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 29, 2000
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 1-9466
Lehman Brothers Inc.
(Exact Name of Registrant As Specified In Its Charter)
Delaware 13-2518466
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 ______
As of March 31, 2000, 1,006 shares of the Registrant's Common Stock, par value
$0.10 per share, were outstanding.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED FEBRUARY 29, 2000
INDEX
Part I. FINANCIAL INFORMATION Page
Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Income -
Three Months Ended
February 29, 2000 and February 28, 1999............ 3
Consolidated Statement of Financial Condition -
February 29, 2000 and November 30, 1999............ 4
Consolidated Statement of Cash Flows -
Three Months Ended
February 29, 2000 and February 28, 1999............ 6
Notes to Consolidated Financial Statements......... 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...... 14
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.................................. 29
Item 6. Exhibits and Reports on Form 8-K................... 30
Signature ......................................................... 31
EXHIBIT INDEX 32
Exhibits
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions)
Three months ended
-------------------------------------
February 29 February 28
2000 1999
---------------- ----------------
Revenues
Principal transactions $ 653 $ 342
Investment banking 447 255
Commissions 168 111
Interest and dividends 3,765 3,235
Other 10 6
------------- ----------------
Total revenues 5,043 3,949
Interest expense 3,705 3,176
------------- ----------------
Net revenues 1,338 773
------------- ----------------
Non-interest expenses
Compensation and benefits 696 376
Brokerage and clearance 50 50
Technology and communications 45 38
Business development 22 19
Professional fees 18 9
Occupancy 13 9
Management fee 49 35
Other 15 13
------------- ----------------
Total non-interest expenses 908 549
------------- ----------------
Income before taxes 430 224
Provision for income taxes 159 67
============= ================
Net income $ 271 $ 157
================ ================
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
February 29 November 30
2000 1999
------------------ ------------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 1,526 $ 1,384
Cash and securities segregated and on deposit for regulatory
and other purposes 2,437 1,434
Securities and other financial instruments owned:
Governments and agencies 18,832 21,603
Corporate equities 9,830 9,144
Mortgages and mortgage-backed 7,092 8,457
Corporate debt and other 6,473 5,331
Derivatives and other contractual agreements 5,406 5,249
Certificates of deposit and other money market instruments 709 2,123
------------------ ------------------
48,342 51,907
------------------ ------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 68,312 61,365
Securities borrowed 18,629 11,243
Receivables:
Brokers, dealers and clearing organizations 1,549 2,346
Customers 3,942 2,922
Others 4,757 5,920
Property, equipment and leasehold improvements (net of
accumulated depreciation and amortization of $593 in 2000
and $588 in 1999)
276 280
Other assets 266 261
Excess of cost over fair value of net assets acquired (net of
accumulated amortization of $117 in 2000 and $115 in 1999) 118 120
------------------ ------------------
Total Assets $ 150,154 $ 139,182
================== ==================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION - (Continued)
(Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
February 29 November 30
2000 1999
---------------- -----------------
LIABILITIES AND STOCKHOLDER'S EQUITY
<S> <C> <C>
Commercial paper and short-term debt $ 736 $ 615
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 13,878 10,237
Derivatives and other contractual agreements 3,785 3,985
Corporate equities 3,375 3,207
Corporate debt and other 2,092 1,218
---------------- -----------------
23,130 18,647
---------------- -----------------
Collateralized short-term financing:
Securities sold under agreements to repurchase 76,833 76,587
Securities loaned 13,794 9,809
Advances from Holdings and other affiliates 17,608 16,118
Payables:
Brokers, dealers and clearing organizations 2,550 2,485
Customers 6,168 5,535
Accrued liabilities and other payables 1,996 2,324
Long-term debt:
Senior notes 191 186
Subordinated indebtedness 3,774 3,773
---------------- -----------------
Total liabilities 146,780 136,079
---------------- -----------------
Commitments and contingencies
STOCKHOLDER'S EQUITY
Preferred stock, $0.10 par value; 10,000 shares authorized; none outstanding
Common stock, $0.10 par value; 10,000 shares authorized;
1,006 shares issued and outstanding
Additional paid-in capital 1,684 1,684
Accumulated other comprehensive income 2 2
Retained earnings 1,688 1,417
-----------------
----------------
Total stockholder's equity 3,374 3,103
================ =================
Total liabilities and stockholder's equity $ 150,154 $ 139,182
================ =================
</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 29 February 28
2000 1999
----------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITES
<S> <C> <C>
Net income $ 271 $ 157
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 9 14
Provisions for losses and other reserves 9 7
Other adjustments 6 (7)
Net change in:
Cash and securities segregated (1,003) (174)
Securities and other financial instruments owned 3,565 (6,285)
Securities borrowed (7,386) 1,721
Receivables from brokers, dealers and clearing organizations 797 188
Receivables from customers (1,020) 269
Securities and other financial instruments sold but not yet purchased 4,483 (1,717)
Securities loaned 3,985 4,874
Payables to brokers, dealers and clearing organizations 65 1,452
Payables to customers 633 80
Accrued liabilities and other payables (337) (268)
Other operating assets and liabilities, net 1,159 (1,643)
----------------- ----------------
Net cash provided by (used in) operating activities 5,236 (1,332)
----------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITES
Net proceeds from commercial paper and short-term debt 121 189
Resale agreements net of repurchase agreements (6,701) 7,147
Increase (decrease) in advances from Holdings and other affilitates 1,490 (5,879)
----------------- ----------------
Net cash provided by (used in) financing activities (5,090) 1,457
----------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (4) (6)
----------------- ----------------
Net cash used in investing activities (4) (6)
----------------- ----------------
Net change in cash and cash equivalents 142 119
----------------- ----------------
Cash and cash equivalents, beginning of period 1,384 460
================= ================
Cash and cash equivalents, end of period $ 1,526 $ 579
================= ================
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $3,710 and $4,035 for the three months ended February 29,
2000 and February 28, 1999, respectively. Income taxes paid totaled $4 for the
three months ended February 28, 1999.
