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 February 28, 1997
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 April 11, 1997 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 FEBRUARY 28, 1997
INDEX
Part I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Operations -
Three Months Ended February 28, 1997
and February 29, 1996 .................................... 4
Consolidated Statement of Financial Condition -
February 28, 1997 and November 30, 1996 .................. 5
Consolidated Statement of Cash Flows -
Three Months Ended February 28, 1997
and February 29, 1996..................................... 7
Notes to Consolidated Financial Statements.................. 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........13
Part II. OTHER INFORMATION
Item 1. Legal Proceedings ................................ 23
Item 6. Exhibits and Reports on Form 8-K .............24
Signatures...................................................................25
EXHIBIT INDEX .......................................................26
Exhibits
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of OPERATIONS
(Unaudited)
(In millions)
Three months ended
February 28 February 29
1997 1996
------------- ---------
Revenues
Principal transactions $ 226 $ 291
Investment banking 192 160
Commissions 83 81
Interest and dividends 2,931 2,528
Other 8 8
-------- --------
Total revenues 3,440 3,068
Interest expense 2,819 2,461
----- -----
Net revenues 621 607
------ ------
Non-interest expenses
Compensation and benefits 360 314
Brokerage, commissions and
clearance fees 50 47
Communications 22 26
Professional services 21 17
Business development 17 20
Occupancy and equipment 16 20
Depreciation and amortization 13 14
Management fees 15 24
Other 38 47
------- -------
Total non-interest expenses 552 529
------ ------
Income before taxes 69 78
Provision for income taxes 22 33
------- -------
Net income $ 47 $ 45
======= =======
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION
(Unaudited)
(in millions)
<TABLE>
<CAPTION>
February 28 November 30
ASSETS 1997 1996
--------------- -----------
<S> <C> <C>
Cash and cash equivalents $ 965 $ 396
Cash and securities segregated and on deposit
for regulatory and other purposes 1,035 663
Securities and other financial instruments owned:
Governments and agencies 26,727 21,251
Corporate stocks 3,156 3,164
Corporate debt and other 4,378 4,739
Derivatives and other contractual agreements 5,272 5,298
Mortgages and mortgage-backed 1,470 2,055
Certificates of deposit and other money market instruments 3,585 3,819
------- -------
44,588 40,326
------ ------
Collateralized short-term agreements:
Securities purchased under agreements to resell 37,765 33,145
Securities borrowed 25,950 19,035
Receivables:
Brokers, dealers and clearing organizations 3,424 4,909
Customers 4,506 3,956
Others 4,202 4,611
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $511 in 1997 and $502 in 1996) 276 283
Deferred expenses and other assets 245 214
Excess of cost over fair value of net assets
acquired (net of accumulated amortization
of $95 in 1997 and $94 in 1996) 165 166
----------- -----------
Total assets $123,121 $107,704
======== ========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION - (Continued)
(Unaudited)
(in millions, except per share data)
<TABLE>
<CAPTION>
February 28 November 30
LIABILITIES AND STOCKHOLDER'S EQUITY 1997 1996
<S> <C> <C>
Commercial paper and short-term debt $ 1,629 $ 2,299
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 11,563 9,326
Corporate stocks 3,091 1,143
Corporate debt and other 2,396 2,735
Derivatives and other contractual agreements 4,192 4,662
------- -------
21,242 17,866
------ ------
Collateralized short-term financing:
Securities sold under agreements to repurchase 61,980 52,200
Securities loaned 13,752 10,085
Advances from Holdings and other affiliates 9,385 8,552
Payables:
Brokers, dealers and clearing organizations 1,766 2,200
Customers 5,070 6,395
Accrued liabilities and other payables 2,071 2,250
Long-term debt:
Senior notes 218 215
Subordinated indebtedness 4,246 3,950
--------- ---------
Total liabilities 121,359 106,012
------- -------
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 1997 and 1996;
Additional paid-in capital 1,851 1,828
Foreign currency translation adjustment 3 3
Accumulated deficit (92) (139)
------------- ------------
Total stockholder's equity 1,762 1,692
----------- -----------
Total liabilities and stockholder's equity $123,121 $107,704
======== ========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Three months ended
February 28 February 29
1997 1996
--------------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income $ 47 $ 45
Adjustments to reconcile income to net cash provided by
(used in) operating activities:
Depreciation and amortization 13 14
Provisions for losses and other reserves 9 10
Other adjustments 2 5
Net change in:
Cash and securities segregated (372) 20
Securities and other financial instruments owned (4,262) (971)
Securities purchased under agreements to resell (4,620) (6,161)
Securities borrowed (6,915) 1,916
