 1996 and $109 million for the third quarter of 1995.
This decrease was attributed to a change in the mix of the Company's assets and
a reduction of spreads on certain U.S. government matched book financing
transactions.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table of net revenues by business unit and the
accompanying discussion have been prepared in order to present the Company's net
revenues in a format that reflects the manner in which the Company manages its
businesses. For internal management purposes, the Company has been segregated
into five major business units: Fixed Income, Equity, Corporate Finance
Advisory, Merchant Banking and Asset Management. Each business unit represents a
grouping of financial activities and products with similar characteristics.
These business activities result in revenues that are recognized in multiple
revenue categories contained in the Company's Consolidated Statement of
Operations. Net revenues by business unit contain certain internal allocations,
including funding costs, which are centrally managed.
Three Months Ended August 31, 1996
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- --------------------------------------------------------------------------------
Fixed Income $232 $ 11 $ 67 $310
Equity (40) 49 53 62
Corporate Finance Advisory 50 50
Merchant Banking (4) 19 15
Asset Management 5 $ 1 6
- --------------------------------------------------------------------------------
$188 $ 65 $189 $ 1 $443
- --------------------------------------------------------------------------------
Three Months Ended August 31, 1995
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- --------------------------------------------------------------------------------
Fixed Income $205 $ 21 $ 48 $ 3 $277
Equity 63 73 64 200
Corporate Finance Advisory 1 49 50
Merchant Banking (2) 25 23
Asset Management 1 6 4 11
- --------------------------------------------------------------------------------
$268 $100 $186 $ 7 $561
- --------------------------------------------------------------------------------
Fixed Income. The Company's fixed income net revenues reflect customer
flow activities (both institutional and high-net-worth retail), secondary
trading, debt underwriting, syndicate and financing activities related to fixed
income products. Fixed income products include government securities, mortgage-
and asset-backed securities, money market products, dollar- and non-dollar
corporate debt securities, emerging market securities, municipal securities,
financing (global access to debt financing sources including repurchase and
reverse repurchase agreements), foreign exchange, commodities and fixed income
derivative products. Fixed income net revenues increased 12% to $310 million for
the third quarter of 1996 from $277 million for the third quarter of 1995. The
improvement in the third quarter results over the prior year reflected the
stronger syndicate calendar in 1996 and improved customer flow and net trading
results (principal transactions and net interest) from a number of fixed income
products including mortgages, fixed income derivatives, high yield and firm
financing. Investment banking revenues, as a component of fixed income revenues,
increased to $67 million for 1996 from $48 million for 1995 due to a
strengthening in origination volumes and an improved mix of underwriting
revenues.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Equity. Equity net revenues reflect customer flow activities (both
institutional and high-net-worth retail), secondary trading, equity
underwriting, equity finance and arbitrage activities. The Company's equity net
revenues decreased to $62 million for 1996 from $200 million for 1995,
reflecting reduced customer flow activities and lower equity underwriting due to
concerns about U.S. interest rates and corporate earnings. Declining valuations
and less liquidity in the marketplace prompted many issuers to postpone
transactions that had been planned for the third quarter.
Corporate Finance Advisory. Corporate finance advisory net revenues,
classified in the Consolidated Statement of Operations as a component of
investment banking revenues, result primarily from fees earned by the Company in
its role as strategic advisor to its clients. This role primarily consists of
advising clients on mergers and acquisitions, divestitures, leveraged buyouts,
financial restructurings, and a variety of cross-border transactions. The net
revenues for corporate finance advisory were $50 million in 1996 and 1995. These
results reflect continued strength in the merger and acquisition market
environment.
Merchant Banking. The Company is the general partner for four merchant
banking partnerships, including three institutional funds and one employee
investment vehicle. Current merchant banking investments held by the
partnerships include both publicly traded and privately held companies
diversified on a geographic and industry basis. At August 31, 1996 the
Company's investment in such merchant banking partnerships, for which the
Company acts as a general partner, was $86 million. There are no funding
commitments to these partnerships.
