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 May 31, 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 1-9466
Lehman Brothers Holdings Inc.
(Exact Name of Registrant As Specified In Its Charter)
Delaware 13-3216325
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) 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 ______
As of June 30, 1997, 101,562,887 shares of the Registrant's Common Stock, par
value $.10 per share, were outstanding.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MAY 31, 1997
INDEX
Part I. FINANCIAL INFORMATION Page Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Operations -
Three and Six Months Ended
May 31, 1997 and 1996 ........................ 3
Consolidated Statement of Financial Condition -
May 31, 1997 and November 30, 1996 .......... 5
Consolidated Statement of Cash Flows -
Six Months Ended
May 31, 1997 and 1996........................ 7
Notes to Consolidated Financial Statements....... 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...... 14
Part II. OTHER INFORMATION
Item 1. Legal Proceedings ............................... 29
Item 6. Exhibits and Reports on Form 8-K ........... 30
Signatures............................................................... 31
EXHIBIT INDEX .......................................................32
Exhibits
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of OPERATIONS
(Unaudited)
(In millions, except per share data)
Three months ended
May 31 May 31
1997 1996
--------------- ----------
Revenues
Principal transactions $ 326 $ 398
Investment banking 274 223
Commissions 91 94
Interest and dividends 3,099 2,749
Other 16 12
-------- -------
Total revenues 3,806 3,476
Interest expense 2,952 2,643
------ -----
Net revenues 854 833
------- ------
Non-interest expenses
Compensation and benefits 433 422
Brokerage, commissions and 61 58
clearance fees
Professional services 47 39
Communications 36 38
Occupancy and equipment 34 37
Business development 26 25
Depreciation and amortization 21 22
Other 24 23
------- -------
Total non-interest expenses 682 664
------ ------
Income before taxes 172 169
Provision for income taxes 51 61
------- -------
Net income $ 121 $ 108
===== =====
Net income applicable to common stock $ 114 $ 102
===== =====
Average common and common equivalent
shares outstanding 120.4 114.8
===== =====
Earnings per common share $0.95 $0.89
===== =====
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of OPERATIONS
(Unaudited)
(In millions, except per share data)
Six months ended
May 31 May 31
1997 1996
--------------- ----------
Revenues
Principal transactions $ 672 $ 811
Investment banking 514 433
Commissions 188 190
Interest and dividends 6,377 5,405
Other 54 23
-------- -------
Total revenues 7,805 6,862
Interest expense 6,026 5,208
------ -----
Net revenues 1,779 1,654
----- -----
Non-interest expenses
Compensation and benefits 902 839
Brokerage, commissions and 118 115
clearance fees
Professional services 88 73
Communications 70 78
Occupancy and equipment 69 77
Business development 51 52
Depreciation and amortization 43 46
Other 47 47
------- -------
Total non-interest expenses 1,388 1,327
----- -----
Income before taxes 391 327
Provision for income taxes 126 115
------ ------
Net income $ 265 $ 212
===== =====
Net income applicable to common $ 252 $ 195
stock ===== =====
Average common and common equivalent
shares outstanding 119.4 115.9
===== =====
Earnings per common share $2.11 $1.68
===== =====
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
May 31 November 30
ASSETS 1997 1996
-------- ------------
<S> <C> <C>
Cash and cash equivalents $ 2,120 $ 2,149
Cash and securities segregated and on deposit
for regulatory and other purposes 1,348 688
Securities and other financial instruments owned:
Governments and agencies 28,145 26,638
Corporate stocks 10,294 6,937
Corporate debt and other 10,214 8,821
Mortgages and mortgage-backed 8,847 8,314
Derivatives and other contractual agreements 7,477 6,909
Certificates of deposit and other money market instruments 3,332 3,834
--------- ---------
68,309 61,453
--------- --------
Collateralized short-term agreements:
Securities purchased under agreements to resell 40,093 32,340
Securities borrowed 22,085 20,651
Receivables:
Brokers, dealers and clearing organizations 1,832 2,878
Customers 6,594 5,813
Others 1,352 1,253
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $699 in 1997 and $668 in 1996) 467 477
Deferred expenses and other assets 750 722
Excess of cost over fair value of net assets
acquired (net of accumulated amortization
of $107 in 1997 and $103 in 1996) 168 172
------------ ------------
Total assets $145,118 $128,596
======== ========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (Continued)
(Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
May 31 November 30
1997 1996
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt $ 11,089 $ 8,202
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 17,343 13,202
Corporate stocks 8,467 4,971
Corporate debt and other 1,818 1,375
Derivatives and other contractual agreements 6,663 6,816
-------- -------
34,291 26,364
------- ------
Collateralized short-term financings:
Securities sold under agreements to repurchase 57,179 56,119
Securities loaned 6,904 6,296
Payables:
Brokers, dealers and clearing organizations 1,230 1,004
Customers 8,748 7,582
Accrued liabilities and other payables 3,594 3,233
Long-term debt:
Senior notes 14,409 12,571
Subordinated indebtedness 3,536 3,351
--------- ---------
Total liabilities 140,980 124,722
------- -------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred Stock, $1 par value; 38,000,000 shares authorized:
5% Cumulative Convertible Voting, Series A, 13,000,000 shares
authorized, issued and outstanding; $39.10 liquidation preference
per share 508 508
Redeemable Voting, 1,000 shares issued and outstanding;
$1.00 liquidation preference per share
Common Stock, $.10 par value; 300,000,000 shares authorized;
shares issued: 107,888,042 in 1997 and 106,793,538 in 1996;
shares outstanding: 101,541,385 in 1997 and 100,449,144 in 1996 11 11
Common Stock issuable 346 326
Additional paid-in capital 3,222 3,198
Foreign currency translation adjustment 3 20
Retained earnings (deficit) 194 (43)
Common Stock in treasury at cost: 6,346,657 shares in 1997
and 6,344,394 shares in 1996 (146) (146)
------------ ------------
Total stockholders' equity 4,138 3,874
----------- -----------
Total liabilities and stockholders' equity $145,118 $128,596
======== ========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
May 31 May 31
1997 1996
---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income $ 265 $ 212
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 43 46
Provisions for losses and other reserves 19 22
Deferred tax benefit (33)
Other adjustments 42 23
Net change in:
Cash and securities segregated (660) 328
Securities and other financial instruments owned (6,856) (3,962)
Securities purchased under agreements to resell (7,753) (7,627)
Securities borrowed (1,434) (3,005)
Receivables from brokers, dealers and clearing organizations 1,046 (103)
Receivables from customers (781) (3,466)
Securities and other financial instruments sold but