Receivables from brokers, dealers and clearing
organizations 1,485 (4,778)
Receivables from customers (550) (2,131)
Securities and other financial instruments sold but
not yet purchased 3,376 1,608
Securities sold under agreements to repurchase 9,780 5,415
Securities loaned 3,667 969
Payables to brokers, dealers and clearing organizations (434) 1,411
Payables to customers (1,325) 2,036
Accrued liabilities and other payables (188) 576
Other operating assets and liabilities, net 372 (2,578)
------ ------
Net cash provided by (used in) operating activities $ 85 $(2,594)
-------- -------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS -- (Continued)
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Three months ended
February 28 February 29
1997 1996
--------------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
<S> <C> <C>
Principal payments of senior notes $ (44)
Proceeds from issuance of subordinated indebtedness $ 308 200
Principal payments of subordinated indebtedness (9)
Net payments for commercial paper and
short-term debt (670) (129)
Decrease in advances from Holdings
and other affiliates 833 2,662
Capital contributions 36
Dividends and capital distributions paid (12) (110)
------- ------
Net cash provided by financing activities 486 2,579
------ -----
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and
leasehold improvements (2)
--------
Net cash used in investing activities (2)
--------
Net change in cash and cash equivalents 569 (15)
------ ------
Cash and cash equivalents, beginning of period 396 287
------ ------
Cash and cash equivalents, end of period $ 965 $ 272
====== ======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $2,833 and $2,462 for the three months ended
February 28, 1997 and February 29, 1996, respectively. Income taxes paid totaled
$27 and $14 for the three months ended February 28, 1997 and February 29, 1996,
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
(collectively, 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, 1996 was derived from the audited financial
statements. It is recommended that these consolidated 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, 1996 (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 prior
period amounts reflect reclassifications to conform to the current period's
presentation.
2. Long-Term Debt:
During the three months ended February 28, 1997, the Company issued
$308 million of fixed-rate subordinated indebtedness with maturities ranging
from 1998 to 2007. The majority of 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, $9 million
of long-term debt matured during the three months ended February 28, 1997.
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 February 28, 1997, LBI's regulatory net
capital, as defined, of $1,466 million exceeded the minimum requirement by
$1,352 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.
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 8 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):
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Three Months Ended
February 28, 1997 February 28, 1997
----------------- -----------------
Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $4,249 $2,689 $4,200 $2,706
Foreign exchange forward contracts and options 719 1,306 630 1,149
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 155 144 166 168
Equity contracts (including equity swaps, warrants
and options) 132 35 129 44
Commodity contracts (including swaps, forwards,
and options) 17 18 36 32
-------------------------------------------------------
Total $5,272 $4,192 $5,161 $4,099
-------------------------------------------------------
</TABLE>
* Amounts represent carrying value (exclusive of collateral) of contracts 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, 1996 November 30, 1996
----------------- -----------------
Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $3,943 $3,159 $3,336 $1,917
Foreign exchange forward contracts and options 834 1,089 668 1,118
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 221 248 236 237
Equity contracts (including equity swaps, warrants
and options) 254 127 233 74
Commodity contracts (including swaps, forwards,
and options) 46 39 51 50
------------------------------------------------------
Total $5,298 $4,662 $4,524 $3,396
-----------------------------------------------------
</TABLE>
* Amounts represent carrying value (exclusive of collateral) of contracts and do
not include receivables or payables related to exchange-traded futures
contracts.
Assets included in the table above primarily represent the Company's
unrealized gains, net of unrealized losses for situations in which the Company
has a master netting agreement. Similarly, liabilities represent net amounts
owed to counterparties. Therefore, the fair value of assets related to
derivative contracts at February 28, 1997 represents the Company's net
receivable for derivative financial instruments before consideration of
collateral. Included within this amount was $5,123 million and $149 million,
respectively, related to OTC and exchange-traded contracts.