Merchant banking net revenues primarily represent the Company's
proportionate share of net realized and net unrealized gains and losses from the
sale and revaluation of investments held by the partnerships. Such amounts are
classified in the Consolidated Statement of Operations as a component of
investment banking revenues. Merchant banking net revenues also reflect the
related net interest expense relating to the financing of the Company's
investment in the partnerships. Merchant banking revenues for the third quarter
of 1996 were $15 million versus $23 million for the third quarter of 1995,
reflecting a reduction in the net gains recognized on the publicly traded
investments held by the partnerships.
Asset Management. Revenues from asset management activities decreased
to $6 million for 1996 from $11 million for 1995. Asset management revenues
primarily consist of fees from the management of various funds, commissions from
the sale of funds to customers and fees from the management of certain accounts
for institutions and high-net-worth individuals.
Non-Interest Expenses. Non-interest expenses were $453 million for the
third quarter of 1996 and $500 million for the third quarter of 1995.
Compensation and benefits expense was $267 million for the third quarter of 1996
and $306 million for the third quarter of 1995 consistent with lower levels of
business activities in the current year quarter.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Non-compensation and benefits expenses were $186 million for 1996 and
$194 million for 1995. Non-compensation and benefits expenses in 1996 and 1995
includes management fees of $7 million and $24 million, respectively, which have
been allocated by Holdings to the Company.
Income Taxes. For the third quarter of 1996, the Company's income tax
benefit was $10 million on a pretax loss of $10 million. For the third quarter
of 1995, the Company reported a tax provision of $22 million on pretax earnings
of $61 million. The effective tax rates for these periods differ from the
statutory U.S. federal income tax rate as a result of state taxes and tax
benefits attributable to income subject to preferential treatment.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
For the Nine Months Ended August 31, 1996 and August 31, 1995
The Company reported net income of $100 million for the nine months
ended August 31, 1996 and net income of $44 million for the nine months ended
August 31, 1995. The improved results for 1996 reflect stronger earnings and
enhanced margins, amid a period of generally improved market conditions.
Net revenues increased to $1,665 million for the nine months of 1996
from $1,499 million for the nine months of 1995. The increase in net revenues
reflected continued strengthening in the customer flow and trading activities in
a number of fixed income and equity product areas and improved investment
banking results. The increase in revenues from investment banking in 1996
reflected a significant strengthening in underwriting volumes and improved
corporate finance advisory revenues partially offset by reduced merchant banking
revenues.
Net interest revenues were $233 million for the nine months of 1996 and
$265 million for the nine months of 1995. Changes in net interest revenue should
not be viewed in isolation, as the results of the Company's trading activities
can fluctuate between either principal transactions or net interest revenues
depending upon the method of financing and/or hedging related to specific
inventory positions. The decrease in net interest revenues was due to a
reduction of spreads on certain U.S. government matched book financing
transactions and an increase in interest-bearing liabilities, partially offset
by a slight increase in total interest-earning assets.
The following table of net revenues by business unit and the
accompanying discussion have been prepared in order to present the Company's net
revenues in a format that reflects the manner in which the Company manages its
businesses. Net revenues by business unit contain certain internal allocations,
including costs, which are centrally managed.
Nine Months Ended August 31, 1996
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- --------------------------------------------------------------------------------
Fixed Income $ 902 $ 42 $ 198 $ 3 $1,145
Equity 12 167 154 4 337
Corporate Finance Advisory 137 137
Merchant Banking (10) 34 24
Asset Management 14 8 22
- --------------------------------------------------------------------------------
$ 904 $ 223 $ 523 $ 15 $1,665
- --------------------------------------------------------------------------------
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Nine Months Ended August 31, 1995
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- --------------------------------------------------------------------------------
Fixed Income $674 $ 66 $110 $ 12 $ 862
Equity 100 215 109 3 427
Corporate Finance Advisory 2 123 125
Merchant Banking (11) 65 2 56
Asset Management (2) 19 12 29
- --------------------------------------------------------------------------------
$763 $300 $407 $ 29 $1,499
- --------------------------------------------------------------------------------
Fixed Income. Fixed income net revenues increased 33% to $1,145 million
for the nine months ended August 31, 1996 from $862 million for the nine months
ended August 31, 1995, reflecting the general strengthening of the business
environment in 1996. Fixed income revenues for 1996 improved versus 1995
primarily as a result of increased customer trading volumes reflecting a
strengthening in the U.S. economy with a reduced federal deficit and relatively
low levels of inflation. The improved market conditions resulted in a
significant increase in investment banking results and greater contributions
from customer flow and trading activities in a number of fixed income products
including governments, mortgages, fixed income derivatives and high yield.