not yet purchased 7,927 5,858
Securities sold under agreements to repurchase 1,060 6,297
Securities loaned 608 2,284
Payables to brokers, dealers and clearing organizations 226 215
Payables to customers 1,166 1,508
Accrued liabilities and other payables 342 (186)
Other operating assets and liabilities, net (289) (74)
------- --------
Net cash used in operating activities $(5,062) $(1,630)
------- -------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)
(In millions)
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
May 31 May 31
1997 1996
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior notes $3,120 $1,271
Principal payments of senior notes (1,101) (1,171)
Proceeds from issuance of subordinated indebtedness 395 975
Principal payments of subordinated indebtedness (209) (246)
Net proceeds from commercial paper and
short-term debt 2,887 1,773
Payment for repurchase of preferred stock (200)
Payments for treasury stock purchases (118)
Dividends paid (25) (32)
------- -------
Net cash provided by financing activities 5,067 2,252
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and leasehold improvements (34) (19)
------- -------
Net cash used in investing activities (34) (19)
------- -------
Net change in cash and cash equivalents (29) 603
------- ------
Cash and cash equivalents, beginning of period 2,149 874
------ ------
Cash and cash equivalents, end of period $2,120 $1,477
====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $5,781 and $5,213 for the six months ended May
31, 1997 and 1996, respectively. Income taxes paid totaled $71 and $50 for the
six months ended May 31, 1997 and 1996, respectively.
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The consolidated financial statements include the accounts of Lehman
Brothers Holdings Inc. ("Holdings") and subsidiaries (collectively, the
"Company" or "Lehman Brothers"). Lehman Brothers 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 and regional headquarters in London and Tokyo are complemented by
offices in additional locations in North America, Europe, the Middle East, Latin
and South America and the Asia Pacific Region. The Company is engaged primarily
in providing financial services. The principal U.S. subsidiary of Holdings is
Lehman Brothers Inc. ("LBI"), a registered broker-dealer. 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 six months ended May 31, 1997, the Company issued $3,515
million of long-term debt (comprised of $3,120 million of senior notes and $395
million of subordinated debt). Of the total issuances for the first six months
of 1997, $1,501 million were U.S. dollar fixed rate, $834 million were U.S.
dollar floating rate, $519 million were foreign currency denominated fixed rate,
and $661 million were foreign currency denominated floating rate. The issuances
were primarily utilized to refinance current and prefund the remaining
maturities of long-term debt in 1997 and to increase total capital
(stockholders' equity plus long-term debt).
The Company's floating rate new issuances contain contractual interest
rates based primarily on London Interbank Offered Rates ("LIBOR"). All of the
Company's fixed rate new issuances were effectively converted to floating rate
obligations through the use of interest rate swaps.
The Company had approximately $1,310 million of long-term debt mature
during the six months ended May 31, 1997.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
3. 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 May 31, 1997, LBI's regulatory net capital, as defined, of $1,619
million exceeded the minimum requirement by $1,515 million.
Lehman Brothers International (Europe) ("LBIE"), a United Kingdom
registered broker-dealer and subsidiary of Holdings, is subject to the capital
requirements of the Securities and Futures Authority ("SFA") of the United
Kingdom. Financial resources, as defined, must exceed the total financial
resources requirement of the SFA. At May 31, 1997, LBIE's financial resources
were $303 million in excess of regulatory requirements. Lehman Brothers Japan
Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the capital
requirements of the Japanese Ministry of Finance and, at May 31, 1997, had net
capital of $130 million in excess of the specified levels required. Certain
other non-U.S. subsidiaries are subject to various securities, commodities and
banking regulations and capital adequacy requirements promulgated by the
regulatory and exchange authorities of the countries in which they operate. At
May 31, 1997, these other subsidiaries were in compliance with their applicable
local capital adequacy requirements. The Company's triple-A rated derivatives
subsidiary, Lehman Brothers Financial Products Inc. ("LBFP"), has established
certain capital and operating restrictions which are reviewed by various rating
agencies. At May 31, 1997 LBFP had capital which exceeded the requirement of the
most stringent rating agency by $100 million.
There are no restrictions on Holdings' present ability to pay dividends
on its common stock, other than Holdings' obligation first to make dividend
payments on its preferred stock and the governing provisions of the Delaware
General Corporation Law.
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 12 to the Consolidated Financial
Statements, included in the Form 10-K.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
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. The Company currently 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* Six Months Ended
May 31, 1997 May 31, 1997
------------ ------------
Assets Liabilities Assets Liabilities
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $4,056 $2,868 $4,369 $2,819
Foreign exchange forward contracts and options 1,228 1,358 1,162 1,515
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 216 248 218 213
Equity contracts (including equity swaps, warrants
and options) 1,622 1,634 1,706 1,405
Commodity contracts (including swaps, forwards,
and options) 355 555 381 630
--------------------------------------------------------
Total $7,477 $6,663 $7,836 $6,582
--------------------------------------------------------
</TABLE>
<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) $4,008 $3,185 $3,446 $1,945
Foreign exchange forward contracts and options 970 1,206 903 1,200
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 226 286 239 238
Equity contracts (including equity swaps, warrants
and options) 1,167 1,304 1,118 1,076
Commodity contracts (including swaps, forwards,
and options) 538 835 451 587
------------------------------------------------------
Total $6,909 $6,816 $6,157 $5,046
-----------------------------------------------------
</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 HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
Assets included in the previous table 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 May 31, 1997 represents the Company's net receivable for
derivative financial instruments before consideration of collateral. Included
within the $7,477 million fair value of assets at May 31, 1997 was $7,036
million related to swaps and OTC contracts and $441 million related to
exchange-traded option and warrant contracts.
