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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-9466
LEHMAN BROTHERS HOLDINGS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
DELAWARE 13-3216325
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3 WORLD FINANCIAL CENTER 10285
NEW YORK, NEW YORK (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 526-7000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b)OF THE ACT:
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<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
- ------------------------------------------------------------------------------------------------------
<S> <C>
Common Stock, $0.10 par value New York Stock Exchange
Pacific Stock Exchange
Select Technology Index Call Warrants Expiring May 15, 1998 American Stock Exchange
Global Telecommunications Stock Upside Note Securities(SM) Due 2000 American Stock Exchange
8 3/4% Notes Due 2002 New York Stock Exchange
8.30% Quarterly Income Capital Securities Series A, Due December 31, 2035 New York Stock Exchange
$55 Million Serial Zero Coupon Senior Notes Due May 16, 1998 American Stock Exchange
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
Aggregate market value of the common equity held by non-affiliates of the
Registrant at February 10, 1998 was approximately $6,868,507,423. For purposes
of this information, the outstanding shares of common stock owned by certain
executive officers of the Registrant were deemed to be shares of common stock
held by affiliates.
As of February 10, 1998, 119,097,077 shares of the Registrant's Common
Stock, $0.10 par value per share, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
(1) Lehman Brothers Holdings Inc. 1997 Annual Report to Stockholders (the
"Annual Report") -- Incorporated in part in Form 10-K, Parts I, II and IV.
(2) Lehman Brothers Holdings Inc. Proxy Statement for its 1998 Annual
Meeting of Stockholders (the "Proxy Statement") -- Incorporated in part in Form
10-K, Parts I and III.
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PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
As used herein, "Holdings" or the "Registrant" means Lehman Brothers
Holdings Inc., a Delaware corporation, incorporated on December 29, 1983.
Holdings and its subsidiaries are collectively referred to as the "Company", the
"Firm" or "Lehman Brothers," and the principal subsidiary of Holdings, Lehman
Brothers Inc., a Delaware corporation, is referred to herein as "LBI."
The Company is one of the leading global investment banks serving
institutional, corporate, government and high-net-worth individual clients and
customers. Its executive offices are located at 3 World Financial Center, New
York, New York 10285 and its telephone number is (212) 526-7000.
LEHMAN BROTHERS
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 America and the Asia Pacific region. The
Company is engaged primarily in providing financial services. Other businesses
in which the Company is engaged represent less than 10 percent of consolidated
assets, revenues or pre-tax income.
The Company's business includes capital raising for clients through
securities underwriting and direct placements; corporate finance and strategic
advisory services; merchant banking; securities sales and trading; research; and
the trading of foreign exchange, derivative products and certain commodities.
The Company acts as a market-maker in all major equity and fixed income products
in both the domestic and international markets. Lehman Brothers is a member of
all principal securities and commodities exchanges in the United States, as well
as the National Association of Securities Dealers, Inc. ("NASD"), and holds
memberships or associate memberships on several principal international
securities and commodities exchanges, including the London, Tokyo, Hong Kong,
Frankfurt, Paris, Stockholm and Milan stock exchanges.
The Company's business activities are highly integrated and constitute a
single industry segment. Financial information concerning the Company for the
fiscal years ended November 30, 1997, November 30, 1996 and November 30, 1995,
including the amount of revenue contributed by classes of similar products or
services that accounted for 10% or more of the Company's consolidated revenues
in any one of those periods, is set forth in the Consolidated Financial
Statements and the Notes thereto in the 1997 Annual Report and is incorporated
herein by reference. Information with respect to the Company's operations by
geographic area are set forth in Note 14 to the Notes to Consolidated Financial
Statements on pages 92-93 of the 1997 Annual Report and is incorporated herein
by reference.
Since 1990, Lehman Brothers has focused on a "client/customer-driven"
strategy. Under this strategy, Lehman Brothers concentrates on serving the needs
of major issuing and advisory clients and investing customers worldwide to build
an increasing flow of business that leverages the Company's research,
underwriting and distribution capabilities. Customer flow continues to be the
primary source of the Company's net revenues. Developing long-term relationships
with issuing clients and investing customers is a central premise of the
Company's client/customer-driven strategy. Based on management's belief that
each client and customer directs a majority of its financial transactions to a
limited number of investment banks, Lehman Brothers' investment banking and
institutional and private client sales professionals focus on a targeted group
of clients and customers worldwide to identify and develop lead relationships.
The Company believes that such relationships position Lehman Brothers to receive
a substantial portion of its clients' and customers' financial business and
lessen the volatility of net revenues generally associated with the financial
services industry.
LEHMAN BUSINESSES
Lehman Brothers is a leading underwriter of global fixed income and equity
securities in the public and private markets. The Company is also a prominent
advisor for corporations and governments around the world.
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INVESTMENT BANKING
Lehman Brothers' Investment Banking professionals are responsible for
developing and maintaining relationships with issuing clients, gaining a
thorough understanding of their specific needs and bringing together the full
resources of Lehman Brothers to accomplish their financial objectives.
Investment Banking is organized into industry, product and geographic coverage
groups, enabling individual bankers to develop specific expertise in particular
industries and markets. Global industry coverage groups include Financial
Services, Healthcare, Industrial, Media and Telecommunications, Natural
Resources, Power, Real Estate and Technology. Where appropriate, specialized
product groups are partnered with the industry and geographic groups to provide
tailor-made solutions for Lehman Brothers' clients. These groups include Equity
Capital Markets, which includes equity and equity-related securities and
derivatives; Debt Capital Markets, which incorporates expertise in syndicate,
liability management, derivatives and private placements; Mergers and
Acquisitions; and Leveraged Finance, which includes high yield debt and bank
loan syndication.
Mergers and Acquisitions/Strategic Advisory. Lehman Brothers has a long
history of providing strategic advisory services to corporate, institutional and
government clients around the world on a wide range of financial matters,
including mergers and acquisitions, restructurings and spin-offs, targeted stock
transactions, share repurchase strategies, takeover defenses, corporate
governance issues and tax optimization strategies. Linkages between strategic
advisory services and the Firm's foreign exchange, derivatives and leveraged
financing products are widely utilized. The Company's Mergers and Acquisitions
group works closely with product, industry and geographic coverage bankers
around the world. Geographically, Lehman Brothers maintains investment banking
offices in six cities within the U.S. and in 18 cities in Europe, Canada, the
Middle East, Asia and Latin America.