Investment banking revenues, as a component of fixed income revenues, increased
to $198 million for 1996 from $110 million for 1995 due to a strengthening in
origination volumes and an improved mix of underwriting revenues.
Equity. The Company's equity net revenues decreased 21% to $337 million
for 1996 from $427 million for 1995. Equity revenues decreased in 1996 as
significantly improved underwriting results were more than offset by reduced
profitability from the Company's equity customer flow activities. The improved
underwriting volumes reflected the favorable economic environment in 1996 with
generally increased trading volumes on listed exchanges and record flows of
capital into equity mutual funds.
Corporate Finance Advisory. The net revenues for corporate finance
advisory were $137 million in 1996 and $125 million in 1995. The environment for
merger and acquisition activity during 1996 was strong as a result of heightened
industry and cross-border consolidation.
Merchant Banking. Merchant banking net revenues for the 1996 were $24
million versus $56 million for 1995, reflecting a reduction in the net gains
recognized on the publicly traded investments held by the partnerships.
Asset Management. Revenues from asset management activities decreased
to $22 million for 1996 from $29 million for 1995. These revenues primarily
consist of fees from the management of various funds, commissions from the sale
of funds to customers and fees from the management of certain accounts for
institutions and high-net-worth individuals.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Non-Interest Expenses. Non-interest expenses were $1,502 million for
the nine months of 1996 and $1,448 million for the nine months of 1995.
Compensation and benefits expense was $884 million for the 1996 and $753 million
for 1995 consistent with higher levels of business activities in the current
year quarter.
Non-compensation and benefits expenses were $618 million for 1996 and
$695 million for 1995. Non-compensation and benefits expenses in 1996 and 1995
includes management fees of $51 million and $124 million, respectively, which
have been allocated by Holdings to the Company.
Income Taxes. For the nine months ended August 31, 1996, the Company's
income tax provision was $63 million on pretax earnings of $163 million,
resulting in an effective tax rate of 39%. For the nine months of 1995, the
Company reported a tax provision of $7 million on pretax earnings of $51
million. The effective tax rate for these periods differ from the statutory U.S.
federal income tax rate as a result of state taxes and tax benefits attributable
to income subject to preferential treatment.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Company's total assets increased to $97.8 billion at August 31, 1996 from
$82.6 billion at November 30, 1995. The increase in total assets is primarily
attributable to an increase in fixed income and equity financing activities.
The Company's balance sheet is highly liquid and consists primarily of
cash and cash equivalents, securities and other financial instruments owned
which are marked-to-market daily and collateralized short-term financing
agreements. As the Company's primary activities are based on customer flow
transactions, the Company experiences a rapid asset turnover rate. In addition,
the highly liquid nature of these assets provides the Company with flexibility
in financing and managing its business. The overall size of the Company's total
assets and liabilities fluctuates from time to time and at specific points in
time (such as calendar quarter ends) may be higher than fiscal quarter ends.
Funding and Capital Policies
The Firm's Finance Committee which includes senior officers from key
areas of the Company, is responsible for establishing and managing the capital
funding and liquidity policies of the Company. This includes recommendations for
balance sheet size as well as the allocation of balance sheet to product areas
as determined by internal profitability models including cost of capital and
return on equity targets. The primary goal of the Company's funding principles
as set by the Finance Committee are to provide sufficient liquidity and
availability of funding sources across a wide range of market environments.
As a policy, the Company attempts to maintain sufficient capital and
funding to finance itself on a fully secured basis. The Company attempts to meet
its funding requirements through a combination of collateralized short-term
financings and short-term secured debt and Total Capital, (long-term debt plus
stockholder's equity). In conjuction with this policy, the Company's overall
liquidity objectives include maintaining a combination of excess unencumbered
securities, unutilized bank lines and capital which would be available to fund
less liquid assets and meet current maturities of short- and long-term unsecured
borrowings.
The Company's liquidity contingency plans are continually reviewed and
updated as the Company's asset/liability mix and liquidity requirements change.