With respect to OTC contracts, the Company views its net credit
exposure to be $4,038 million at May 31, 1997, representing the fair value of
the Company's OTC contracts in an unrealized gain position, after consideration
of collateral of $2,998 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 May 31, 1997
Risk Rating Equivalent Net Credit Exposure
- - ------------ ------------------------- -------------------
1 AAA/Aaa 22%
2 AA-/Aa3 or higher 22%
3 A-/A3 or higher 39%
4 BBB-/Baa3 or higher 10%
5 BB-/Ba3 or higher 5%
6 B+/B1 or lower 2%
- - --------------------------------------------------------------------------------
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.
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 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 14 to the Consolidated
Financial Statements, in the Form 10-K.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
6. Incentive Plans:
In the first quarter of 1997, the Company granted approximately 2.3
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 the Company's common stock
meets, or exceeds, $39, $42, and $45 for fifteen out of twenty consecutive
trading days. 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.
7. Severance Charge:
The Company recorded an $84 million severance charge ($50 million
aftertax) in the fourth quarter of 1996 related to certain strategic actions
taken to improve ongoing profitability. The 1996 severance charge reflected the
culmination of a worldwide business unit economic performance review which was
undertaken in the fourth quarter of 1996 to focus the Company on its core
investment banking, equity and fixed income sales and trading areas. This
formalized review resulted in personnel reductions of approximately 270 people
across a number of underperforming fixed income and equity businesses, including
exiting the precious metals business in the U.S., Europe and Asia; exiting
energy trading in the U.S. and Europe; consolidating Asian fixed income risk
management activities into one center in Tokyo; refocusing foreign exchange
trading activities and combining the Company's New York Private Client Services
offices. Additionally, the charge reflects various other strategic personnel
reductions which were aimed at delayering management. The severance charge is
expected to lead to personnel cost savings beginning in fiscal 1997 of $90
million annually. The charge is also expected to result in a permanent decrease
in nonpersonnel expenses of approximately $20 million annually. The Company
intends to reinvest substantially all these savings into certain businesses to
expedite the Company's strategic initiatives; these actions are expected to
result in improved operating revenues.
Cash outlays relating to the charge were approximately $19 million in
the fourth quarter of 1996 and approximately $53 million during the first six
months of 1997. The remaining residual payments will be paid by the end of the
third quarter of 1997 as deferred payment arrangements are completed.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Business Environment
Market conditions in the first half of 1997 reflected record corporate
advisory activities, strong underwriting volumes in worldwide fixed income
products, and generally active trading activities in worldwide debt and equity
markets. These favorable conditions were mitigated in part by significantly
reduced equity underwriting volumes and increased volatility in the foreign
exchange markets, particularly in Europe and Asia.
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 reflect 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 favorable U.S. macroeconomic
environment and the strong dollar. In late March 1997, a strong pattern of
growth in the U.S. economy prompted the Federal Reserve to raise the
Federal Funds rate by 25 basis points to 5 1/2%. This rate hike precipitated
a general decline in trading volumes and origination activities in the U.S.
fixed income market.
Rising interest rates and fears of additional rate hikes by the Federal
Reserve continued to depress U.S. trading and origination activities through
March and into April. However, by mid-April, economic data reinforced the view
that U.S. interest rates would remain stable as GDP growth decelerated and
inflation indicators remained low. This led to a recovery of the U.S. fixed
income markets in late April as interest rates began to decline and trading
volumes regained strength. This recovery further accelerated in May and into
June, with interest rates on the 30-year U.S. Treasury declining to 6.65% on
June 20, 1997 from a peak of 7.17% on April 11th.
Trading activities in worldwide equity markets continued to show
strength in 1997. U.S. trading volumes improved over prior year record levels,
as investor demand remained strong and the equity markets benefited from
increasing capital flows. The U.S. equity markets, while experiencing a
correction in the second quarter, continued to show strength surpassing prior
year valuation levels. The trough in the S&P 500 was also on April 11 when the
index reached 738; the U.S. stock market is up more than 20% since then.
European equity markets saw improved trading volumes and valuations in 1997,
despite a valuation adjustment in March, as the stronger U.S. dollar and
declining European rate environment contributed to a favorable equity
environment.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Worldwide underwriting volumes in fixed income products remained strong
in the first half of 1997. U.S. underwriting volumes, while experiencing a
slowdown in March and April, strengthened over the prior year. The improvement
was fueled in part by straight debt financings timed in anticipation of higher
interest rates, as well as favorable pricing in the spread sectors. Equity and
related underwriting volumes declined considerably from the strong 1996 levels,
as rising interest rates and the U.S. equity market correction had a negative
effect on the timing of equity offerings. New issuance activity was also
negatively impacted by the volatility experienced in the international markets,
as the weakening of the Yen and certain Asian markets caused equity-market
selloffs and corresponding reductions in new issuance activities. Elections and
EMU uncertainty also contributed to reduced European issuance activity.
Corporate finance advisory activities outpaced the record 1996 levels,
reflecting increased consolidation and globalization across industry sectors and
the overall strength in the global capital markets. The pace of strategic merger
and acquisition activity is expected to remain strong throughout 1997.
While fiscal 1996 and 1997 have been characterized by favorable
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 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 HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
For the Three Months Ended May 31, 1997 and 1996
The Company reported net income of $121 million for the second quarter
ended May 31, 1997, representing an increase of 12% from net income of $108
million for the second quarter ended May 31, 1996. Earnings per common share
increased to $0.95 for the second quarter of 1997 from $0.89 for the second
quarter of 1996.