With respect to OTC contracts, the Company's views its net credit
exposure to be $3,537 million at February 28, 1997, representing the fair value
of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral of $1,586 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 February 28, 1997
Risk Rating Equivalent Net Credit
Exposure
1 AAA/Aaa 27%
2 AA-/Aa3 or higher 19%
3 A-/A3 or higher 43%
4 BBB-/Baa3 or higher 7%
5 BB-/Ba3 or higher 3%
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. Exchange-traded contracts are transacted
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 10 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 three months ended February 28, 1997, the Company paid $12
million to Holdings as a return of capital.
7. Incentive Plans:
In the first quarter of 1997, Holdings granted approximately 2.2
million options (the "1997 Options") under the 1996 Management Ownership Plan to
members of the Corporate Management Committee and to certain senior officers.
The 1997 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 Holdings' common stock meets, or
exceeds, $39, $42, and $45 for fifteen out of twenty 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. No compensation expense has
been recognized for these stock options as they were issued with an exercise
price above the market price of the common stock on the date of the grant.
<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 and economic conditions experienced in fiscal
1996, continued into the first quarter of 1997. Market conditions in 1997
reflected strong investor demand in worldwide debt and equity markets, continued
strength in corporate finance advisory activities, and a sustained pace of
underwriting in fixed income products. While worldwide market conditions
continued to be favorable in the first quarter of 1997, certain market factors
weakened from the fourth quarter of 1996.
Global fixed income markets were robust throughout most of the first
quarter of 1997, with heavy trading volumes in both the U.S. and Europe. Trading
activity in the U.S. continued to be strong, reflecting investor optimism that
the environment of sustained growth and low inflation levels would continue.
Additionally, U.S. trading activity was bolstered by active purchases of U.S.
securities by foreign investors due to the uncertainty about the market
implications of European Monetary Union and the strong dollar.
Worldwide equity markets saw continued strength in the level of trading
activity with U.S. trading volumes in the first quarter exceeding the record
levels experienced in the fourth quarter of 1996. Valuation levels on worldwide
exchanges continued to improve, particularly in the U.S. and Europe. In the
U.S., valuation levels were positively impacted by better than expected growth,
favorable earnings prospects and low inflation levels. In Europe, positive
industry fundamentals in terms of market liquidity and earnings prospects along
with the strong U.S. dollar continued to drive the equity markets.
Underwriting volumes in worldwide fixed income products were robust in
the first quarter of 1997. In the U.S., underwriting volumes continued to
benefit from the strength in the spread sectors, particularly in high yield
securities, and from increased financings timed in anticipation of higher
interest rates. Equity and related underwriting volumes were relatively strong,
but considerably below fourth quarter 1996 levels.
In mid-February, investors became concerned about a possible tightening
in U.S. interest rates based upon remarks by the Federal Reserve Board Chairman
and evidence that the U.S. economy was growing more rapidly than expected. This
led to a rise in U.S. interest rates and a general decline in U.S. equity market
valuations, which negatively affected customer flow and origination activities
throughout the latter part of February and into March. On March 25, 1997, the
Federal Reserve raised the Federal Funds rate 25 basis points to 5 1/2%.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Corporate finance advisory activities maintained strength in 1997,
reflecting increased consolidation and globalization across industry sectors and
the overall strength of the global capital markets. The pace of strategic merger
and acquisition activity is expected to hold throughout 1997.
While fiscal 1996 and 1997 have been characterized by strong financial
markets, nevertheless, the financial services industry is cyclical. As a result,
the Company's businesses are evaluated across the market cycles for operating
profitability and their contribution to the Company's long-term strategic
objectives. The Company strives to minimize the effects of economic downturns
through its diversified product base, its global presence, and its risk
management practices.
Note: Except for the historical information contained herein, this Management's
Discussion and Analysis of Financial Condition and Results of Operations
contains forward-looking statements that are based on current
expectations, estimates and projections about the industries in which the
Company operates. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions
which are difficult to predict. The Company undertakes no obligation to
update publicly any forward-looking statements, whether as a result of
new information, future events or otherwise.
<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 February 28, 1997 and February 29, 1996
The Company reported net income of $47 million for the first quarter
ended February 28, 1997, representing an increase of 4% from net income of $45
million for the first quarter ended February 29, 1996.