Additionally, the Company periodically tests its secured and unsecured credit
facilities to ensure availability and operational readiness. The Company's
liquidity and Total Capital policies are designed to ensure that the Company can
meet its funding needs over a wide range of economic, credit and market
environments.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Short-Term Funding
Each of the Company's businesses is required to fund its products
primarily through global collateralized financings. There are two principal
business areas which are responsible for these efforts, Lehman Brothers' Fixed
Income Financing ("Financing") and Equity Finance. Financing works in
conjunction with the institutional fixed income sales and trading professionals
to provide financing to customers and the Company through the repurchase
markets. Equity Finance provides a similar function in the equity markets
typically through securities loaned/securities borrowed transactions. The
ability of the Company to leverage its global market expertise and distribution
capabilities are key to a successful financing effort. The amount of the
Company's collateralized borrowing activities will vary reflecting changes in
the mix and overall levels of securities and other financial instruments owned
and global market conditions. However, at all times, the majority of the
Company's assets are funded with collateralized borrowing sources.
The Company's treasury area works closely with Financing and Equity
Finance to develop funding plans to support the business areas, as well as to
execute daily funding activities. On a daily basis, treasury is responsible for
meeting any funding needs not met through Financing and Equity Finance. Treasury
funding is managed globally through regional centers which have access to the
capital markets though the issuance of commercial paper, as well as, access to
bank credit lines and other short- and long-term debt instruments.
At August 31, 1996 and at November 30, 1995, $66 billion and $56
billion, respectively, of the Company's total balance sheet was financed using
collateralized borrowing sources. The remainder of the financing for the balance
sheet was comprised of commercial paper and short-term debt, payables and Total
Capital. As of August 31, 1996 and November 30, 1995, commercial paper and
short-term debt was $4.8 billion and $1.0 billion, respectively. Of these
amounts, commercial paper outstanding at August 31, 1996 was $5 million with an
average maturity of 31 days. At November 30, 1995, there was no commercial paper
outstanding.
The Company maintains uncommitted lines of credit with a broad range of
banks and financial institutions from which it draws funds in a variety of
currencies. Uncommitted lines consist of facilities that the Company has been
advised are available but for which no contractual lending obligation exist.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Total Capital
Long-term assets are financed with Total Capital. The Company maintains
Total Capital 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.
At August 31, 1996 and November 30, 1995, Total Capital consisted of
the following:
August 31, November 30,
Long-term debt: 1996 1995
-------------- ----------
Senior notes $ 212 $ 420
Subordinated indebtedness 3,793 3,077
----- -----
4,005 3,497
----- -----
Stockholder's equity:
Common equity 1,981 2,028
----- -----
Total Capital $5,986 $5,525
====== ======
During the nine months ended August 31, 1996, the Company issued $975
million in long-term debt, which was $504 million in excess of its maturing
debt. These issuances were primarily utilized to refinance current and prefund
expected maturities of long term debt in 1996 and 1997.
At August 31, 1996, the Company had approximately $1.6 billion
available for issuance of debt securities under various shelf registrations.
The Company's common stockholder's equity decreased by $47 million to
$1,981 million at August 31, 1996 from $2,028 million at November 30, 1995 due
to the payment of dividends to Holdings partially offset by the retention of
earnings.
Dependence on Credit Ratings
The Company relies on external sources to finance a significant portion
of its day-to-day operations. Access to global capital markets for short-term
financing, such as commercial paper and short-term debt, senior notes and
subordinated indebtedness are dependent on the Company's short- and long-term
debt ratings. The current short- and long-term senior and subordinated ratings
of the Company are as follows:
LBI
Short-term Long-term**
- --------------------------------------------------------------------------------
Duff & Phelps Credit Rating Co. D-1 A/A-
Fitch Investors Service Inc. F-1 A/A-
IBCA A1 A/A-
Moody's P2 A3*/Baa1
S&P+ A-1 A+*/A
Thomson BankWatch TBW-1 A/A-
- --------------------------------------------------------------------------------
* Provisional ratings on shelf registration
** Senior/subordinated
+ Long term ratings outlook revised to negative on September 21, 1994
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Specific Business Activities and Transactions
The following sections include information on specific business
activities of the Company which affect overall liquidity and capital resources:
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 as BB+ or lower, or equivalent ratings by
recognized credit rating agencies, as well as non-rated securities or loans
which, in the opinion of management, are non-investment grade. Non-investment
grade securities generally involve greater risks than investment grade
securities due to the issuer's creditworthiness and the liquidity of the market
for such securities. In addition, these issuers have higher levels of
indebtedness, resulting in an increased sensitivity to adverse economic
conditions. The Company recognizes these risks and aims to reduce market and
credit risk through the diversification of its products and counterparties. 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, 1996 and
November 30, 1995 included long positions with an aggregate market value of
approximately $768 million and $940 million, respectively, and short positions
with an aggregate market value of approximately $140 million and $72 million,
respectively. The portfolio may from time to time contain concentrated holdings
of selected issues. The Company's largest high yield position was $44 million
and $47 million at August 31, 1996 and at November 30, 1995, respectively.