Net revenues increased to $854 million for the second quarter of 1997
from $833 million for the second quarter of 1996. The increase in net revenues
from the second quarter of 1996 resulted from particular strength in a number of
strategic, higher margin businesses that the Company is focusing on, including
the global merger and acquisition advisory, merchant banking, equity
derivatives, and mortgage businesses.
Compensation and benefits expense as a percentage of net revenues was
50.7% for both the second quarter of 1997 and 1996, reflecting the ninth
successive quarter of consistent compensation levels relative to net revenues.
Nonpersonnel expenses increased to $249 million in the second quarter of 1997
from $242 million in the second quarter of 1996; however, nonpersonnel expenses
as a percentage of net revenues were 29.1% for the second quarter of 1997,
relatively unchanged from 29.0% for the second quarter of 1996.
The Company, through its subsidiaries, is a market-maker of equity and
fixed income products in major 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 $473 million for the second quarter of 1997 from $504
million for the second quarter of 1996. The decrease in combined revenues from
principal transactions and net interest in the second quarter of 1997 was due to
reduced revenues from customer flow activities in certain fixed income and
equity products and higher interest expenses resulting from the Company's
increased level of long-term debt. The decrease was partially offset by
increases in equity financing and derivative transactions.
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 May 31, 1997
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $358 $11 $71 $ 5 $445
Equity 122 76 41 2 241
Corporate Finance Advisory (3) 83 80
Merchant Banking (4) 80 76
Other 4 (1) 9 12
- - ---------------------------------------------------------------------------------------------------------------------------
$473 $91 $274 $16 $854
- - ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended May 31, 1996
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $411 $15 $74 2 $502
Equity 96 74 71 3 244
Corporate Finance Advisory 57 57
Merchant Banking (5) 20 15
Other 2 5 1 7 15
- - ---------------------------------------------------------------------------------------------------------------------------
$504 $94 $223 $12 $833
- - ---------------------------------------------------------------------------------------------------------------------------
</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 and
fixed income derivative products. Fixed income net revenues decreased 11% to
$445 million for the second quarter of 1997 from $502 million for the second
quarter of 1996. The reduction in the second quarter results versus the prior
year quarter reflected reduced customer flow activities from a number of fixed
income products including foreign exchange, high yield, and firm financing
partially offset by improved results in mortgages and governments. Investment
banking revenues, as a component of fixed income revenues, were relatively
unchanged, decreasing to $71 million for the second quarter of 1997 from $74
million for the second quarter of 1996.
<PAGE>
LEHMAN BROTHERS HOLDINGS 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, equity derivatives and equity arbitrage
activities. The Company's equity net revenues decreased to $241 million for the
second quarter of 1997 from $244 million for the second quarter of 1996 as
customer trading and underwriting activities were negatively impacted by the
market correction. Increased revenues from derivatives and equity financing
activities were offset by a decline in NASDAQ, U.S. listed and international
equity trading revenues for the second quarter of 1997. Investment banking
revenues, as a component of equity revenues, decreased to $41 million for the
second quarter of 1997 from $71 million for the second quarter of 1996 as the
higher interest rate environment prompted a correction in the U.S. equity
markets, resulting in lower levels of underwriting volume.
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 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 activities increased to $80 million for the second
quarter of 1997, reflecting a 40% increase from the $57 million recognized in
the second quarter of 1996. This increase exemplified continued strength in the
overall merger and acquisition market environment.
Merchant Banking. The Company is the general partner for six 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 $76
million for the second quarter of 1997 and $15 million in the second quarter of
1996. This increase was principally due to a realized gain on the sale of a
significant portion of a publicly traded investment held by the partnerships.
The Company expects to complete the divestiture of both this investment and an
additional investment in the third quarter of 1997.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Non-Interest Expenses. Non-interest expenses were $682 million for the
second quarter of 1997 and $664 million for the second quarter of 1996.
Compensation and benefits expense as a percentage of net revenues remained
unchanged from the prior year quarter at 50.7%. Nonpersonnel expenses increased
from $242 million in the second quarter of 1996 to $249 million in the second
quarter of 1997; however, nonpersonnel expenses as a percentage of net revenues
of 29.1% for 1997 remained relatively unchanged from 29.0% for 1996.
Income Taxes. The Company's income tax provision was $51 million for
the second quarter of 1997 compared to $61 million for the second quarter of
1996. The effective tax rate was 30% for the second quarter of 1997 and 36% for
the second quarter of 1996. The decrease in the effective tax rate reflects an
increase in tax benefits attributable to income subject to preferential tax
treatment, an increase in the Company's net deferred tax assets resulting from a
change in state and local tax laws, partially offset by a decrease in tax
benefits from foreign operations.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
For the Six Months Ended May 31, 1997 and 1996
The Company reported net income of $265 million for the six months
ended May 31, 1997, representing an increase of 25% from net income of $212
million for the six months ended May 31, 1996. Earnings per common share
increased to $2.11 for the six months of 1997 from $1.68 for the six months of
1996.
Net revenues increased to $1,779 million for the six months of 1997
from $1,654 million for the six months of 1996. The increase in net revenues
from the first half of 1996 resulted from particular strength in a number of
strategic, higher margin businesses that the Company is focusing on including
the global merger and acquisition advisory, merchant banking and mortgage
businesses.
Compensation and benefits expense as a percentage of net revenues was
50.7% for both the first half of 1997 and 1996. Nonpersonnel expenses declined
as a percentage of net revenues to 27.3% for the six months of 1997 from 29.5%
for the comparable period in 1996. The reduction in nonpersonnel expenses from
$488 million in the six months of 1996 to $486 million in the six months of 1997
along with the increase in net revenues led to an improvement in the Company's
pretax operating margin to 22.0% in the first half of 1997 from 19.7% in the
first half of 1996.