FIXED INCOME
Lehman Brothers actively participates in all key fixed income markets
worldwide and maintains a 24-hour trading presence in global fixed income
securities. The Company combines professionals from the distribution, research
and trading areas of Fixed Income, together with investment bankers, into teams
to serve the financial needs of the Company's clients and customers. The Company
is a leading underwriter of new issues, and is also a preeminent market-maker in
these and other fixed income securities. The Company's global presence
facilitates client and customer transactions and provides liquidity in
marketable fixed and floating rate debt securities.
Fixed Income businesses include the following:
Government and Agency Obligations. Lehman Brothers is one of the leading
primary dealers in U.S. government securities, as designated by the Federal
Reserve Bank of New York, participating in the underwriting and market-making of
U.S. Treasury bills, notes and bonds, and securities of federal agencies. The
Company is also a market-maker in the government securities of all G7 countries,
and participates in other major European and Asian government bond markets. The
Company is active in the Canadian market through its Toronto office, in France
as a reporting dealer and in Italy as a super-primary dealer.
Money Market Products. Lehman Brothers holds a dominant market position in
the origination and distribution of commercial paper. The Company is an
appointed dealer for over 600 commercial paper programs on behalf of companies
and government agencies worldwide.
Corporate Debt Securities. Lehman Brothers engages in the underwriting and
market making of fixed and floating rate investment grade debt worldwide. Since
1995, the Company has received global medium-term note mandates for over 270
programs with a borrowing capacity of $657 billion. The Company is also a major
participant in the preferred stock market, managing numerous offerings of
long-term and perpetual preferreds and auction rate securities.
High Yield Securities and Bank Loans. The Company also underwrites and
makes markets in non-investment grade debt securities and bank loans. The
Company now provides a "one-stop" leveraged finance solution for corporate and
financial acquirers and high yield issuers.
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Emerging Market Securities. The Company is active in the trading,
structuring and underwriting of Latin American, Eastern European, and Asian
dollar and local currency instruments. The Company maintains investment banking
offices in Mexico City, Sao Paulo, Buenos Aires and New Delhi, among other
locations.
Mortgage and Asset-Backed Securities. The Company is a leading underwriter
of and market-maker in residential and commercial mortgage- and asset-backed
securities and is active in all areas of secured lending, structured finance and
securitized products. Lehman Brothers underwrites and makes markets in the full
range of U.S. agency-backed mortgage products, mortgage-backed securities,
asset-backed securities and whole loan products. The Company also is engaged in
principal real estate investments. Internationally, the Firm has expanded its
capabilities in mortgage and asset-backed securities, leases, mortgages,
multi-family financing and commercial loans.
Municipal and Tax-Exempt Securities. Lehman Brothers is a major dealer in
municipal and tax-exempt securities, including general obligation and revenue
bonds, notes issued by states, counties, cities, and state and local
governmental agencies, municipal leases, tax-exempt commercial paper and put
bonds. Lehman Brothers is also a leader in the structuring, underwriting and
sale of tax-exempt and taxable securities and derivative products for city,
state, not-for-profit and other public sector clients.
Financing. The Company's Financing unit engages in three primary functions:
managing the Company's matched book activities, supplying secured financing to
customers, and providing funding for the Company's activities. Matched book
funding involves lending cash on a short-term basis to institutional customers
collateralized by marketable securities, typically government or government
agency securities. The Company enters into these agreements in various
currencies and seeks to generate profits from the difference between interest
earned and interest paid. The Financing unit works with the Company's
institutional sales force to identify customers that have cash to invest and/or
securities to pledge to meet the financing and investment objectives of the
Company and its customers. Financing also coordinates with the Company's
treasury area to provide collateralized financing for a large portion of the
Company's securities and other financial instruments owned. In addition to its
activities on behalf of its U.S. clients and customers, the Company is a major
participant in the European and Asian repurchase agreement markets, providing
secured financing for the Firm's customers in those regions.
Fixed Income Derivatives. The Company offers a broad range of derivative
product services in all major currencies on a 24-hour-per-day global basis.
Derivatives professionals are integrated into all of the Company's fixed income
areas in response to the continued convergence of the cash and derivative
markets worldwide.
Foreign Exchange. Lehman Brothers' global foreign exchange operation
provides its customers with 24-hour access and trade execution in all currencies
for spot, forward and over-the-counter option markets. In a collaboration with
the Firm's emerging markets unit, the Firm's foreign exchange activities have
increasingly diversified into Latin America, Eastern Europe and Asian
currencies. Lehman Brothers also provides advisory services to central banks,
corporations and investors worldwide, structuring innovative products to fit
their specific needs. The Firm makes extensive use of its worldwide
macroeconomics research to advise clients on the appropriate strategies to
minimize interest rate and currency risk. In addition to the Company's
traditional client/customer-driven foreign exchange activities, Lehman Brothers
also trades foreign exchange for its own account.
EQUITIES
Lehman Brothers has integrated professionals from the Equities sales,
trading, investment banking and research areas to serve the financial needs of
the Company's equity clients and customers. The Company's equity expertise and
the integrated nature of the Company's global operations enable Lehman Brothers
to structure and execute global equity transactions for clients worldwide. The
Company is a leading underwriter of initial public and secondary offerings of
equity and equity-related securities. Lehman Brothers also makes markets in
these and other securities, and executes block trades on behalf of clients and
customers. The Company actively participates in assisting governments around the
world in raising equity capital as part of their privatization programs.
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The Equities group is responsible for the Company's equity operations and
all dollar and non-dollar equity and equity-related products worldwide. These
products include listed and over-the-counter ("OTC") securities, American
Depositary Receipts, convertibles, options, warrants and derivatives. The
Company participates in the global equity and equity-related markets in all
major currencies through its worldwide presence and membership in major stock
exchanges, including among others, those in New York, London, Tokyo, Hong Kong,
Frankfurt, Paris, Milan and Stockholm.
Equity Derivatives. Lehman Brothers offers equity derivative capabilities
across a wide spectrum of products and currencies, including domestic and
international program trading, listed options and futures and structured
derivatives. In 1997, Lehman Brothers reorganized its equity derivatives
business into two major product areas - a global volatility business,
encompassing options-related products, and a global portfolio trading business
that specializes in index arbitrage, agency/risk baskets and other structured
products.
Equity Finance. Lehman Brothers maintains an extensive Equity Financing
and Prime Broker business to provide liquidity to its clients and customers and
supply a source of secured financing for the Firm. Equity Finance provides
margin lending for the purchase of equities and other capital markets' products
as well as securities lending and short selling facilitation. The Prime Broker
business, which significantly increased its global business in 1997, engages in
full operations, clearing and processing services for that unit's customers.