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, to be accomplished substantially through
securitizations, asset sales and mortgage remittances. In 1995, the Company
purchased the partnership interest owned by Westinghouse and sold an additional
interest to an affiliate of Lennar Inc., (Lennar), a third party mortgage
servicer. Currently, the Company and Lennar hold 75% and 25% of the partnership,
respectively. Following the increase in ownership percentage, the partnership
has been consolidated in the Company's Statement of Financial Position. The
Company's net investment in the partnership at August 31, 1996 is $57 million.
The partnership expects to substantially liquidate the remaining real estate by
the end of 1996. The Company's original investment in the partnership was
approximately $136 million. The Company also advanced approximately $750 million
of financing to the partnership in 1993, which has subsequently been repaid in
its entirety from proceeds related to the disposition of the real estate assets.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Noncore Activities and Investments. In March 1990, the Company
discontinued the origination of limited partnership syndications (the assets of
which are primarily real estate) and investments in real estate. Currently,
Holdings and the Company act as a general partner for approximately $4 billion
of partnership investment capital and manage the remaining real estate
investment portfolio. At August 31, 1996, the Company had $8 million of
commitments and contingent liabilities under guarantees and credit enhancements,
net of applicable reserves. In certain circumstances, the Company has elected to
provide 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.
Non-core activities and investments have declined 87% since November
30, 1995. It is management's intention to prudently liquidate noncore assets
when possible.
<PAGE>
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.
Actions Relating to First Capital Holdings Inc. (Reported in LBI's Annual
Report on Form 10-K and First Quarter Report on Form 10-Q)
FCH Shareholder and Agent Actions. The parties to this action have
agreed to a settlement in principle, subject to documentation and court
approval.
American Express Shareholder Action and American Express Derivative
Action. On July 29 and August 5, 1996, the Court entered final judgments and
orders approving the settlements and dismissing the American Express Derivative
Action and the American Express Shareholder Action, respectively.
Warren D. Chisum, et al. v. Lehman Brothers Inc. et al. (Reported in LBI's First
Quarter Report on Form 10-Q)
On July 11, 1996, the Court issued a memorandum opinion and order
dismissing plaintiffs' RICO claim.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. China International United Petroleum and Chemical Co., Ltd. (Reported
in LBI's Annual Report on Form 10-K)
In September, 1996, the parties settled this action. The case has been
dismissed.
Leetate Smith et al. v. Merrill Lynch at al. (Reported in LBI's Annual Report
on Form 10-K and First Quarter Report on Form 10-Q)
On August 8, 1996, the State Court filed an order granting preliminary
approval of the settlement, subject to notice to the class and a hearing on
final approval.
Actions relating to National Association of Securities Dealers Automated
Quotations System "(NASDAQ") Market Maker Antitrust and Securities Litigation
(Reported in LBI's Annual Report on Form 10-K )
LBI entered into a Stipulation and Order resolving a civil complaint
filed by the U.S. Department of Justice alleging that LBI and 23 other Nasdaq
market makers violated Section 1 of the Sherman Act in connection with certain
market making practices. In entering into the Stipulation and Order the parties
agreed that the defendants would not engage in certain types of market making
activities and the defendants undertook specified steps to assure compliance
with their agreement. The Stipulation and Order are subject to approval by the
United States District Court for the Southern District of New York following a
public hearing, and if the Court approves the Stipulation and Order, the
complaint will be dismissed with prejudice
MCC Proceeds Inc. v. Merrill Lynch et al. (Reported in LBI's Annual Report on
Form 10-K)
MCC Proceeds appealed the dismissal, and LBIE has responded.