Principal transactions and net interest revenues increased to $1,023
million for the six months of 1997 from $1,008 million for the six months of
1996. The increase in the combined revenues from principal transactions and net
interest in the six months of 1997 was the result of reduced revenues from
customer flow activities in certain fixed income and equity products and higher
interest expenses resulting from the Company's increased level of long-term
debt. This decrease was partially offset by improved results in equity financing
activities and international equities trading.
<PAGE>
LEHMAN BROTHERS HOLDINGS 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. Net revenues by business unit contain certain internal allocations,
including funding costs, which are centrally managed.
<TABLE>
<CAPTION>
Six Months Ended May 31, 1997
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $ 826 $ 21 $172 $ 8 $1,027
Equity 205 160 106 3 474
Corporate Finance Advisory (3) 149 146
Merchant Banking (8) 84 76
Other 3 7 3 43 56
- - ---------------------------------------------------------------------------------------------------------------------------
$1,023 $188 $514 $54 $1,779
- - ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended May 31, 1996
Principal
Transactions and Investment
Net Interest Commissions Banking Other Total
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fixed Income $ 850 $ 33 $147 $ 4 $1,034
Equity 159 146 124 3 432
Corporate Finance Advisory 107 107
Merchant Banking (8) 54 46
Other 7 11 1 16 35
- - ---------------------------------------------------------------------------------------------------------------------------
$1,008 $190 $433 $23 $1,654
- - ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
Fixed Income. Fixed income net revenues decreased to $1,027 million for
the six months of 1997 from $1,034 million for the six months of 1996. The
improved revenues in a number of fixed income products including derivatives and
mortgages were offset by reduced customer flow activities in firm financing and
foreign exchange. Investment banking revenues, as a component of fixed income
revenues, increased to $172 million for the six months of 1997 from $147 million
for the six months of 1996 due to increased underwriting volumes and a mix
change to higher margin debt products.
Equity. The Company's equity net revenues increased to $474 million for
the six months of 1997 from $432 million for the six months of 1996. Increased
revenues from equity financing and international equities (primarily Europe)
were partially offset by a decline in U.S. listed equity trading revenues for
the first half of 1997. Investment banking revenues, as a component of equity
revenues, decreased to $106 million for the six months of 1997 from $124 million
for the six months of 1996 as the higher interest rate environment prompted a
correction in the U.S. equity markets, resulting in lower levels of underwriting
volume.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Corporate Finance Advisory. Net revenues from corporate finance
advisory activities increased to $146 million for the six months of 1997
reflecting a 36% increase from the $107 million recognized in the six months of
1996. This increase reflected continued strength in the overall merger and
acquisition market environment.
Merchant Banking. Merchant banking net revenues were $76 million for
the six months of 1997 and $46 million in the six months of 1996. This increase
was principally due to a realized gain on the sale of a significant portion of a
publicly traded investment held by the partnerships. The Company expects to
complete the divestiture of this and an additional investment in the third
quarter of 1997.
Other. Other net revenues for the six months of 1997 include
approximately $25 million relating to the realization of certain non-core
assets.
Non-Interest Expenses. Non-interest expenses were $1,388 million for
the six months of 1997 and $1,327 million for the six months of 1996.
Compensation and benefits expense as a percentage of net revenues remained
unchanged from the comparable prior year period at 50.7%. Nonpersonnel expenses
declined as a percentage of net revenues to 27.3% for the six months of 1997
from 29.5% for the comparable period in 1996. The reduction in nonpersonnel
expenses from $488 million in the six months of 1996 to $486 million in the six
months of 1997 along with the increase in net revenues led to an improvement in
the Company's pretax operating margin to 22.0% in the first half of 1997 from
19.7% in the first half of 1996.
Income Taxes. The Company's income tax provision was $126 million for
the first half of 1997 compared to $115 million for the first half of 1996. The
effective tax rate was 32% for 1997 and 35% for 1996. The decrease in the
effective tax rate reflects an increase in tax benefits attributable to income
subject to preferential tax treatment, an increase in the Company's net deferred
tax assets resulting from a change in state and local tax laws, partially offset
by a decrease in tax benefits from foreign operations.
<PAGE>
LEHMAN BROTHERS HOLDINGS 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 $145.1 billion at May 31, 1997
from $128.6 billion at November 30, 1996. The increase in total assets is
primarily attributable to an increase in customer flow financing activities as
well as an increased level of securities and other financial instruments owned,
primarily corporate debt and equity.
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. 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 various month ends) 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 treasury staff members of the Finance Committee work 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 across a wide range of
market environments. There are five key elements of its funding strategy that
the Company attempts to achieve:
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 unsecured liabilities which have maturities similar
to the anticipated liquidation period of the assets.
<PAGE>
LEHMAN BROTHERS HOLDINGS 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, Total
Capital and a contingency funding plan. Financial stress is defined as any
event which severely constrains 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 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, OECD government 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 May 31, 1997 and November 30, 1996, $98 billion and $89
billion, respectively, of the Company's total balance sheet was financed using
collateralized borrowing sources.
As of May 31, 1997 and November 30, 1996, commercial paper and
short-term debt outstanding was $11.1 billion and $8.2 billion, respectively. Of
these amounts, commercial paper outstanding as of May 31, 1997 was $5.6 billion
with an average maturity of 72 days, compared to $3.1 billion with an average
maturity of 64 days as of November 30, 1996.