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
America and the Asia Pacific Region. The Company is engaged in providing
financial services. 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. 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, 1999 (the "Form 10-K"). The Consolidated Statement of Financial Condition at
November 30, 1999 was derived from the audited financial statements.
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. Capital Requirements:
The Company operates globally through a network of subsidiaries, with several
being subject to regulatory requirements. In the United States, LBI, as a
registered broker-dealer, 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 29, 2000, LBI's regulatory net capital, as defined, of
$1,656 million exceeded the minimum requirement by $1,524 million.
In addition, the Company's "AAA" rated derivatives subsidiaries, Lehman Brothers
Financial Products Inc. ("LBFP") and Lehman Brothers Derivative Products Inc.
("LBDP"), have established certain capital and operating restrictions which are
reviewed by various rating agencies. At February 29, 2000, LBFP and LBDP each
had capital which exceeded the requirement of the most stringent rating agency
by approximately $114 million and $30 million, respectively.
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 investments governing the indebtedness
of LBI contractually limit its ability to pay dividends.
<PAGE>
LEHMAN BROTHERS INC and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
3. Derivative Financial Instruments:
In the normal course of business, 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 risk resulting from its trading activities
(collectively, "Trading-Related Derivative Activities").
Derivative transactions entered into for Trading-Related Derivative Activities
are recorded at market or fair value with realized and unrealized gains and
losses recognized currently in Principal transactions in the Consolidated
Statement of Income. Market or fair value for trading-related instruments is
generally determined by either quoted market prices (for exchange-traded futures
and options) or pricing models (for over-the-counter swaps, forwards and
options).
Pricing models utilize a series of market inputs to determine the present value
of future cash flows, with adjustments, as required for credit risk and
liquidity risk. Further valuation adjustments may be recorded, as deemed
appropriate for new or complex products or for positions with significant
concentrations. These adjustments are integral components of the mark-to-market
process. Credit-related valuation adjustments incorporate business and economic
conditions, historical experience, concentrations, estimates of expected losses
and the character, quality and performance of credit sensitive financial
instruments.
Unrealized gains and losses on derivative contracts are recorded on a net basis
in the Consolidated Statement of Financial Condition for those transactions with
counterparties executed under a legally enforceable master netting agreement and
are netted across products when such provisions are stated in the master netting
agreement. Listed in the following table is the fair value and average fair
value of the Company's Trading-Related Derivative Activities. Average fair
values of these instruments were calculated based upon month-end statement of
financial condition values, which the Company believes do not vary significantly
from the average fair value calculated on a more frequent basis. Variances
between average fair values and period-end values are due to changes in the
volume of activities in these instruments and changes in the valuation of these
instruments due to variations in market and credit conditions.
<PAGE>
LEHMAN BROTHERS INC and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Three Months Ended
February 29, 2000 February 29, 2000
--------------------------------- ----------------------------------
(in millions) Assets Liabilities Assets Liabilities
- -------------------------------------------------------- -------------- -- --------------- -------------- --- ---------------
Interest rate and currency swaps and options
<S> <C> <C> <C> <C>
(including caps, collars and floors) $ 3,950 $ 2,542 $ 3,904 $ 3,126
Foreign exchange forward contracts and
options
399 328 452 348
Other fixed income securities contracts
(including options and TBAs) 127 238 316 268
Equity contracts (including equity swaps,
warrants and options) 930 677 923 677
-------------- -- --------------- -------------- --- ---------------
Total $ 5,406 $ 3,785 $ 5,595 $ 4,419
-------------- -- --------------- -------------- --- ---------------
</TABLE>
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Twelve Months Ended
November 30, 1999 November 30, 1999
---------------------------------- ---------------------------------
(in millions) Assets Liabilities Assets Liabilities
- -------------------------------------------------------- -------------- -- ---------------- --------------- - ---------------
Interest rate and currency swaps and options
<S> <C> <C> <C> <C>
(including caps, collars and floors) $ 3,409 $ 2,738 $ 3,620 $ 2,388
Foreign exchange forward contracts and
options 650 424 678 582
Other fixed income securities contracts
(including options and TBAs) 256 192 243 232
Equity contracts (including equity swaps,
warrants and options) 934 631 459 406
Commodity contracts (including swaps,
forwards and options) 3 1
-------------- -- ---------------- --------------- - ---------------
Total $ 5,249 $ 3,985 $ 5,003 $ 3,609
-------------- -- ---------------- --------------- - ---------------
</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 situations in which the Company has a master netting
agreement. Similarly, liabilities represent net amounts owed to counterparties.
Therefore, the fair value of assets/liabilities related to derivative contracts
at February 29, 2000 represents the Company's net receivable/payable for
derivative financial instruments before consideration of collateral. Included
within the $5,406 million fair value of assets at February 29, 2000 was $4,640
million related to swaps and other OTC contracts and $766 million related to
exchange-traded option and warrant contracts. Included within the $5,249 million
<PAGE>
LEHMAN BROTHERS INC and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
fair value of assets at November 30, 1999 was $4,489 million related to swaps
and other OTC contracts and $760 million related to exchange-traded option and
warrant contracts.