1993 New York Stock Exchange Audit
In September, 1996, LBI consented, without admitting or denying
guilt, to findings by a New York Stock Exchange Hearing Panel that it
failed to meet certain requirements concerning operations, reporting ,
recordkeeping and supervision in August 1993. LBI consented to a censure and a
fine of $125,000.
Securities and Exchange Commission Administrative Proceeding
On September 12, 1996, LBI, as successor to Shearson Lehman
Brothers Inc.("Shearson"), was named as a Respondent in an administrative
proceeding pursuant to Sections 15(b) and 21C of the Securities Exchange
Act of 1934 ("Exchange Act"). The SEC alleged that Shearson (1) failed
reasonably to supervise a registered representative, with a view to
preventing his charging two clients excessive markups on fixed income
securities; (2) sent erroneous customer confirmations in violation of
Section 10(b) of the Exchange Act and Rule 10b-10; and (3) failed to maintain
certain required books and records. Without admitting or denying the
allegations, LBI consented to (1) a censure; (2) a requirement to cease and
desist from future violations of the relevant Exchange Act provisions; and (3)
payment of a civil penalty of $50,000.
CBOE Proceeding
The Chicago Board of Options Exchange reported that the Company had
failed to submit exercise advices to the Exchange when two proprietary
trading accounts exercised 7200 OEX calls in September 1994. Without
admitting or denying the allegations, the Company paid a fine of $25,000 to
settle this matter.
<PAGE>
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
(b) Reports on Form 8-K:
None
<PAGE>
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 15, 1996 By /s/ Richard S. Fuld, Jr.
---------------------------
Richard S. Fuld, Jr.
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: October 15, 1996 By /s/ Charles B. Hintz
-----------------------
Charles B. Hintz
Chief Financial Officer
(Principal Financial Officer)
<PAGE>
EXHIBIT INDEX
Exhibit No. Exhibit
Exhibit 12. Computation in Support of Ratio of Earnings to Fixed Charges
Exhibit 27. Financial Data Schedule
<PAGE>
Exhibit 12
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
COMPUTATION in SUPPORT of RATIO of EARNINGS to FIXED CHARGES
(Dollars in millions)
<TABLE>
<CAPTION>
For the For the For the
For the Year Eleven Months Twelve Months Nine Months
Ended Ended Ended Ended
December 31, November 30, November 30, August 31,
------------------------------------ ------------ ------------ ----------
1991 1992 1993 1994 1995 1996
<S> <C> <C> <C> <C> <C> <C>
Fixed charges:
Interest expense:
Subordinated indebtedness $ 231 $ 210 $ 192 $ 184 $ 204 $ 160
Bank loans and other
borrowings* 4,068 4,363 4,393 5,661 9,750 7,407
Interest component of
rentals of office and equipment 64 64 62 27 25 14
Other adjustments** 88 127 53 6
-------- ------- ---- -------- -------- ---------
101 2
-
TOTAL (A) $4,451 $4,764 $4,748 $5,925 $9,981 $7,587
====== ====== ====== ====== ====== ======
Earnings:
Pre-tax income (loss) from
continuing operations $ 283 $ 319 $ $ 1 $ $ 163
(146) 78
Fixed charges 4,451 4,764 4,748 5,925 9,981 7,587
Other adjustments*** (69) (68) (68) (52) (5)
-------- -------- -------- -------- ------ --------
TOTAL (B) $4,665 $5,015 $4,534 $5,874 $10,058 $7,745
====== ====== ====== ====== ======= ======
(B / A) 1.05 1.05 **** **** 1.01 1.02
</TABLE>
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest and debt issuance costs,
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 $214 million in 1993 and $51 million in 1994 in
order to cover the deficiencies.
<PAGE>
Exhibit 27
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
LEHMAN BROTHERS INC. and SUBSIDIARIES
This schedule contains summary financial information extracted from the
Consolidated Statement of Financial Condition at August 31, 1996 (Unaudited) and
the Consolidated Statement of Operations for the nine months ended August 31,
1996 (Unaudited) and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<CIK> 0000728586
<NAME> Lehman Brothers Inc.
<S> <C>
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