Net revenues increased to $621 million for the first quarter of 1997
from $607 million for the first quarter of 1996. The increase in net revenues
from the first quarter of 1996 resulted from broad-based improvement in both the
Company's equity and investment banking businesses, due to increased levels of
customer flow and origination activities.
The Company, through its subsidiaries, is a market-maker in all major
equity and fixed income products in both the domestic and international markets.
As part of its market-making activities, the Company maintains inventory
positions of varying amounts across a broad range of financial instruments that
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. Principal transactions and net interest
revenues decreased to $338 million for the first quarter of 1997 from $358
million for the first quarter of 1996. The decrease in the combined revenues
from principal transactions and net interest in the first quarter of 1997
resulted from certain fixed income products partially offset by increases in
equity products.
<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 four major business units: Fixed Income, Equity, Corporate Finance
Advisory, and Merchant Banking. 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.
<TABLE>
<CAPTION>
Three Months Ended February 28, 1997
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $302 $ 9 $ 88 $ 2 $401
Equity 36 71 54 161
Corporate Finance Advisory 45 45
Merchant Banking (3) 3
Other 3 3 2 6 14
- ---------------------------------------------------------------------------------------------------------------------------
$338 $83 $192 $ 8 $621
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended February 29, 1996
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $351 $17 $ 63 $ 3 $434
Equity 9 59 48 2 118
Corporate Finance Advisory 40 40
Merchant Banking (2) 9 7
Other 5 3 8
- ---------------------------------------------------------------------------------------------------------------------------
$358 $81 $160 $ 8 $607
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
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 dollar- and non-dollar 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
decreased 8% to $401 million for the first quarter of 1997 from $434 million for
the first quarter of 1996. The decrease in the first quarter revenues from the
prior year reflected lower principal transactions and net interest from certain
fixed income products including foreign exchange, governments and firm
financing, partially offset by improved overall underwriting results. Investment
banking revenues, as a component of fixed income revenues, increased to $88
million for the first quarter of 1997 from $63 million for the first quarter of
1996 due to increased underwriting 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 increased 36% to $161 million for the first quarter of 1997 from $118
million for the first quarter of 1996. The increase versus the first quarter of
1996 resulted from increased contributions from convertible securities,
distribution of international equities (primarily European) and NASDAQ.
Investment banking revenues, as a component of equity revenues, increased to $54
million for the first quarter of 1997 from $48 million for the first quarter of
1996 due to increased underwriting volumes.
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. Net
revenues from corporate finance advisory increased to $45 million for the first
quarter of 1997 reflecting a 13% increase from the $40 million recognized in the
first quarter of 1996. This increase reflected continued strength in the overall
merger and acquisition market environment.
Merchant Banking. The Company is the general partner for four merchant
banking partnerships. Current merchant banking investments held by the
partnerships include both publicly traded and privately held companies
diversified on a geographic and industry basis. 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 net interest expense relating to the financing of the
Company's investment in the partnerships. Merchant banking net revenues were
less than $1 million for the first quarter of 1997 and $7 million in the first
quarter of 1996. This decrease was principally due to a reduction in the net
gains recognized on the publicly traded investments held by the partnerships.
Non-Interest Expenses. Non-interest expenses were $552 million for the
first quarter of 1997 and $529 million for the first quarter of 1996.
Compensation and benefits expense was $360 million for 1997 and $314 million for
1996.
Income Taxes. The Company's income tax provision was $22 million for
the first quarter of 1997 compared to $33 million for the first quarter of 1996.
The effective tax rate was 32% for the first quarter of 1997 and 42% for the
first quarter of 1996. The decrease in the effective tax rate reflects an
increase in benefits derived from income subject to preferential tax treatment
and a reduction in state and local taxes.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
Overview
As a leading global investment bank that actively participates in the global
capital markets, the Company has large and diverse capital requirements. Many of
the businesses in which the Company operates are capital intensive. Capital is
required to finance, among other things, the Company's securities inventory,
underwriting activities, principal investments, merchant banking activities and
investments in fixed assets.
The Company's total assets increased to $123.1 billion at February 28, 1997 from
$107.7 billion at November 30, 1996. The increase in total assets is primarily
attributable to an increase in matched book fixed income and equity financing
activities as well as an increased level of government and agency securities
owned.
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) and may be higher than at fiscal quarter ends.