MERCHANT BANKING
Lehman Brothers' merchant banking activities include making principal
investments in corporations in partnership with clients of the Firm, raising
capital from institutional and high-net-worth investors and managing these
investments until they are realized. The Firm's Merchant Banking group has more
than 20 dedicated professionals based in New York, London and Hong Kong.
In September 1997, the Firm established a new $2 billion merchant banking
fund, for which a subsidiary of LBI will act as general partner. The Company has
commitments to invest up to an additional $498 million in the partnerships,
which in turn will make direct merchant banking related investments.
The Company's current merchant banking activities include investments in
nine active partnerships, for which the Company acts as general partner, as well
as direct investments. These merchant banking investments include both publicly
traded and privately held companies diversified on a geographic and industry
basis. At November 30, 1997, the investment in merchant banking partnerships was
$167 million and direct investments were $75 million.
GLOBAL DISTRIBUTION
Lehman Brothers' institutional and private client sales organizations
encompass distinct global sales forces that have been integrated into the Fixed
Income and Equities businesses to provide investors with the full array of
products and research offered by the Firm.
Fixed Income Sales. The Firm's Fixed Income sales force is one of the
largest in the industry, with approximately 325 professionals in 14 locations
worldwide, serving the investing and liquidity needs of major institutional
investors. Employing a relationship management approach that provides superior
information flow and product opportunities for the Firm's customers, the Fixed
Income sales organization covers the major share of the buying power in the
global fixed income markets. Further, the Firm's expertise in foreign exchange
and derivatives provides customers with comprehensive solutions to their global
risk management needs.
Equity Sales. Lehman Brothers' institutional Equity sales group of over
315 professionals provides an extensive range of services to institutional
investors through locations in the U.S., Europe and Asia. The Equity sales
organization focuses on developing long-term relationships though a
comprehensive understanding of customers' investment objectives, while providing
proficient execution and consistent liquidity in a wide range of global equity
securities and derivatives.
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Private Client Sales. The Company's Private Client Services group of 288
professionals serves the investment needs of private investors with substantial
assets as well as over 1,000 mid-sized institutional accounts worldwide. The
group has a global presence with investment representatives located in 12
offices worldwide. Among other services, investment professionals provide their
clients with direct access to fixed income, equity, foreign exchange and
derivative products, as well as the Firm's research and execution capabilities,
thereby serving as a valuable extension of the Firm's institutional sales force.
RESEARCH
Fixed Income Research. Fixed Income research at Lehman Brothers
encompasses the full range of research disciplines: quantitative, economic,
strategic, credit, portfolio, relative value and market-specific analysis. Fixed
Income research is integrated with and supports the Company's investment
banking, sales and trading activities. An important objective of Fixed Income
research is to have in place high quality research analysts covering industry,
geographic and economic sectors that support the activities of the Company's
clients and customers. The department's 275 specialists provide expertise in
U.S., European and Asian government and agency securities, derivatives,
sovereign issues, corporate securities, high yield, asset- and mortgage-backed
securities, real estate, emerging market debt and municipal securities.
Equity Research. The Equity Research department, comprised of 260
professionals, is integrated with and supports the Company's investment banking,
sales and trading activities. To ensure in-depth expertise within various
markets, Equity Research has established regional teams on a worldwide basis
that are staffed with industry and strategy specialists.
OTHER BUSINESS ACTIVITIES
Lehman Brothers also participates in business opportunities such as
arbitrage and proprietary trading that leverage the Company's expertise,
infrastructure and resources. These businesses may generate substantial revenues
but generally entail a higher degree of risk as the Company trades for its own
account.
Arbitrage. Lehman Brothers engages in a variety of arbitrage activities.
In traditional or "riskless" arbitrage, the Company seeks to benefit from
temporary price discrepancies that occur when a security is traded in two or
more markets, or when a convertible or derivative security is trading at a price
disparate from its underlying security. The Company's "risk" arbitrage
activities involve the purchase of securities at discounts from the expected
values that would be realized if certain proposed or anticipated corporate
transactions (such as mergers, acquisitions, recapitalizations, exchange offers,
reorganizations, bankruptcies, liquidations or spin-offs) were to occur. To the
extent that these anticipated transactions do not materialize in a manner
consistent with the Company's expectations, the Company is subject to the risk
that the value of these investments will decline. Lehman Brothers' arbitrage
activities benefit from the Company's presence in the global capital markets,
access to advanced information technology, in-depth market research, proprietary
risk management tools and general experience in assessing rapidly changing
market conditions.
Asset Management. In 1997, the Firm launched a series of 12 onshore and
offshore funds managed by 25 third-party managers. The Firm also offers a number
of tailored products to its client base, including an array of single client
funds, managed accounts and advisory services.
Proprietary Trading. In addition to its customer-flow activities, Lehman
Brothers also takes proprietary positions in interest rates, foreign exchange,
various securities, derivatives and commodities for its own account. The
Company's proprietary trading activities bring together various research and
trading disciplines allowing it to take market positions, which at times may be
significant, consistent with the Company's expectations of future events (such
as movements in the level of interest rates, changes in the shape of yield
curves and changes in the value of currencies). The Company is subject to the
risk that actual market events will be different from the Company's
expectations, which may result in significant losses associated with such
proprietary positions. The Company's proprietary trading activities are
generally carried out in consultation with personnel from the relevant major
product areas (e.g., mortgages, derivatives and foreign exchange).
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TRADING SERVICES AND CORPORATE
The Company's Trading Services and Corporate divisions provide support to
its businesses through the processing of certain securities and commodities
transactions; receipt, identification and delivery of funds and securities;
safeguarding of customers' securities; and compliance with regulatory and legal
requirements. In addition, this staff is responsible for technology
infrastructure and systems development, treasury operations, financial control
and analysis, tax planning and compliance, internal audit, expense management,
career development and recruiting and other support functions.
In 1997, the Company invested in a strategic global foundation for
information technology upon which all future investments in technology will be
leveraged. The Company's response to the Year 2000 issue is described under the
caption "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Other -- Impact of the Year 2000" on page 59 of the Annual
Report, and is incorporated herein by reference.
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, information technology infrastructure
and systems.
A complete description of the Firm's Risk Management procedures is
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Risk Management" on pages 55-58 of the Annual Report,
and is incorporated herein by reference.
NON-CORE ASSETS
Prior to 1990, the Company participated in a number of activities that were
not central to its current business as an institutional investment banking firm.