At May 31, 1997, Holdings maintained a Revolving Credit Agreement with
a syndicate of banks. Under the terms of the credit agreement, the banks have
committed to provide up to $2 billion for up to 364 days. Any loans outstanding
on the commitment termination date may mature on the first anniversary of the
commitment termination date at the option of Holdings. The credit agreement
contains covenants which require, among other things, that the Company maintain
specified levels of liquidity and tangible net worth, as defined.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In addition, the Company maintained a $1 billion Secured Revolving
Credit Facility (the "Facility") for Lehman Brothers International (Europe)
("LBIE"), the Company's major operating entity in Europe. Under the terms of the
committed Facility, the bank group has committed to provide up to $1 billion for
up to 364 days on a secured basis. The loans provided by the bank group are
available in several currencies, including U.S. dollar, British pound sterling,
Deutsche mark, ECU, French franc, and Italian lira. The credit agreement
contains covenants which require, among other things, that LBIE maintain
specified levels of tangible net worth, and regulatory capital, and that the
Company maintain specified levels of consolidated stockholders' equity and
tangible net worth, as defined.
There were no borrowings outstanding under the Facility or the
Revolving Credit Agreement as of May 31, 1997. The Company uses the Facility for
general corporate purposes from time to time. The Company maintained compliance
with the applicable covenants for both the Revolving Credit Agreement and the
Facility at all times.
Total Capital
In accordance with the Company's liquidity plan, the Company increased
its Total Capital base in 1997 to $22.1 billion at May 31, 1997 from $19.8
billion at November 30, 1996. Total Capital increased primarily due to an
increase in long-term debt and the retention of earnings.
May 31 November 30
(in millions) 1997 1996
- - --------------------------------------------------------------------------------
Long-Term Debt
Senior Notes $14,409 $12,571
Subordinated Indebtedness 3,536 3,351
------- -------
17,945 15,922
Stockholder's Equity
Preferred Equity 508 508
Common Equity 3,630 3,366
------- -------
4,138 3,874
- - --------------------------------------------------------------------------------
Total Capital $22,083 $19,796
- - --------------------------------------------------------------------------------
During the second quarter of 1997, the Company issued $3,515 billion in
long-term debt, which was $2,205 billion in excess of its maturing debt.
Long-term debt increased to $17.9 billion at May 31, 1997 from $15.9 billion at
November 30, 1996 with a weighted average maturity of 4.1 years at both May 31,
1997 and November 30, 1996.
The increase in Total Capital also reflects an increase in
stockholders' equity to $4.1 billion at May 31, 1997 from $3.9 billion at
November 30, 1996. The net increase in stockholders' equity was primarily due to
the retention of earnings partially offset by the payment of dividends.
At May 31, 1997, the Company had approximately $4.6 billion available
for the issuance of debt securities under various shelf registrations and debt
programs.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Capital Resources and Capital Adequacy
Balance sheet leverage ratios are one methodology utilized to evaluate
the capital adequacy of a company relative to financial risk inherent in the
balance sheet. The Company's leverage ratios computed as the ratio of
quarter-end assets to quarter-end stockholders' equity were 35.1x and 33.2x at
May 31, 1997 and November 30, 1996, respectively. However, the Company's
adjusted leverage ratios, a better measure of market risk, defined as total
assets less the lower of securities purchased under agreements to resell or
securities sold under agreements to repurchase divided by stockholders' equity
were 25.4x and 24.8x at May 31, 1997 and November 30, 1996, respectively. As
mentioned earlier, the increase in gross leverage is primarily attributable to
an increase in customer flow financing activities as well as an increased level
of securities and other financial instruments owned, primarily corporate debt
and equity. The increase in net leverage is principally attributable to the
increased level of securities and other financial instruments owned, primarily
corporate debt and equity.
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 May 31, 1997, the current short- and
long-term senior debt ratings of Holdings and Lehman Brothers Inc. ("LBI") were
as follows:
Holdings LBI
Short-term Long-term Short-term Long-term**
- - --------------------------------------------------------------------------------
Duff & Phelps Credit Rating Co. D-1 A D-1 A/A-
Fitch Investors Service Inc. F-1 A F-1 A/A-
IBCA A1 A- A1 A/A-
Moody's P2 Baa1 P2 A3*/Baa1
S&P+ A-1 A A-1 A+*/A
Thomson BankWatch TBW-1 A- 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 May 31, 1997 and November 30, 1996
included long positions with an aggregate market value of approximately $2.1
billion and $1.7 billion, respectively, and short positions with an aggregate
market value of approximately $140 million and $127 million, respectively. The
portfolio may from time to time contain concentrated holdings of selected
issues. The Company's largest high yield position was $205 million and $80
million at May 31, 1997 and November 30, 1996, respectively.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Merchant Banking Activities
The Company's merchant banking activities include investments in six
partnerships, for which the Company acts as general partner, as well as direct
investments. At May 31, 1997, the investment in merchant banking partnerships
was $483 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.
The Company has a commitment to invest up to $153 million in one of its
merchant banking employee investment vehicles. The Company has no remaining
commitments to the other five merchant banking partnerships or other direct
investments. During 1996, the Company began the process of establishing a new
institutional fund for which it will act as general partner. This prospective
fund is expected to total $1.5 billion, a portion of which may be contributed by
the Company either directly or through an employee investment vehicle.
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 $3.5 billion
of partnership investment capital and manages the remaining real estate
investment portfolio. At May 31, 1997, the Company had $20 million of
investments in these real estate activities, as well as $50 million of
commitments and contingent liabilities under guarantees and credit enhancements,
both net of applicable reserves. The Company believes any exposure under these
commitments and contingent liabilities has been adequately reserved. In certain
circumstances, the Company has elected to provide financial and other support
and assistance to such investments to maintain investment values. There is no
contractual requirement that the Company continue to provide this support.
The Company also has equity, partnership and debt investments made in
previous years that are unrelated to its ongoing businesses. The Company has
other investments that are also awaiting their disposition or the occurrence of
certain events which will ultimately lead to their liquidation. The Company
carries these equity, partnership and debt investments at their fair value,
which approximates $80 million at May 31, 1997.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Management's intention with regard to non-core assets is the prudent
liquidation of these investments as and when possible. This is evidenced by the
realization of certain non-core assets during the first quarter of 1997 which
resulted in the recognition of $25 million of revenue.