Funding and Capital Policies
The Company's Finance Committee, which includes senior officers from key areas
of the Company, is responsible for establishing and managing the funding and
liquidity policies of the Company. The Finance Committee's funding and liquidity
policies include recommendations for capital and balance sheet size as well as
the allocation of capital and balance sheet to product areas. In addition, the
Finance Committee works with the Regional Asset and Liability Committees to
ensure coordination of global funding efforts. The Regional Asset and Liability
Committees are aligned with the Company's geographic funding centers and are
responsible for implementing funding strategies consistent with the direction
set by the Finance Committee and for monitoring and managing liquidity for the
region.
The primary goal of the Company's funding policies is to provide sufficient
liquidity and availability of funding sources at all times and throughout all
market environments. There are five key elements to the Company's funding
strategy which are:
o To maintain an appropriate Total Capital structure to support the business
activities in which the Company is engaged.
o To minimize liquidity and refinancing risk by funding the Company's assets
on a global basis with liabilities which have maturities similar to the
anticipated holding period of the assets.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
o To maintain sufficient liquidity during a period of financial stress
through a combination of collateralized short-term financings and Total
Capital. Financial stress is defined as any event which severely
constraints the Company's access to unsecured funding sources.
o To obtain diversified funding through a global investor base which
maximizes liquidity and reduces concentration risk.
o To maintain funding availability well in excess of actual utilization.
Short-Term Funding
The Company strives to maximize the portion of the Company's balance sheet that
is funded through collateralized borrowing sources, which in turn minimizes the
reliance placed upon unsecured short-term debt.
Collateralized borrowing sources include securities and other financial
instruments sold but not yet purchased, as well as collateralized short-term
financings, defined as securities sold under agreements to repurchase ("repos")
and securities loaned. Because of their secured nature, repos and other types of
collateralized borrowing sources are less credit-sensitive and have historically
been a more stable financing source under adverse market conditions. Also,
collateralized borrowing sources generally provide the Company with access to
lower cost funding.
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 vast majority of the Company's assets are funded with collateralized
borrowing sources. At February 28, 1997 and November 30, 1996, $97 billion and
$80 billion, respectively, of the Company's total balance sheet was financed
using collateralized borrowing sources. As of February 28, 1997 and November 30,
1996, respectively, short-term debt outstanding was $1.6 billion and $2.3
billion. There was no commercial paper outstanding as of February 28, 1997 and
November 30, 1996.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Total Capital
In accordance with the Company's liquidity policies, the Company increased its
Total Capital base in 1997 to $6.2 billion at February 28, 1997 from $5.9
billion at November 30, 1996. Total Capital increased primarily due to an
increase in long-term debt and the retention of earnings.
Total Capital
February 28 November 30
(in millions) 1997 1996
- --------------------------------------------------------------------------------
Long-Term Debt
Senior Notes $ 218 $ 215
Subordinated Indebtedness 4,246 3,950
------- -------
4,464 4,165
Stockholder's Equity 1,762 1,692
- --------------------------------------------------------------------------------
Total Capital $6,226 $5,857
- --------------------------------------------------------------------------------
During the first quarter of 1997, the Company issued $308 million in long-term
debt, which was $299 million in excess of its maturing debt. Long-term debt
increased to $4.5 billion at February 28, 1997 from $4.2 billion at November 30,
1996 with a weighted average maturity of 4.7 years at February 28, 1997 and 4.5
years at November 30, 1996.
The increase in Total Capital also reflects an increase in stockholders' equity
to $1.8 billion at February 28, 1997 from $1.7 billion at November 30, 1996. The
net increase in stockholders' equity was primarily due to the retention of
earnings and capital contributions received.
At February 28, 1997, the Company had approximately $1.1 billion available for
the issuance of debt securities under various shelf registrations.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Dependence on Credit Ratings
The Company, like other companies in the securities industry, relies on
external sources to finance a significant portion of its day-to-day operations.
The Company's access and cost of funding is generally dependent upon its short-
and long-term debt ratings. As of February 28, 1997, the current short- and
long-term senior debt 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
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-rated
companies. For purposes of this discussion, high yield debt securities are
defined as securities or loans to companies rated 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 February 28, 1997 and
November 30, 1996 included long positions with an aggregate market value of
approximately $1.4 billion and $1.3 billion, respectively, and short positions
with an aggregate market value of approximately $211 million and $99 million,
respectively. The portfolio may from time to time contain concentrated holdings
of selected issues. The Company's largest high yield position was $70 million
and $78 million at February 28, 1997 and November 30, 1996, respectively.