As a result of these activities, the Company carries on its balance sheet a
number of relatively illiquid assets (the "Non-Core Assets"), including a number
of individual real estate assets, limited partnership interests and a number of
smaller investments. Subsequent to their purchase, the values of certain of
these Non-Core Assets declined below the recorded values on the Company's
balance sheet, which necessitated the write-down of the carrying values of these
assets and corresponding charges to the Company's Consolidated Statement of
Income. Certain of these activities have resulted in various legal proceedings.
Since 1990, management has devoted substantial resources to reducing the
Company's Non-Core Assets. At November 30, 1997, the Company had $48 million of
net exposure to these real estate activities, including investments, commitments
and contingent liabilities under guarantees and credit enhancements. The value
of the Company's Non-Core Assets includes carrying value plus contingent
exposures net of reserves. Management's intention with regard to these Non-Core
Assets is the prudent liquidation of these investments as and when possible.
COMPETITION
All aspects of the Company's business are highly competitive. The Company
competes in domestic and international markets directly with numerous other
brokers and dealers in securities and commodities, investment banking firms,
investment advisors and certain commercial banks and, indirectly for investment
funds, with insurance companies and others.
The financial services industry has become considerably more concentrated
as numerous securities firms have either ceased operations or have been acquired
by or merged into other firms. In addition, several small
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and specialized securities firms have been successful in raising significant
amounts of capital for their merger and acquisition activities and merchant
banking investment vehicles and for their own accounts. These developments have
increased competition from firms, a number of whom have significantly greater
equity capital than the Company.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. LBI and certain other subsidiaries
of Holdings are registered as broker-dealers and investment advisors with the
Commission and as such are subject to regulation by the Securities and Exchange
Commission (the "SEC") and by self-regulatory organizations, principally the
NASD and national securities exchanges such as the New York Stock Exchange,
which has been designated by the SEC as LBI's primary regulator, and the
Municipal Securities Rulemaking Board. Securities firms are also subject to
regulation by state securities administrators in those states in which they
conduct business. LBI is a registered broker-dealer in all 50 states, the
District of Columbia and the Commonwealth of Puerto Rico. The SEC,
self-regulatory organizations and state securities commissions may conduct
administrative proceedings, which may result in censure, fine, the issuance of
cease-and-desist orders or suspension or expulsion of a broker-dealer or an
investment advisor, its officers or employees.
LBI is registered with the Commodity Futures Trading Commission (the
"CFTC") as a futures commission merchant and is subject to regulation as such by
the CFTC and various domestic boards of trade and other commodity exchanges. The
Company's U.S. commodity futures and options business is also regulated by the
National Futures Association, a not-for-profit membership corporation which has
been designated as a registered futures association by the CFTC.
The Company does business in the international fixed income, equity and
commodity markets and undertakes investment banking activities through its
London subsidiaries. The U.K Financial Services Act of 1986 (the "Financial
Services Act") governs all aspects of the United Kingdom investment banking
business, including regulatory capital, sales and trading practices, use and
safekeeping of customer funds and securities, record keeping, margin practices
and procedures, registration standards for individuals, periodic reporting and
settlement procedures. Pursuant to the Financial Services Act, the Company is
subject to regulations administered by The Securities and Futures Authority
Limited, a self regulatory organization of financial services companies (which
regulates the Company's equity, fixed income, commodities and investment banking
activities), and the Bank of England (which regulates its wholesale money
market, bullion and foreign exchange businesses).
Holdings' subsidiary, Lehman Brothers Japan Inc., is a licensed securities
company in Japan and a member of the Tokyo Stock Exchange, the Osaka Stock
Exchange and the Tokyo Financial Futures Exchange and, as such, is regulated by
the Japanese Ministry of Finance, the Japan Securities Dealers Association and
such exchanges.
The Company believes that it is in material compliance with the regulations
described herein.
CAPITAL REQUIREMENTS
LBI, Lehman Brothers International (Europe) ("LBIE"), the Tokyo branch of
Lehman Brothers Japan Inc. ("LBJTB") and other of Holdings' 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. Reference is made to "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Regulatory Capital" on page 51
of the 1997 Annual Report, and Note 8 of Notes to Consolidated Financial
Statements.
EMPLOYEES
As of November 30, 1997 the Company employed approximately 8,340 persons,
including 5,832 in the U.S. and 2,508 internationally. The Company considers its
relationship with its employees to be good.
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ITEM 2. PROPERTIES
The Company's headquarters occupy approximately 1.1 million square feet of
space at 3 World Financial Center in New York, New York, which is owned by the
Company as tenants-in-common with American Express and various other American
Express subsidiaries, and approximately 77,000 square feet of which has been
subleased.
The Company leases approximately 405,000 square feet for offices located at
101 Hudson Street in Jersey City, New Jersey (the "Operations Center"), of which
approximately 63,000 square feet has been subleased. The Operations Center is
used by systems, operations, and certain administrative personnel and contains
certain back-up trading systems. The lease expires in December 2010.
The Company leases approximately 338,000 square feet of office space in
London, England. Most of the Company's other offices are located in leased
premises, the leases for which expire at various dates through the year 2007.
Facilities owned or occupied by the Company and its subsidiaries are
believed to be adequate for the purposes for which they are currently used and
are well maintained.
ITEM 3. 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 a meritorious defense 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 the consolidated financial
condition of the Company.
Bamaodah v. E.F. Hutton & Company Inc.
In April 1986, Ahmed and Saleh Bamaodah commenced an action against E.F.
Hutton & Company Inc., ("EFH") to recover all losses the Bamaodahs had incurred
since May 1981 in the trading of commodity futures contracts in a
nondiscretionary EFH trading account. The Dubai Civil Court ruled that the
trading of commodity futures contracts constituted illegal gambling under
Islamic law and that therefore the brokerage contract was void. In January 1987,
a judgment was rendered against EFH in the amount of $48,656,000. On January 5,
1991, the Dubai Court of Appeals affirmed the judgment. On March 22, 1992, the
Court of Cassation, Dubai's highest court, revoked and quashed the decision of
the Court of Appeals and ordered that the case be remanded to the Court of
Appeals for a further review. On April 26, 1994, the Dubai Court of Appeals
again affirmed the judgment of the Dubai Civil Court. The Company appealed the
judgment to the Court of Cassation, which reversed the Court of Appeals on
November 27, 1994 and ordered that a new expert be appointed to review the case.
A new expert has been appointed, with instructions to report back to the Court
of Cassation.
Actions Relating To First Capital Holdings Inc.