With respect to OTC contracts, including swaps, the Company views its net credit
exposure to be $2,969 million at February 29, 2000, representing the fair value
of the Company's OTC contracts in an unrealized gain position, after
consideration of amounts due from affiliates of $1,316 million and collateral of
$355 million. Presented below is an analysis of the Company's net credit
exposure at February 29, 2000 for OTC contracts based upon actual ratings made
by external rating agencies or by equivalent ratings established and utilized by
the Company's Credit Risk Management Department.
Counterparty S&P/Moody's Net Credit
Risk Rating Equivalent Exposure
----------- ---------- --------
1 AAA/Aaa 18%
2 AA-/Aa3 or higher 20%
3 A-/A3 or higher 36%
4 BBB-/Baa3 or higher 23%
5 BB-/Ba3 or higher 1%
6 B+/B1 or lower 2%
The Company is also subject to credit risk related to its exchange-traded
derivative contracts. Exchange-traded contracts, including futures and certain
options, are transacted directly on the exchange. To protect against the
potential for a default, all exchange clearinghouses impose net capital
requirements for their membership. Additionally, the exchange clearinghouse
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 provide for settlement within three
days). Therefore, the potential for losses from exchange-traded products is
limited.
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 Notes
1 and 8 to the Consolidated Financial Statements, included in the Form 10-K.
4. Other Commitments and Contingencies:
In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $3.3 billion at
February 29, 2000 and $4.2 billion at November 30, 1999. These commitments
require borrowers to provide acceptable collateral, as defined in the
agreements, when amounts are drawn under the lending facilities. Advances made
under the above lending arrangements are typically at variable interest rates
and generally provide for over-collateralization based upon the borrowers'
creditworthiness.
<PAGE>
LEHMAN BROTHERS INC and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
The Company, through its high grade and high yield sales, trading and
underwriting activities, makes commitments to extend credit in loan syndication
transactions and then participates out a significant portion of these
commitments. The Company had lending commitments to high grade borrowers of $2.3
billion and $2.8 billion at February 29, 2000 and November 30, 1999,
respectively. In addition, lending commitments to high yield borrowers totaled
$1.2 billion and $903 million at February 29, 2000 and November 30, 1999,
respectively. All of these commitments and any related draw-downs of these
facilities are typically secured against the borrowers' assets, have fixed
maturity dates and are generally contingent upon certain representations,
warranties and contractual conditions applicable to the borrower. Total
commitments are not indicative of actual risk or funding requirements as the
commitments may not be drawn or fully utilized, and the Company will continue to
syndicate and/or sell these commitments.
At February 29, 2000 and November 30, 1999, the Company had commitments to
invest up to $413 million and $302 million, respectively, directly and through
partnerships, in private equity-related investments. These commitments will be
funded as required through the end of the respective investment periods,
principally expiring in 2004.
In addition to these specific commitments, the Company had various other
commitments of approximately $300 million at both February 29, 2000 and November
30, 1999.
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 throughout the Company to monitor and
manage these risks on a global basis. For further discussion of these matters,
refer to Note 10 to the Consolidated Financial Statements, in the Form 10-K.
5. Segments
Lehman Brothers operates in three business segments: Investment Banking, Capital
Markets, and Other.
The Investment Banking Division provides advice to corporate, institutional and
government clients throughout the world on mergers, acquisitions, and other
financial matters. The Division also raises capital for clients by underwriting
public and private offerings of debt and equity securities.
<PAGE>
LEHMAN BROTHERS INC and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
The Capital Markets Division includes the Company's sales, trading, research and
financing activities in equity and fixed income cash and derivatives products.
Through the Division, the Company is a global market-maker in numerous equity
and fixed income products, including U.S. and European equities, government and
agency securities, money market products, corporate high grade, high yield
securities, mortgage- and asset-backed securities, municipal securities, bank
loans, foreign exchange and derivatives products. The Division also includes the
Company's risk arbitrage and secured financing businesses. The financing
business manages the Company's equity and fixed income matched book activities,
supplies secured financing to institutional and high-net-worth clients and
customers, and provides secured funding for the Company's inventory of equity
and fixed income products.
Other consists of the Company's asset management and private equity businesses,
neither of which represents more than 10% of the Company's consolidated net
revenues, earnings before taxes or assets.
The Company's segment information for the first quarter of 2000 and 1999 is
presented below and was developed consistent with the accounting policies used
to prepare the Company's consolidated financial statements.
<TABLE>
<CAPTION>
Investment Capital
Banking Markets Other Total
------------------ -------------- ----------------- ---------------------
February 29, 2000
<S> <C> <C> <C> <C>
Net revenue $ 447 $ 883 $ 8 $ 1,338
================== ============== ================= =====================
Earnings before taxes $ 125 $ 309 $ (4) $ 430
================== ============== ================= =====================
Segment assets (billions) $ 1.1 $ 144.3 $ 4.8 $ 150.2
================== ============== ================= =====================
February 28, 1999
Net revenue $ 257 $ 514 $ 2 $ 773
================== ============== ================= =====================
Earnings before taxes $ 78 $ 148 $ (2) $ 224
================== ============== ================= =====================
Segment assets (billions) $0.8 $ 133.8 $ 2.4 $ 137.0
================== ============== ================= =====================
</TABLE>
<PAGE>
LEHMAN BROTHERS INC and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
The following are net revenues by geographic region:
February 29 February 28
2000 1999
------------------ -------------------
Americas* $ 1,197 $ 665
Europe 96 96
Asia Pacific 45 12
------------------ -------------------
Total $ 1,338 $ 773
================== ===================
* Includes non-U.S. revenues of $13 million and $4 million in the first
quarter of 2000 and 1999, respectively.