Recent Developments
In February 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, Earnings Per Share, which is effective for annual and
interim financial statements issued for periods ending after December 15, 1997.
SFAS No. 128 was issued to simplify the standards for calculating earnings per
share ("EPS") previously found in APB No. 15, Earnings Per Share. SFAS 128
replaces the presentation of primary EPS with a presentation of basic EPS. The
new rules also require dual presentation of basic and diluted EPS on the face of
the statement of operations for companies with a complex capital structure. For
the Company, basic EPS will exclude the dilutive effects of stock options and
certain non-vested RSUs. Diluted EPS for the Company will reflect all potential
dilutive securities (similar to fully diluted EPS under APB No. 15). Under the
provisions of FAS 128, basic EPS would have been $0.09 and $0.07 higher than the
amounts reported in the second quarter of 1997 and 1996, respectively.
Additionally, basic EPS would have been $0.18 and $0.14 higher than the amounts
reported for the six months of 1997 and 1996, respectively. Diluted EPS would
have been the same as the fully diluted amounts.
Year 2000
The Company has developed a detailed plan to modify its computer
systems in anticipation of the year 2000. Many of the existing systems process
transactions based on storing two digits for the year of a transaction, rather
than full four digits. If these systems are not identified and reconfigured,
year 2000 transactions would be processed with year "00" which would lead to
processing inaccuracies and potential inoperability. Any costs incurred relating
to this project will be expensed as technology maintenance costs in accordance
with generally accepted accounting principles.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
Lehman Brothers 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, Lehman
Brothers has denied, or believes it has meritorious defenses and will deny,
liability in all significant cases pending against it including the matters
described below, and intends to defend vigorously each such case. Although there
can be no assurance as to the ultimate outcome, based on information currently
available and established reserves, the Company believes that the eventual
outcome of the actions against it, including the matters described below, will
not, in the aggregate, have a material adverse effect on its business or
consolidated financial condition.
Actions Relating to First Capital Holdings Inc. (Reported in Holdings' Annual
Report on Form 10-K)
FCH Shareholder and Agent Actions. On April 21, 1997, the California
District Court entered an order approving the settlement and dismissing the
Action.
Sonnenfeld v. The City and County of Denver, Colorado, et al (Reported in
Holdings' Annual Report on Form 10-K)
On May 30, 1997, the parties entered into a Memorandum of Understanding
to settle and dismiss the action and are in the process of entering into a
definitive settlement agreement which will be submitted to the Court for
approval.
AIA Holding SA et al. v. Lehman Brothers Inc. and Bear Stearns & Co. Inc.
On July 9, 1997, LBI was served with a complaint in the U.S. District
Court for the Southern District of New York in which 277 named plaintiffs assert
24 causes of action against LBI and Bear Stearns & Co., Inc. The amount of
damages claimed is unspecified. The claims arise from the activities of an
individual named Ahmad Daouk, who was employed as an introducing broker who
introduced accounts to Shearson Lehman Hutton between 1988 and 1992. Daouk
allegedly perpetrated a fraud upon the claimants, who are mostly investors of
middle eastern origin, and the compliant alleges that Shearson breached various
contractual and common law duties owed to the investors.
<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:
11 Computation of Per Share Earnings
12.A Computation in Support of Ratio of Earnings to Fixed Charges
12.B Computation in Support of Ratio of Earnings to Combined Fixed
Charges and Preferred Dividends
27 Financial Data Schedule
(b) Reports on Form 8-K:
1. Form 8-K dated June 26, 1997, Items 5 and 7.
<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 HOLDINGS INC.
(Registrant)
Date: July 15, 1997 By /s/ Richard S. Fuld Jr.
--------------------------------
Richard S. Fuld, Jr.
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
Date: July 15, 1997 By /s/ Charles B. Hintz
-----------------------------
Charles B. Hintz
Chief Financial Officer
(Principal Financial Officer)
<PAGE>
EXHIBIT INDEX
Exhibit No. Exhibit
Exhibit 11 Computation of Per Share Earnings
Exhibit 12.A Computation in Support of Ratio of Earnings to
Fixed Charges
Exhibit 12.B Computation in Support of Ratio of Earnings to Combined
Fixed Charges and Preferred Dividends
Exhibit 27 Financial Data Schedule
<PAGE>
Exhibit 11
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
COMPUTATION of PER SHARE EARNINGS
(Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
Three months Three months Six months Six months
ended ended ended ended
May 31 May 31 May 31 May 31
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Primary:
Weighted average shares outstanding:
Common stock 101,363,320 101,692,508 101,024,030 102,883,293
Common stock issuable 17,380,026 11,594,020 16,848,491 11,693,861
Common stock equivalents 1,677,387 1,502,160 1,571,726 1,276,455
-------------- ------------- -------------- --------------
Total common stock and common stock equivalents 120,420,733 114,788,688 119,444,247 115,853,609
=========== =========== =========== ===========
Net income $ 120.7 $ 108.0 $ 265.1 $ 212.1
Preferred dividends (1) (6.3) (6.4) (12.7) (17.6)
------- ------- ------- --------
Net income applicable to common stock $ 114.4 $ 101.6 $ 252.4 $ 194.5
======= ======= ======= =======
Earnings Per Common Share $ 0.95 $ 0.89 $ 2.11 $ 1.68
======== ======== ======== ========
Fully diluted:
Weighted average shares outstanding:
Common stock 101,363,320 101,692,508 101,024,030 102,883,293
Common stock issuable 17,778,309 11,594,020 17,047,633 11,693,861
Common stock equivalents 2,274,780 1,502,160 1,941,027 1,423,471
------------- ------------- ------------- -------------
Total common stock and common stock equivalents 121,416,409 114,788,688 120,012,689 116,000,625
=========== =========== =========== ===========
Net income $ 120.7 $ 108.0 $ 265.1 $ 212.1
Preferred dividends (1) (6.3) (6.4) (12.7) (17.6)
------- ------- ------- --------
Net income applicable to common stock $ 114.4 $ 101.6 $ 252.4 $ 194.5
======= ======= ======= =======
Earnings Per Common Share $ 0.94 $ 0.89 $ 2.10 $ 1.68
======= ======= ======== =======
</TABLE>
(1) Amount for the six months ended May 31, 1996 includes $2 million premium
paid over par value to repurchase the $200 million 8.44% cumulative
preferred stock owned by the American Express Company.