Concurrent with the bankruptcy filing of First Capital Holdings ("FCH") in
May, 1991 and the conservatorship and receivership of its two life insurance
subsidiaries, First Capital Life Insurance Company ("First Capital Life") and
Fidelity Bankers Life Insurance Company ("Fidelity Bankers Life") (First Capital
Life and Fidelity Bankers Life collectively, the "Insurance Subsidiaries"), a
number of lawsuits were commenced, naming one or more of Holdings, Lehman
Brothers and American Express as defendants
8
<PAGE> 10
(individually or collectively, as the case may be, the "American Express
Defendants"). Most of these actions have been subsequently settled and/or
dismissed. The matter still pending is described below.
The Virginia Commissioner of Insurance Action. On December 9, 1992, a
complaint was filed in the United States District Court for the Eastern District
of Virginia (the "Virginia Court") by Steven Foster, the Virginia Commissioner
of Insurance (the "Commissioner") as Deputy Receiver of Fidelity Bankers Life.
The Complaint names Holdings and Weingarten, Ginsberg and Leonard Gubar, a
former director of FCH and Fidelity Bankers Life, as defendants. The Complaint
alleges that Holdings acquiesced in and approved the continued mismanagement of
Fidelity Bankers Life and that it participated in directing the investment of
Fidelity Bankers Life assets. The complaint asserts claims under the federal
securities laws and asserts common law claims including fraud, negligence and
breach of fiduciary duty and alleges violations of the Virginia Securities laws
by Holdings. It allegedly seeks no less than $220 million in damages to Fidelity
Bankers Life and its present and former policyholders and creditors and punitive
damages. Holdings has answered the complaint, denying its material allegations.
As a result of Holdings' motion for summary judgment, the court limited the
damages the Commissioner may seek to less than approximately $30 million.
Easton & Co. v. Mutual Benefit Life Insurance Co., et al., Easton & Co. v.
Lehman Brothers Inc.
Lehman Brothers was named as a defendant in two consolidated class action
complaints pending in the United States District Court for the District of New
Jersey (the "N.J. District Court"). Easton & Co. v. Mutual Benefit Life
Insurance Co., et al. ("Easton I"), and Easton & Co. v. Lehman Brothers Inc.
("Easton II"). The plaintiff in both of these actions is Easton & Co., which is
a broker-dealer located in Fort Lee, New Jersey. Both of these actions allege
federal securities law claims and pendent common law claims in connection with
the sale of certain municipal bonds as to which Mutual Benefit Life Insurance
Company ("MBLI") has guaranteed the payment of principal and interest. MBLI is
an insurance company which was placed in rehabilitation proceedings under the
supervision of the New Jersey Insurance Department on or about July 16, 1991.
Easton I was commenced on or about September 17, 1991. The litigation was
purportedly brought on behalf of a class consisting of all persons and entities
who purchased DeKalb, Georgia Housing Authority MultiFamily Housing Revenue
Refunding Bonds (North Hill Ltd. Project), Series 1991, due November 30, 1994
(the "DeKalb Bonds") during the period from May 3, 1991 (when the DeKalb bonds
were issued) through July 16, 1991. Lehman Brothers acted as underwriter for
this bond issue, which was in the aggregate principal amount of $18.7 million.
The complaint alleged that Lehman Brothers violated Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder, and sought damages in an
unspecified amount or rescission. The complaint also alleged a common law
negligent misrepresentation claim against Lehman Brothers and the other
defendants.
Easton II was commenced on or about May 18, 1992, and named Lehman Brothers
as the only defendant. Plaintiff purported to bring this second lawsuit on
behalf of a class composed of all persons who purchased "MBLI-backed Bonds" from
Lehman Brothers during the period April 19, 1991 through July 16, 1991. The
complaint alleged that Lehman Brothers violated Section 10(b) and Rule 10b-5,
and seeks monetary damages in an unspecified amount, or rescission pursuant to
Section 29(b) of the Exchange Act. The complaint also contained a common law
claim of alleged breach of duty and negligence. On or about February 9, 1993,
the N.J. District Court granted plaintiffs' motion for class certification in
Easton I. The parties agreed to certification of a class in Easton II for
purchases of certain fixed-rate MBLI-backed bonds during the class period. LBI,
together with the other defendants in Easton I and Easton II, has agreed to
settle both cases, subject to court approval.
Warren D. Chisum, et al. v. Lehman Brothers Inc. et al.
On February 28, 1994 a purported class action was filed in the United
States District Court for the Northern District of Texas. An amended complaint
was filed on December 15, 1994. The amended complaint names LBI and two former
EFH employees as defendants. The complaint alleges that defendants violated
Section 10(b) of the Exchange Act and RICO, breached their fiduciary duties and
the limited partners'
9
<PAGE> 11
contract and committed fraud in connection with the origination, sale and
operation of nine EFH net lease real estate limited partnerships. Plaintiffs
seek: (i) to certify a class of all persons who purchased limited partnership
interests in the nine partnerships at issue, (ii) unspecified damages, plus
interest or rescission, (iii) treble damages, (iv) punitive damages and (v)
accounting and attorneys' fees. On April 2, 1996 the Court filed an opinion and
order certifying the litigation as a class action, consisting of all persons who
purchased interests in the nine EFH net lease limited partnerships. On July 11,
1996, the Court issued a memorandum and order dismissing plaintiffs' RICO claim.
Defendants answered the complaint and denied its material allegations. The
parties have entered into a settlement agreement which was preliminarily
approved by the Court on February 20, 1998 and is subject to the Court's final
approval.
Actions Relating to the Sales and Marketing of Limited Partnerships
Subsequent to a January 26, 1996 article in the Wall Street Journal
entitled "SEC, Brokers Study Pact on Partnerships," various putative class
actions were filed in different state courts relating to the sales and marketing
of limited partnerships by E.F. Hutton & Co. and Shearson and their affiliates
during the 1980s. Thereafter all of these actions were consolidated into the two
actions described below, or were effectively stayed while these actions proceed.
Under the terms of an agreement between American Express and Holdings,
American Express has agreed to indemnify Holdings for liabilities which it may
incur in connection with any action relating to any business conducted by The
Balcor Company, a former Lehman Brothers subsidiary ("Balcor"), in which
Holdings is named as a parent company or control person of Balcor. Holdings
believes that some of the allegations in certain of the actions described below
are covered by this indemnity.