The following information describes the Company's methods of allocating
consolidated net revenues to geographic regions. Net revenues, if syndicated or
trading-related, have been distributed based upon the location where the primary
or secondary position was fundamentally risk managed; if fee-related, by the
location of the senior coverage banker; if commission-related, by the location
of the salespeople. In addition, certain revenues associated with domestic
products and services which resulted from relationships with international
clients and customers have been reclassified as international revenues using an
allocation consistent with the Company's internal reporting.
6. Related Parties
In the normal course of business, the Company engages in various securities
trading, investment banking and financial activities with Holdings and many of
its subsidiaries (the "Related Parties"). Various charges, such as compensation
and benefits, occupancy, administration and computer processing are allocated
between the Related Parties, based upon specific identification and allocation
methods.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Business Environment
The principal business activities of Lehman Brothers Holdings Inc. ("Holdings")
and subsidiaries (collectively, the "Company" or "Lehman Brothers") are
investment banking and securities trading and sales, which by their nature are
subject to volatility, primarily due to changes in interest and foreign exchange
rates and security valuations, 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.
Financial Advisory activities on a global basis continued at record levels.
Industrywide, the volume of announced merger and acquisition transactions in the
first quarter soared to $1.1 trillion. The first quarter also reflected
continued activity involving European companies and cross-border mergers and
acquisitions. Merger and acquisition activities continued to reflect the trends
of consolidation, deregulation and globalization across industry sectors and
across borders. Equity new issuance this quarter was at record levels worldwide,
more than doubling as compared to the same period last year. In the U.S., new
equity issuance more than tripled as compared to the first quarter last year.
Fueling the domestic market was increased IPO activity and continued equity
raising in the technology, telecommunications and new media sectors. Debt
issuance was initially dampened by the outward shift in the yield curve in
January and later by the inversion of the yield curve and the anticipation of
future interest rate hikes by the Federal Reserve and the European Central Bank.
At the same time, economic growth in the United States remained very strong
during the first quarter of 2000, and equity trading volumes continued to be
healthy. New economy stocks, as measured by the NASDAQ rose 40% during the
quarter to a new high, but have since corrected. In anticipation of further rate
hikes, the price of old economy stocks, as measured by the Dow Jones Industrial
Index, declined by 7% over the quarter, through the 10,000 level, but later
recovered. In the fixed income markets, the 10-year U.S. Treasury bond yield
initially rose during the quarter, reaching 6.78% in mid-January. However, as
the Dow slid and the U.S. Treasury announced plans for the early retirement of
certain Treasury borrowings, bond yields fell-back to end the quarter at 6.4%,
just 20 basis points above where they had started. In response to the strength
of continued growth, the Fed, as expected, raised the Federal Funds rate on
February 2nd by 25 basis points to 5.75%, the fourth 25 basis point increase
since June 1999.
In February, while European business and consumer confidence had risen to new
cyclical and all-time highs, inflationary pressures also started to rise. Pushed
up by higher oil prices and a weaker euro, European inflation rose to 2% in
January from 1.5% in November, while core inflation also inched higher.
Responding to rising inflationary pressures and a weaker euro, the European
Central Bank raised its key two-week repo rate by 25 basis points on February
3rd. Although the rate hike by the ECB matched that by the Federal Reserve, the
euro continued to fall against the dollar, hitting a new low of $0.94/euro on
February 28th, but later stabilizing at around $0.97/euro. For the period as a
whole, European markets outperformed the broad U.S. index with a return of 8% in
local currency terms (FTSE World Europe), but all of this gain was achieved by
the end of December.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
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 29, 2000 and February 28, 1999
The Company reported record net income of $271 million for the first quarter
ended February 29, 2000, representing an increase of 73% from net income of $157
million for the first quarter ended February 28, 1999.
These results reflect the ongoing successful execution of the Company's strategy
to grow its high margin investment banking and equities businesses and maintain
a strict discipline with regard to its expenses. The Company's strategy is based
on the belief that: (1) these businesses generate higher returns on equity
because they are less capital intensive; and (2) their rapid growth accelerates
the Company's overall rate of growth; and (3) they help reduce earnings
volatility by diversifying the Company's revenue base. The Company's emphasis on
these high margin businesses helped to increase the Company's operating margin
to 32.1% in the first quarter of 2000 from 29.0% in the first quarter of 1999.
In the following tables, the Company's results have been segregated into three
business segments: Investment Banking, Capital Markets and Other. Each segment
represents a group of activities and products with similar characteristics.
These business activities result in revenues from both institutional clients as
well as high-net-worth retail clients and are recognized within the different
revenue categories in the Company's Consolidated Statement of Income. (Net
revenues by segment contain certain internal allocations, including funding
costs, which are centrally managed.)
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Three Months Ended February 29, 2000 and February 28, 1999
(in millions)
Three Months Ended
----------------------------------
Feb 29 Feb 28
2000 1999
--------------- ---------------
Investment Banking $ 447 $ 257
Capital Markets 883 514
Other 8 2
=============== ===============
Total $ 1,338 $ 773
=============== ===============
The following discussion provides an analysis of the Company's net revenues for
the periods above.