<PAGE>
Exhibit 12.A
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
COMPUTATION in SUPPORT of RATIO of EARNINGS to FIXED CHARGES
(Dollars in millions)
(Unaudited)
<TABLE>
<CAPTION>
For the For the For the For the For the
year eleven months year year six months
ended ended ended ended ended
December 31 November 30 November 30 November 30 May 31
-------------------- ----------- ----------- ----------- ------
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Fixed Charges:
Interest expense:
Subordinated indebtedness $ 150 $ 144 $ 158 $ 206 $ 220 $ 127
Bank loans and other
borrowings* 5,035 5,224 6,294 10,199 10,596 5,899
Interest component of rentals
of office and equipment 74 76 42 44 34 16
Other adjustments** 2 7 4 28 16 7
---------- --------- --------- ---------- ---------- ----------
TOTAL (A) $5,261 $5,451 $6,498 $10,477 $10,866 $ 6,049
======= ====== ======== ======= ======= =======
Earnings:
Pretax income (loss) from
continuing operations $ (247) $ 27 $ 193 $ 369 $ 637 $ 391
Fixed charges 5,261 5,451 6,498 10,477 10,866 6,049
Other adjustments*** _____ (6) (28) (14) (6)
------- ------- --------- --------- ----------
(4)
TOTAL (B) $5,014 $5,472 $6,687 $10,818 $11,489 $ 6,434
====== ====== ====== ======= ======= =======
(B / A) **** 1.00 1.03 1.03 1.06 1.06
</TABLE>
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest and debt issuance costs
and amortization of capitalized interest.
*** 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 and debt issuance costs and
undistributed net income of affiliates accounted for at equity.
**** Earnings were inadequate to cover fixed charges and would have had to
increase $247 million in 1992 in order to cover the deficiencies.
<PAGE>
Exhibit 12.B
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
COMPUTATION in SUPPORT of RATIO of EARNINGS to COMBINED
FIXED CHARGES and PREFERRED DIVIDENDS
(Dollars in millions)
(Unaudited)
<TABLE>
<CAPTION>
For the For the For the For the For the
year eleven months year year six months
ended ended ended ended ended
December 31 November 30 November 30 November 30 May 31
------------------ ----------- ----------- ----------- ------
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Combined Fixed Charges
and Preferred Dividends:
Interest expense:
Subordinated indebtedness $ 150 $ 144 $ 158 $ 206 $ 220 $ 127
Bank loans and other
borrowings* 5,035 5,224 6,294 10,199 10,596 5,899
Interest component of rentals
of office and equipment 74 76 42 44 34 16
Other adjustments** 2 7 4 28 16 7
---------- --------- --------- --------- --------- ---------
Total fixed charges 5,261 5,451 6,498 10,477 10,866 6,049
Preferred dividends (tax
equivalent basis) 48 48 58 64 58 19
-------- -------- -------- --------- --------- ---------
TOTAL (A) $5,309 $5,499 $6,556 $10,541 $10,924 $ 6,068
====== ====== ====== ======= ======= =======
Earnings:
Pretax income (loss) from
continuing operations $ (247) $ 27 $ 193 $ 369 $ 637 $ 391
Fixed charges 5,261 5,451 6,498 10,477 10,866 6,049
Other adjustments*** _____ (6) (28) (14) (6)
-------- ------- -------- -------- --------
(4)
TOTAL (B) $5,014 $5,472 $6,687 $10,818 $11,489 $ 6,434
====== ====== ====== ======= ======= =======
(B / A) **** **** 1.02 1.03 1.05 1.06
</TABLE>
* Includes amortization of long-term debt discount.
** Other adjustments include capitalized interest and debt issuance costs
and amortization of capitalized interest.
*** 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 and debt issuance costs and
undistributed net income of affiliates accounted for at equity.
**** Earnings were inadequate to cover fixed charges and preferred dividends
and would have had to increase $295 million in 1992 and $27 million in
1993 in order to cover the deficiencies.
<PAGE>
Exhibit 27
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
This schedule contains summary financial information extracted from the
Company's Consolidated Statement of Financial Condition at May 31, 1997
(Unaudited) and the Consolidated Statement of Operations for the six months
ended May 31, 1997 (Unaudited) and is qualified in its entirety by reference to
such financial statements.
1,000,000
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> NOV-30-1997
<PERIOD-START> DEC-01-1996
<PERIOD-END> MAY-31-1997
<CASH> 3,468
<RECEIVABLES> 9,333
<SECURITIES-RESALE> 40,093
<SECURITIES-BORROWED> 22,085
<INSTRUMENTS-OWNED> 68,309
<PP&E> 467
<TOTAL-ASSETS> 144,789
<SHORT-TERM> 11,089
<PAYABLES> 9,534
<REPOS-SOLD> 57,179
<SECURITIES-LOANED> 6,904
<INSTRUMENTS-SOLD> 34,291
<LONG-TERM> 17,945
<COMMON> 11
0
508
<OTHER-SE> 3,619
<TOTAL-LIABILITY-AND-EQUITY> 144,789
<TRADING-REVENUE> 672
<INTEREST-DIVIDENDS> 6,377
<COMMISSIONS> 188
<INVESTMENT-BANKING-REVENUES> 514
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 6,026
<COMPENSATION> 902
<INCOME-PRETAX> 391
<INCOME-PRE-EXTRAORDINARY> 265
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 265
<EPS-PRIMARY> $2.11
<EPS-DILUTED> $2.10
</TABLE>