In re Lehman Brothers Limited Partnership Litigation. On October 18, 1996,
a purported first consolidated and amended class action complaint was filed in
the Court of Chancery of the State of Delaware in and for New Castle County on
behalf of all persons who purchased units in various public, proprietary limited
partnerships organized by Shearson or E.F. Hutton & Co. or operated by
affiliates of those entities between 1981 and the present (with certain
exceptions). Defendants are LBI and 56 Lehman-affiliated general partners. The
complaint alleges that defendants breached their fiduciary duties or aided and
abetted such a breach by allegedly misrepresenting and or failing to disclose
the nature of the risks and the status and financial condition of the
partnerships; collecting excessive fees; failing to exercise due care in
selecting investments for the partnerships; and recommending and selling the
partnerships as suitable investments. The complaint seeks, among other things
(1) to certify the case as a class action; (2) to declare that defendants
breached their duties; (3) to enjoin defendants from operating the partnerships
for their own benefit; (4) to account for all profits and impose a constructive
trust on them; and (5) to award compensatory damages, costs and expenses and
attorneys' fees.
Klein, et al. v. Lehman Brothers, Inc., et al. On January 15, 1998, a
purported third amended class action complaint was filed in the Superior Court
of New Jersey, Law Division: Union County on behalf of investors in certain
specified limited partnerships sponsored by Balcor and sold by various entities,
including, among others, Shearson and certain of its affiliates. Named as
defendants are LBI, various affiliates of LBI, American Express Company, Smith
Barney Holdings, Inc., Balcor, a number of Balcor-originated limited
partnerships and various individuals and entities affiliated with Balcor. The
complaint alleges claims in connection with the marketing, sale and operation of
the limited partnerships for common law fraud and deceit, equitable fraud,
negligent misrepresentation, breach of fiduciary duty and contract and violation
of certain New Jersey statutes relating to the sale of securities. The complaint
seeks compensatory damages for lost principal and interest, general damages and
punitive damages, treble damages under the New Jersey statutes, and costs and
attorneys' fees.
Maxwell Related Litigation
There is one remaining lawsuit arising out of transactions entered into
with the late Robert Maxwell or entities controlled by Maxwell interests.
10
<PAGE> 12
MCC Proceeds Inc. v. Lehman Brothers International (Europe). This action
was commenced by issuance of a writ in the High Court of Justice in London,
England on July 14, 1995. In this action, MCC Proceeds Inc., as successor to
Macmillan, Inc., seeks a declaration of the rightful ownership of approximately
10.6 million shares of Berlitz International Inc. common stock. The High Court
granted LBIE's application to dismiss the proceeding and assessed costs against
MCC Proceeds. On December 19, 1997, the Court of Appeal affirmed the dismissal
of this proceeding.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. Minmetals International Non-Ferrous Metals Trading Company
On November 15, 1994, two Lehman Brothers subsidiaries, Lehman Brothers
Commercial Corporation ("LBCC") and Lehman Brothers Special Financing Inc.
("LBSF"), commenced an action against Minmetals International Non-Ferrous Metals
Trading Company ("Minmetals") and China National Metals and Minerals Import and
Export Company ("CNM") in the United States District Court for the Southern
District of New York alleging breach of contract against Minmetals and breach of
guarantee against CNM. The litigation arose from the refusal by Minmetals and
CNM to honor their obligations with respect to certain foreign exchange and swap
transactions. LBCC and LBSF seek to recover approximately $52.5 million from
Minmetals and/or CNM. On June 26, 1995, the court granted CNM's motion to
dismiss the claims against it, but also granted LBCC and LBSF leave to replead.
Minmetals filed fourteen counterclaims against Lehman entities based on
violations of federal securities and commodities laws and rules, and theories of
fraud, breach of fiduciary duty and conversion. The court denied a motion by the
Lehman counterclaim defendants to dismiss the six fraud-based counterclaims. On
June 24, 1996, the court granted the motion of LBCC and LBSF to file an amended
complaint naming CNM as an additional defendant. Discovery is progressing.
Actions Relating to National Association of Securities Dealers Automated
Quotations System
("NASDAQ") Market Maker Antitrust and Securities Litigation.
Beginning in May, 1994, several class actions were filed in various state
and federal courts against various broker-dealers making markets in NASDAQ
securities. With respect to a number of those actions LBI was either
specifically named as a defendant or was not specifically named as a defendant
but could be deemed to be a member of the defendant class as defined in the
complaints. Plaintiffs in these cases have alleged violations of the antitrust
laws, securities laws and have pled a variety of other statutory and common law
claims. All of these actions are based on the theory that because odd-eighth
quotes occur less often than quarter quotes, NASDAQ market makers must be
colluding wrongfully to maintain a wider spread.
By Order filed October 14, 1994, the Judicial Panel on Multidistrict
Litigation consolidated these actions in the Southern District of New York and
ordered that all related actions be transferred and coordinated for all pretrial
purposes. The case is captioned In Re NASDAQ Market-Makers Antitrust Litigation,
MDL No. 1023.
On December 16, 1994, plaintiffs served a consolidated Amended Complaint
naming 33 defendants including LBI. Plaintiffs claim violations of the federal
antitrust laws including Section I of the Sherman Antitrust Act. Plaintiffs seek
unspecified compensatory damages trebled in accordance with the antitrust laws,
costs including attorneys' fees as well as injunctive relief. The court
dismissed the action with leave to replead, stating that the complaint failed to
identify the securities involved with sufficient specificity. The plaintiffs
replied and the defendants answered the amended complaint on November 17, 1995.
On December 23, 1997, LBI settled the class action along with 29 other
broker-dealers. The settlement is subject to final approval by the court.
LBI entered into a Stipulation and Order resolving a civil complaint filed
by the U.S. Department of Justice alleging that LBI and 23 other NASDAQ market
makers violated Section 1 of the Sherman Act in connection with certain market
making practices. In entering into the Stipulation and Order the parties agreed
that the defendants would not engage in certain types of market making
activities and the defendants undertook specified steps to assure compliance
with their agreement. The Stipulation and Order were approved by the United
States District Court for the Southern District of New York, which decision is
on
11
<PAGE> 13
appeal to the Second Circuit Court of Appeals. If the approval is affirmed
throughout the appellate process, the complaint will be dismissed with
prejudice.
Sonnenfeld v. The City and County of Denver, Colorado, et al.
On August 4, 1995, a Consolidated Amended Class Action Complaint (the
"Complaint") was filed in the United States District Court for the District of
Colorado, consolidating and amending previously filed complaints and adding,
among other defendants, LBI. The Complaint was purportedly brought on behalf of
all persons, other than defendants, who purchased Denver Airport System Revenue
Bonds during the period February 27, 1992 through May 3, 1994 that were issued
by the City and County of Denver and who were damaged by their investments. The
parties entered into a settlement of the action which was approved by the Court
on December 8, 1997.