Investment Banking This segment's net revenues result from fees earned by the
Company for underwriting public and private offerings of fixed income and equity
securities, raising capital and advising clients on merger and acquisition
activities and other services. Investment Banking's net revenues increased 74%
in the first quarter of 2000 to $447 million from $257 million in the first
quarter of 1999, principally as a result of an increase in equity underwriting
and financial advisory services. The increased net revenues are an outgrowth of
the Company's ongoing efforts to grow its Investment Banking franchise. The
record results in equity underwriting were driven by issuances in the
communications/media sector and a significant increase in convertible offerings.
Debt underwriting revenues remained relatively unchanged from the first quarter
of 1999 despite challenging market conditions resulting from yield curve
volatility.
Investment Banking Net Revenues
- ------------------------ ------------------------------
(in millions) Three Months Ended
February 29 February 28
2000 1999
----------------------- --------------- --------------
Equity Underwriting $ 183 $ 45
Debt Underwriting 128 130
Financial Advisory 136 82
------------------------ --------------- --------------
$ 447 $ 257
----------------------- --------------- --------------
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Capital Markets This segment's net revenues reflect institutional and private
client flow activities and secondary trading and financing activities related to
a broad spectrum of fixed income and equity products. These products include
dollar and non-dollar government securities, mortgages, mortgage- and
asset-backed securities, money market products, dollar and non-dollar corporate
debt securities, emerging market securities, municipal securities, foreign
exchange, fixed income and equity related derivatives, convertible securities
and common and preferred equity securities.
Capital Markets' net revenues were $883 million for the first quarter of 2000
and $514 million for the first quarter of 1999. Customer flow sales and trading
volumes continued to increase at healthy rates, significantly contributing to
this increase.
Net revenues from the equity component of Capital Markets increased 343% to $616
million in the first quarter of 2000 from $139 million in the first quarter of
1999. Revenues benefited in the first quarter of 2000 from significantly
increased institutional customer flow activity in cash and derivative products.
In addition, the Company realized gains of approximately $150 million on a
principal investment it had in VerticalNet, Inc.
Capital Markets Net Revenues
---------------------- ---------------------------------
(in millions) Three Months Ended
February 29 February 28
2000 1999
--------------- -----------------
Equities $ 616 $ 139
Fixed Income 267 375
---------------------- --------------- -----------------
$ 883 $ 514
---------------------- --------------- -----------------
Net revenues from the fixed income component of Capital Markets decreased to
$267 million in the first quarter of 2000 from $375 million in the first quarter
of 1999. Strong customer flow trading in high yield securities was offset by
challenging market conditions overall and the Y2K induced slowdown earlier in
the quarter.
Other Other revenues reflect earnings from the Company's asset management and
private equity businesses. Other revenues were $8 million in the first quarter
of 2000 from $2 million in the first quarter of 1999.
Non-Interest Expenses Non-interest expenses were $908 million for the first
quarter of 2000 and $549 million for the first quarter of 1999. Compensation and
benefits expense as a percentage of net revenues increased to 52.0% for the
quarter compared to the prior year quarter of 48.6%. This increase reflects the
Company's continued expansion of its investment banking, and equities franchise
as well as investment needs in technology and e-commerce capabilities.
Nonpersonnel expenses were $212 million for the first quarter of 2000 and $173
million for the first quarter of 1999, an increase of 22.5%, reflecting the
impact of increased investments in personnel and growth in net revenues.
However, nonpersonnel expenses declined as a percentage of net revenues to 15.8%
for the first quarter of 2000 from 22.4% for the first quarter of 1999 as the
Company's net revenues increased at a significantly faster rate.
Income Taxes The Company's income tax provision was $159 million for the first
quarter of 2000 compared to $67 million for the first quarter of 1999. The
effective tax rate was 37.0% for the first quarter of 2000 and 29.9% for the
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
first quarter of 1999. The increase in the effective tax rate relates primarily
to a significantly higher level of pre-tax income, which minimizes the impact of
transactions that are subject to preferential tax treatment.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Funding, Capital Resources and Liquidity
Funding and Capital Policies The Company's Finance Committee is responsible for
establishing and managing the funding and liquidity policies of the Company.
These policies include recommendations for capital and balance sheet size as
well as the allocation of capital and balance sheet to product areas. Members of
the Company's treasury department and business unit financing groups work with
the Finance Committee to ensure coordination of global funding efforts and
implementation of the funding and liquidity policies. Regional asset and
liability committees in the Company's principal funding centers are responsible
for implementing funding strategies for their respective regions.
The primary goal of the Company's funding policies is to provide sufficient
liquidity and availability of funding sources to meet the needs of the Company's
businesses. The key elements of these policies are to:
(1) Maintain a total capital structure that supports the business
activities in which the Company is engaged.
(2) Finance the Company's assets, primarily on a secured basis. Together with
Total Capital, secured funding provides a stable funding base and enables
the Company to minimize its reliance on short-term unsecured debt.
(3) Maintain funding availability in excess of actual utilization and obtain
diversified funding through a global investor base which increases
liquidity and reduces concentration risk.
(4) Maintain sufficient financial resources to enable the Company to meet its
obligations in periods of financial stress, defined as any event that
severely constrains the Company's access to unsecured funding sources.