Merchant Banking Activities. The Company's merchant banking activities
include investments in four partnerships, for which the Company acts as general
partner, as well as direct investments. At February 28, 1997, the investment in
merchant banking partnerships was $100 million. The Company's policy is to carry
its investments, including its partnership interests, at fair value based upon
the Company's assessment of the underlying investments.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 $3.9 billion of partnership investment capital
and manages the remaining real estate investment portfolio. At February 28,
1997, the Company's investments in these real estate activities, as well as
commitments and contingent liabilities under guarantees and credit enhancements
were fully reserved. 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.
Management's intention with regard to non-core assets is the prudent
liquidation of these investments as and 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.
Action Relating to Mutual Fund Redemptions
On March 5, 1997, the NASD Regulation Inc. accepted a letter of Acceptance,
Waiver and Consent from LBI. Without admitting or denying the allegations,
LBI consented to the entry of findings that, during the period between
October 1, 1990 and February 16, 1996, the Company charged excessive
fees/commissions aggregating $1,963,485.70 for executing non-proprietary mutual
fund redemption transactions in violation of NASD Conduct Rules 2830(j) and
2110. LBI consented to a censure, a fine in the amount of $250,000,
and agreed to disgorge to the relevant retail customers $2,923,482.61, including
pre-judgment interest.
<PAGE>
ITEM 6 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: April 14, 1997 By /s/ Richard S. Fuld, Jr.
---------------------------
Richard S. Fuld, Jr.
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: April 14, 1997 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
(Unaudited)
(Dollars in millions)
<TABLE>
<CAPTION>
For the For the For the For the
For the Year Eleven Months Twelve Months Twelve Months Three Months
Ended Ended Ended Ended Ended
December 31 November 30 November 30 November 30 February 28
----------- ----------- ----------- ----------- -----------
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Fixed charges:
Interest expense:
Subordinated indebtedness $ 210 $ 192 $ 184 $ 204 $ 221 $ 61
Bank loans and other
borrowings* 4,363 4,393 5,661 9,750 9,900 2,758
Interest component of
rentals
of office and equipment 64 62 27 25 18 4
Other adjustments** 53 2 7 4
---- ---- -------- --------- --------- ----------
127 101
TOTAL (A) $4,764 $4,748 $5,925 $9,981 $10,146 $2,827
====== ====== ====== ====== ======= ======
Earnings:
Pre-tax income (loss) from
continuing operations $ 319 $ $ 1 $ 78 $ 309 $ 69
(146)
Fixed charges 4,764 4,748 5,925 9,981 10,146 2,827
Other adjustments*** (68) (68) (52) (1) (6) (4)
-------- -------- -------- ----------- ----------- ---------
TOTAL (B) $5,015 $4,534 $5,874 $10,058 $10,449 $2,892
====== ====== ====== ======= ======= ======
(B / A) **** **** 1.01 1.03 1.02
1.05
</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 February 28, 1997 (Unaudited)
and the Consolidated Statement of Operations for the three months ended February
28, 1997 (Unaudited) and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> NOV-30-1997
<PERIOD-START> DEC-01-1996
<PERIOD-END> FEB-28-1997
<CASH> 2,000
<RECEIVABLES> 12,132
<SECURITIES-RESALE> 37,765
<SECURITIES-BORROWED> 25,950
<INSTRUMENTS-OWNED> 44,588
<PP&E> 276
<TOTAL-ASSETS> 123,121
<SHORT-TERM> 1,629
<PAYABLES> 16,221
<REPOS-SOLD> 61,048
<SECURITIES-LOANED> 13,752
<INSTRUMENTS-SOLD> 21,242
<LONG-TERM> 4,464
<COMMON> 0
0
0
<OTHER-SE> 1,762
<TOTAL-LIABILITY-AND-EQUITY> 123,121
<TRADING-REVENUE> 226
<INTEREST-DIVIDENDS> 2,931
<COMMISSIONS> 83
<INVESTMENT-BANKING-REVENUES> 192
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 2,819
<COMPENSATION> 360
<INCOME-PRETAX> 69
<INCOME-PRE-EXTRAORDINARY> 47
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 47
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