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 by an introducing broker which 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 complaint alleges that Shearson breached various
contractual and common law duties owed to the investors. LBI and Bear Stearns &
Co., Inc. have filed a motion to dismiss the complaint and expect a ruling on
such motion within the next several months.
Actions Relating to Bre-X Minerals Ltd.
McNamara et al. v. Bre-X Minerals Ltd. et al. On July 25, 1997, an Amended
Class Action Complaint was filed in the United States District Court for the
Eastern District of Texas against 16 defendants, including LBI, which seeks
unspecified compensatory damages, interest, costs and attorney's fees on behalf
of purchasers of Bre-X common stock and/or Bresea common stock. The Complaint
raises claims under the federal securities laws and the common law of fraud and
negligent misrepresentation. The Complaint's stated basis for naming LBI is that
one of its securities analysts published research on Bre-X. On or about November
21, 1997, several defendants, including LBI, moved to dismiss the Complaint, or,
in the alternative, to transfer venue to the Southern District of New York.
Plaintiffs have also filed a motion for class certification, which is stayed
pending resolution of the motions to dismiss.
Klaasen v. Lehman Brothers Inc. et al. On October 2, 1997, William L.
Klaasen, "individually and for all those similarly situated within the State of
California," filed a Complaint against LBI in the Superior Court for the State
of California in and for the County of San Diego. The Complaint raises a claim
for common law negligence, and seeks, on behalf of California purchasers of
Bre-X and Bresea stock, class certification, rescission, interest, compensatory
and punitive damages, disgorgement and restitution of profits and compensation
received by LBI, and costs. The action is currently stayed by consent until the
earlier of April 1, 1998 or 30 days following the decision on the motion to
dismiss in the McNamara case.
Chow et al. v. Bre-X Minerals Ltd. et al. On October 10, 1997, 125 named
plaintiffs filed an action in the Court of Queen's Bench of Alberta, in Calgary,
Canada, against 35 named defendants, including LBI. Plaintiffs' claim against
LBI, which has not yet been served, is for common law negligence.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
12
<PAGE> 14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The approximate number of holders of record of the Registrant's Common
Stock was 25,332 at February 10, 1998. Information concerning the market for the
Registrant's common equity and related stockholder matters is set forth on page
98 of the Annual Report and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data contained on pages 95-96 of the Annual Report is
deemed a part of this Annual Report on Form 10-K and is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations is set forth under the same caption on pages 36-61 of the Annual
Report. Such information is hereby incorporated herein by reference and should
be read in conjunction with the Consolidated Financial Statements of the
Registrant and its Subsidiaries together with the Notes thereto contained on
pages 63-94 of the Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Management" on pages 55-58
of the Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Registrant and its
Subsidiaries together with the Notes thereto and the Report of Independent
Auditors thereon required by this Item are contained in the Annual Report on
pages 62-94 and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to Directors of the Registrant is set forth under the
caption "Election of Directors" on pages 5-8 of the Proxy Statement and
information relating to Executive Officers of the Registrant is set forth under
the caption "Executive Officers of the Company" on pages 11-12 of the Proxy
Statement and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation is set forth under the
captions "Compensation of Directors", "Compensation Committee Report of
Executive Officer Compensation", "Compensation of Executive Officers", "Pension
Benefits" and "Employment Contracts, Termination of Employment and Change of
Control Arrangements" on pages 10, 13-18 of the Proxy Statement and is
incorporated herein by reference.
13
<PAGE> 15
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to security ownership of management and certain
beneficial owners is set forth under the caption "Security Ownership of
Directors and Executive Officers" on page 12 of the Proxy Statement and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions is
set forth under the captions "Certain Transactions and Agreements with Directors
and Executive Officers", "Certain Transactions and Agreements with American
Express and Subsidiaries", "Certain Transactions and Agreements with Nippon
Life" and "Certain Transactions with Other Institutional Investors and Their
Subsidiaries" on pages 19-22 of the Proxy Statement and is incorporated herein
by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K
(a) 1. Financial Statements:
The Financial Statements and the Notes thereto and the Report of
Independent Auditors thereon and filed as a part hereof are listed on page F-1
hereof by reference to the corresponding page number in the Annual Report.
2. Financial Statement Schedules:
The financial statement schedule and the notes thereto filed as a part are
listed on page F-1 hereof.
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -------
<S> <C>
3.1 Restated Certificate of Incorporation of the Registrant dated May 27, 1994
(incorporated by reference to Exhibit 3.1 of the Registrant's Transition Report on
Form 10-K for the eleven months ended November 30, 1994).
3.2 By-Laws of the Registrant, amended as of March 26, 1997 (incorporated by reference
to Exhibit 10 of the Registrant's Quarterly Report on Form 10-Q for the quarter
ended February 28, 1997).
4.1 The instruments defining the rights of holders of the long-term debt securities of
the Registrant and its subsidiaries are omitted pursuant to section (b) (4) (iii)
(A) of Item 601 of Regulation S-K. The Registrant hereby agrees to furnish copies of
these instruments to the Securities and Exchange Commission upon request.
9.1 1997 Trust under Lehman Brothers Holdings Inc. Incentive Plans (incorporated by
reference to the Registrant's Form 8-K dated September 4, 1997).
10.1 Agreement of Tenants-In-Common by and among American Express Company, American
Express Bank Ltd., American Express Travel Related Services Company, Inc., Shearson
Lehman Brothers Inc., Shearson Lehman Government Securities, Inc. and Shearson
Lehman Commercial Paper Incorporated (incorporated by reference to Exhibit 10.1 of
the Registrant's Transition Report on Form 10-K for the eleven months ended November
30, 1994).
10.2 Tax Allocation Agreement between Shearson Lehman Brothers Holdings Inc. and American
Express Company (incorporated by reference to Exhibit 10.2 of the Registrant's
Transition Report on Form 10-K for the eleven months ended November 30, 1994).
10.3 Transaction Support Services Agreement dated as of September 30, 1994 by and between
Bear, Stearns Securities Corp. and Lehman Brothers Inc. (incorporated by reference
to Exhibit 10.15 of the Registrant's Transition Report on Form 10-K for the eleven
months ended November 30, 1994).
</TABLE>
14
<PAGE> 16
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -------
<S> <C>
10.4 Lease dated as of October 13, 1993 between 101 Hudson Leasing Associates and Lehman
Brothers Holdings Inc. (incorporated by reference to Exhibit 10 of Holdings'
Quarterly Report on Form 10-Q for the quarter ended September 30, 1993).