Total Capital Total Capital (defined as long-term debt and stockholder's equity)
was $7.3 billion at February 29, 2000 compared to $7.1 billion at November 30,
1999. The net increase in Total Capital resulted from the retention of earnings.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
February 29 November 30
(in millions) 2000 1999
- ------------------------------------------------------------------------------
Long-term Debt
Senior Notes $ 191 $ 186
Subordinated Indebtedness 3,774 3,773
----- -----
3,965 3,959
Stockholder's Equity 3,374 3,103
- ------------------------------------------------------------------------------
Total Capital $ 7,339 $ 7,062
- ------------------------------------------------------------------------------
During the first three months of 2000, the Company had no new issuances and
long-term debt remained relatively unchanged from November 30, 1999. The
weighted-average maturity of long-term debt at February 29, 2000 and November
30, 1999 was 4.5 years and 4.8 years, respectively.
Secured Funding The Company strives to maximize the portion of the Company's
balance sheet that is funded on a secured basis. Secured funding includes
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 have historically been a stable financing source
irrespective of market conditions. At February 29, 2000 and November 30, 1999,
$110 billion and $101 billion, respectively, of the Company's total balance
sheet of $150 billion and $139 billion at February 29, 2000 and November 30,
1999, respectively, was financed on a secured basis.
By maximizing its use of secured funding, the Company minimizes its reliance on
unsecured financing. As of February 29, 2000 and November 30, 1999, short-term
debt outstanding totaled $736 million and $615 million, respectively. There was
no commercial paper outstanding as of February 29, 2000 or November 30, 1999.
Balance Sheet The Company's total assets increased to $150 billion at February
29, 2000 from $139 billion at November 30, 1999. The Company's adjusted total
assets, defined as total assets less the lower of securities purchased under
agreements to resell or securities sold under agreements to repurchase were $82
billion at February 29, 2000 compared to $78 billion at November 30, 1999. The
Company believes adjusted total assets is a more effective measure of evaluating
balance sheet usage when comparing companies in the securities industry. The
increase in adjusted total assets reflects higher levels of securities borrowed
offset by lower amounts of securities owned both associated with increased
customer flow activities.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
The Company's balance sheet consists primarily of cash and cash equivalents,
securities and other financial instruments owned, and collateralized short-term
financing agreements. The liquid nature of these assets provides the Company
with flexibility in financing and managing its business. The majority of these
assets are funded on a secured basis through collateralized short-term financing
agreements with the remaining assets being funded through short-term unsecured
financing and Total Capital.
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 to and cost of funding is generally dependent upon its short-
and long- term debt ratings. As of February 29, 2000 the short- and long-term
debt ratings of LBI were as follows:
LBI
--------------------------------
Short-term Long-term**
- ----------------------------------------------- ---------------- ---------------
Duff & Phelps Credit Rating Co. D-1 A/A-
Fitch IBCA, Inc. F-1 A/A-
Moody's P-1 A2*/A3
Standard & Poor's Corp. A-1 A+*/A
Thomson BankWatch TBW-1 A+/A
* Provisional ratings on shelf registration
** Senior/subordinated
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Other
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 instruments 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 instruments
are carried at market value, and unrealized gains or losses for these securities
are reflected in the Company's Consolidated Statement of Income. The Company's
portfolio of such instruments at February 29, 2000 and November 30, 1999
included long positions with an aggregate market value of approximately $1.5
billion and $1.3 billion, respectively, and short positions with an aggregate
market value of approximately $181 million and $177 million, respectively. The
Company may, from time to time, mitigate its net exposure to any single issuer
through the use of derivatives and other financial instruments.
Additional information about the Company's High Yield Securities and Lending
Activities, including related commitments, can be found in Note 4 to the
Consolidated Financial Statements (Other Commitments and Contingencies).
The Company has investments in seven merchant banking and venture
capital-related partnerships, for which the Company acts as general partner, as
well as related direct investments. At February 29, 2000, the Company's
investment in these partnerships totaled $54 million and related direct
investments totaled $516 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. Additional information about
the Company's private equity activities, including related commitments, can be
found in Note 4 to the Consolidated Financial Statements (Other Commitments and
Contingencies).
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Risk Management
As a leading global investment banking company, risk is an inherent part of the
Company's businesses. Global markets, by their nature, are prone to uncertainty
and subject participants to a variety of risks. The Company has developed
policies and procedures to identify, measure and monitor each of the risks
involved in its trading, brokerage and investment banking activities on a global
basis. The principal risks of Lehman Brothers are market, credit, liquidity,
legal and operational risks. Risk Management is considered to be of paramount
importance. The Company devotes significant resources across all of its
worldwide trading operations to the measurement, management and analysis of
risk, including investments in personnel and technology.
The Company seeks to reduce risk through the diversification of its businesses,
counterparties and activities in geographic regions. The Company accomplishes
this objective by allocating the usage of capital to each of its businesses,
establishing trading limits for individual products and traders and setting
credit limits for individual counterparties, including regional concentrations.
The Company seeks to achieve adequate returns from each of its businesses
commensurate with the risks that they assume.
Overall risk management policy is established by a Risk Management Committee
(the "Committee") comprised of the Chief Executive Officer, the Global Risk
Manager, the Chief Financial and Administrative Officer, the Head of Equities,
the Head of Fixed Income, the Head of Global Sales and Research, the Head of
Investment Banking and the Head of Private Equity. The Committee brings together
senior management with the sole intent of discussing risk-related issues and
provides an effective forum for managing risk at the highest levels within the
Company. The Committee meets on a monthly basis, or more frequently if required,
to discuss, among other matters, significant market exposures, concentrations of
positions (e.g., counterparty, market risk), potential new transactions or
positions and risk limit exceptions.
The Global Risk Management Group (the "Group") supports the Committee, is
independent of the trading areas and reports directly to the Chief Executive
Officer. The Group combines two departments, credit risk management and market
risk management, into one unit. This facilitates the analysis of counterparty
credit and market risk exposures and leverages personnel and information
technology resources in a cost-efficient manner. The Group maintains staff in
each of the Company's regional trading centers and has daily contact with
trading staff at all levels within the Company. These discussions include a
review of trading positions and risk exposures.
Credit Risk Credit risk represents the possibility that a counterparty will be
unable to honor its contractual obligations to the Company. Credit risk
management is therefore an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department")
has global responsibility for implementing the Company's overall credit risk
management framework.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
The CRM Department manages the credit exposure related to trading activities by
giving initial credit approval for counterparties, establishing credit limits by
counterparty, country and industry group and by requiring collateral in
appropriate circumstances. In addition, the CRM Department strives to ensure
that master netting agreements are obtained whenever possible. The CRM
Department also considers the duration of transactions in making its credit
decisions, along with the potential credit exposure for complex derivative
transactions. The CRM Department is responsible for the continuous monitoring
and review of counterparty credit exposure and creditworthiness and
recommending, where appropriate, valuation adjustments to the market value of
derivative related contracts. Credit limits are reviewed periodically to ensure
that they remain appropriate in light of market events or the counterparty's
financial condition.
Market Risk Market risk represents the potential change in value of a portfolio
of financial instruments due to changes in market rates, prices and
volatilities. Market risk management also is an essential component of the
Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for implementing the
Company's overall market risk management framework. It is responsible for the
preparation and dissemination of risk reports, developing and implementing the
firmwide Risk Management Guidelines and evaluating adherence to these
guidelines. These guidelines provide a clear framework for risk management
decision-making. To that end the MRM Department identifies and quantifies risk
exposures, develops limits, and reports and monitors these risks with respect to
the approved limits. The identification of material market risks inherent in
positions includes, but is not limited to, interest rate, equity, and foreign
exchange risk exposures. In addition to these risks, the MRM Department also
evaluates liquidity risks, credit and sovereign concentrations.
The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.
Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client-driven market-making transactions, the size of the Company's
proprietary and arbitrage positions, and the volatility of financial instruments
traded. The Company seeks to mitigate, whenever possible, excess market risk
exposures through the use of futures and option contracts and offsetting cash
market instruments.
The Company participates globally in interest rate, equity, and foreign exchange
markets. The Company's Fixed Income division has a broadly diversified market
presence in U.S. and foreign government bond trading, emerging market
securities, corporate debt (investment and non-investment grade), money market
instruments, mortgages and mortgage-backed securities, asset-backed securities,
municipal bonds, and interest rate derivatives. The Company's Equities division
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
facilitates domestic and foreign trading in equity instruments, indices, and
related derivatives. The Company's foreign exchange businesses are involved in
trading currencies on a spot and forward basis as well as through derivative
products and contracts.
The Company incurs short-term interest rate risk when facilitating the orderly
flow of customer transactions through the maintenance of government and high
grade corporate bond inventories. Market-making in high yield instruments
exposes the Company to additional risk due to potential variations in credit
spreads. Trading in international markets exposes the Company to spread risk
between the term structure of interest rates in differing countries. Mortgages
and mortgage-related securities are subject to prepayment risk and changes in
the level of interest rates. Trading in derivatives and structured products
exposes the Company to changes in the level and volatility of interest rates.
The Company actively manages interest rate risk through the use of interest rate
futures, options, swaps, forwards, and offsetting cash market instruments.
Inventory holdings, concentrations and agings are monitored closely and used by
management to selectively hedge or liquidate undesirable exposures.
The Company is a significant intermediary in the global equity markets through
its market-making in U.S. and non-U.S. equity securities, including common
stock, convertible debt, exchange-traded and OTC equity options, equity swaps
and warrants. These activities expose the Company to market risk as a result of
price and volatility changes in its equity inventory. Inventory holdings are
also subject to market risk resulting from concentrations, aging and liquidity
that may adversely impact market valuation. Equity market risk is actively
managed through the use of index futures, exchange-traded and OTC options, swaps
and cash instruments. Equity risk exposures are aggregated and reported to
management on a regular basis.
The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar as well as a variety of developed and emerging
market currencies. The Company hedges its risk exposures primarily through the
use of currency forwards, swaps, futures, and options.
Value at Risk For purposes of Securities and Exchange Commission ("SEC") risk
disclosure requirements, the Company discloses an entity-wide value at risk
analysis of virtually all of the Company's trading activities. The value at risk
calculation measures the potential loss in expected revenues with a 95%
confidence level. The methodology incorporates actual trading revenues over a
standardized 250-day historical period. A confidence level of 95% implies, on
average, that daily trading revenues or losses will exceed daily expected
trading revenues by an amount greater than value at risk one out of every 20
trading days.
Average value at risk computed in this manner was $18.3 million and $20.0
million for the periods ended February 29, 2000 and November 30, 1999,
respectively. Value at risk at February 29, 2000 and November 30, 1999 was $14.1
million and $14.0 million, respectively. Value at risk is one measurement of
potential losses in revenues that may result from adverse market movements over
a specified period of time with a selected likelihood of occurrence.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Value at risk has substantial limitations, including its reliance on historical
performance and data as valid predictors of the future. Consequently, value at
risk is only one of a number of tools the Company utilizes in its daily risk
management activities.
As discussed throughout Management's Discussion and Analysis, the Company seeks
to reduce risk through the diversification of its businesses and a focus on
customer flow activities. This diversification and focus, combined with the
Company's risk management controls and processes, helps mitigate the net revenue
volatility inherent in the Company's trading activities. Although historical
performance is not necessarily indicative of future performance, the Company
believes its focus on business diversification and customer flow activities
should continue to help mitigate the volatility of future net trading revenues.
<PAGE>
LEHMAN BROTHERS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
New Accounting Developments
In September 1999, the FASB issued an Exposure Draft, "Business Combinations and
Intangible Assets." The proposal would eliminate the use of the
pooling-of-interests method and require that all business combinations be
accounted for using the purchase method. The Exposure Draft would also require
goodwill arising from the application of the purchase method to be written off
over a maximum 20-year amortization period, which is shorter than the current
40-year period. The provisions of the Exposure Draft related to business
combinations are expected to be applied only for those business combinations
initiated after the issuance of a final statement, projected to be late in
2000.In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which requires all derivatives to be
recorded on the balance sheet at fair value.
In June 1999, the FASB extended the implementation date of SFAS No. 133 by one
year. As a result, SFAS No. 133 will now be effective for the Company on
December 1, 2000 (Fiscal Year 2001). The expected impact of adoption on the
Company's results of operations has not yet been determined, however it is not
likely to be material since most of the Company's derivatives are carried at
fair value.
<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 the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company'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,
including the Company.
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, and 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.
In re Mobilemedia Securities Litigation (Reported in LBI's 1999 Annual Report on
Form 10-K)
On February 24, 2000, the Court entered an Order and Final Judgment finally
approving a settlement and dismissing the action.
Pamahi Investment Corp., et al. v. Lehman Brothers Inc., et al. (Reported in
LBI's 1999 Annual Report on Form 10-K)
On March 17, 2000, the motion of LBI and its former branch manager to sever
the arbitration into a separate case for each set of claimants was granted,
and all claims other than those of the lead claimant, Pamahi Investment
Corp., were dismissed without prejudice to renewal in a separate
proceeding. Pamahi claims damages of $5.96 million; no other Claimants
assert claims for damages in excess of that amount.
<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>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEHMAN BROTHERS INC.
(Registrant)
Date: April 14, 2000 By: /s/ David Goldfarb
---------------------------
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
LEHMAN BROTHERS INC. and SUBSIDIARIES
COMPUTATION of RATIOS of EARNINGS to FIXED CHARGES
(Dollars in millions)
(Unaudited)
<TABLE>
<CAPTION>
For the For the For the For the For the For the
Twelve Twelve Twelve Twelve Twelve Three
Months Months Months Months Months Months Ended
Ended Ended Ended Ended Ended February 29
November 30 November 30 November 30 November 30 November 30 2000
1995 1996 1997 1998 1999
------------- ------------- ------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Pre-tax earnings from continuing
operations $ 78 $ 309 $ 593 $ 847 $ 1,013 $ 430
Add: Fixed charges (excluding
capitalized interest) 9,980 10,140 12,233 14,746 12,552 3,709
------------- ------------- ------------- -------------- ------------- --------------
Pre-tax earnings before fixed
charges 10,058 10,449 12,826 15,593 13,565 4,139
============= ============= ============= ============== ============= ==============
Fixed charges:
Interest 9,954 10,121 12,216 14,730 12,535 3,705
Other(a) 27 25 19 20 17 4
------------- ------------- ------------- -------------- ------------- --------------
Total fixed charges $ 9,981 $ 10,146 $ 12,235 $ 14,750 $ 12,552 $ 3,709
============= ============= ============= ============== ============= ==============
RATIO OF EARNINGS TO FIXED
CHARGES 1.01 1.03 1.05 1.06 1.08 1.12
</TABLE>
(a) Other fixed charges consist of the interest factor in rentals and
capitalized interest.
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
(This schedule contains summary financial information extracted from the
Company's Consolidated Statement of Financial Condition at February 29, 2000
(Unaudited) and the Consolidated Statement of Income for the three months ended
February 29, 2000 (Unaudited) and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> NOV-30-2000
<PERIOD-START> DEC-01-1999
<PERIOD-END> FEB-29-2000
<CASH> 3,963
<RECEIVABLES> 10,248
<SECURITIES-RESALE> 68,312
<SECURITIES-BORROWED> 18,629
<INSTRUMENTS-OWNED> 48,474
<PP&E> 276
<TOTAL-ASSETS> 150,154
<SHORT-TERM> 736
<PAYABLES> 8,718
<REPOS-SOLD> 76,833
<SECURITIES-LOANED> 13,794
<INSTRUMENTS-SOLD> 23,130
<LONG-TERM> 3,965
0
0
<COMMON> 0
<OTHER-SE> 3,374
<TOTAL-LIABILITY-AND-EQUITY> 150,154
<TRADING-REVENUE> 653
<INTEREST-DIVIDENDS> 3,765
<COMMISSIONS> 168
<INVESTMENT-BANKING-REVENUES> 447
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 3,705
<COMPENSATION> 696
<INCOME-PRETAX> 430
<INCOME-PRE-EXTRAORDINARY> 271
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 271
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