10.5 Lehman Brothers Inc. Executive and Select Employees Plan (incorporated by reference
to Exhibit 10.4 of the Registrant's Registration Statement on Form S-1 (Reg. No.
33-12976)).
10.6 Lehman Brothers Holdings Inc. Deferred Compensation Plan for Non-Employee Directors
(incorporated by reference to Exhibit 10.11 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-12976)).
10.7 Amended and Restated Agreements of Limited Partnership of Shearson Lehman Hutton
Capital Partners II (incorporated by reference to Exhibit 10.48 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1988).
10.8 Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (incorporated by
reference to Exhibit 10.25 of the Registrant's Registration Statement on Form S-1
(Reg. No. 33-52977)).
10.9 Lehman Brothers Holdings Inc. 1996 Management Ownership Plan (incorporated by
reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-Q for the
quarter ended August 31, 1996).
10.10+ Lehman Brothers Holdings Inc. Short-Term Executive Compensation Plan (incorporated
by reference to Exhibit 10.2 of the Registrant's Quarterly Report on Form 10-Q for
the quarter ended August 31, 1996).
10.11+ Lehman Brothers Holdings Inc. 1996 Short-Term Executive Compensation Plan
(incorporated by reference to Exhibit 10.26 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-52977)).
10.12+ Lehman Brothers Holdings Inc. 1994 Employee Stock Purchase Plan (incorporated by
reference to Exhibit 10.27 of the Registrant's Registration Statement on Form S-1
(Reg. No. 33-52977)).
10.13 Purchase and Exchange Agreement dated April 28, 1994, between the Registrant and
American Express Company (incorporated by reference to Exhibit 10.29 of the
Registrant's Transition Report Form 10-K for the Eleven Months ended November 30,
1994).
10.14 Option Agreement, dated May 27, 1994, by and among American Express Company,
American Express Bank Ltd., American Express Travel Related Services Company, Inc.,
Lehman Brothers Inc., Lehman Government Securities, Inc. and Lehman Commercial Paper
Incorporated (incorporated by reference to Exhibit 10.31 of the Registrant's
Transition Report Form 10-K for the Eleven Months ended November 30, 1994).
10.15+ Lehman Brothers Inc. Voluntary Deferred Compensation Plan (For Select Executives)
(incorporated by reference to Exhibit 10.33 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-52977)).
10.16+ Lehman Brothers Inc. Voluntary Deferred Compensation Plan (For Transferred
Participants' Vested Amounts as of July 31, 1993) (incorporated by reference to
Exhibit 10.34 of the Registrant's Registration Statement on Form S-1 (Reg. No.
33-52977)).
10.17+ Lehman Brothers Inc. Executive and Select Employees Plan (For Transferred
Participants) (incorporated by reference to Exhibit 10.35 of the Registrant's
Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.18+ Lehman Brothers Holdings Inc. Cash Award Plan. (incorporated by reference to Exhibit
10.36 of the Registrant's Transition Report on Form 10-K for the Eleven Months ended
November 30, 1994).
</TABLE>
15
<PAGE> 17
<TABLE>
<CAPTION>
EXHIBIT
NO.
- -------
<S> <C>
10.19 Amended and Restated Agreement of Limited Partnership of Lehman Brothers Capital
Partners III, L.P. (incorporated by reference to Exhibit 10.27 to the Registrant's
Annual Report on Form 10-K for the fiscal year ended November 30, 1995).
10.20 Agreement of Limited Partnership of Lehman Brothers Capital Partners IV, L.P.*
11.1 Computation of per share Earnings.*
12.1 Computation in support of ratio of earnings to fixed charges.*
12.2 Computation in support of ratio of earnings to combined fixed charges and preferred
dividends.*
13. The following portions of the Company's 1997 Annual Report to Stockholders, which
are incorporated by reference herein:
13.1 "Management's Discussion and Analysis of Financial Condition and Results of
Operations", pages 36-61.*
13.2 Consolidated Financial Statements of the Registrant and its Subsidiaries together
with the Notes thereto and the Report of Independent Auditors thereon, pages 62-94.*
13.3 "Selected Financial Data", pages 95-96.*
13.4 "Other Stockholder Information" and "Price Range of Common Stock", page 98.*
21.1 List of the Registrant's Subsidiaries.*
23.1 Consent of Ernst & Young LLP.*
24.1 Powers of Attorney.*
27.1 Financial Data Schedule.*
(b) Reports on Form 8-K.
1. Form 8-K dated March 24, 1997, Items 5 and 7.
2. Form 8-K dated June 26, 1997, Items 5 and 7.
3. Form 8-K dated September 4, 1997, Item 7.
4. Form 8-K dated September 30, 1997, Items 5 and 7.
5. Form 8-K dated January 7, 1998, Items 5 and 7.
</TABLE>
- ---------------
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this Form 10-K pursuant to Item 14(c).
16
<PAGE> 18
SIGNATURES
Pursuant to the Requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
LEHMAN BROTHERS HOLDINGS INC.
Dated: February 27, 1998
By: /s/ KAREN M. MULLER
------------------------------------
Title: Vice President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
<S> <C> <C>
* Chief Executive Officer and February 27, 1998
- --------------------------------------------- Chairman of the Board of
Richard S. Fuld, Jr. Directors
(principal executive
officer)
* Chief Financial Officer February 27, 1998
- --------------------------------------------- (principal financial and
Charles B. Hintz accounting officer)
* Director February 27, 1998
- ---------------------------------------------
Michael L. Ainslie
* Director February 27, 1998
- ---------------------------------------------
John F. Akers
* Director February 27, 1998
- ---------------------------------------------
Roger S. Berlind
* Director February 27, 1998
- ---------------------------------------------
Thomas H. Cruikshank
* Director February 27, 1998
- ---------------------------------------------
Henry Kaufman
* Director February 27, 1998
- ---------------------------------------------
Hideichiro Kobayashi
* Director February 27, 1998
- ---------------------------------------------
John D. Macomber
* Director February 27, 1998
- ---------------------------------------------
Dina Merrill
* Director February 27, 1998
- ---------------------------------------------
Masahiro Yamada
*By: /s/ KAREN M. MULLER
- ---------------------------------------------
Attorney-in-Fact
February 27, 1998
</TABLE>
17
<PAGE> 19
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
PAGE
--------------------------
FORM 10-K ANNUAL REPORT
--------- -------------
<S> <C> <C>
FINANCIAL STATEMENTS
Report of Independent Auditors....................................... 62
Consolidated Statement of Income for the Twelve Months Ended November
30, 1997, November 30, 1996 and November 30, 1995.................. 63
Consolidated Statement of Financial Condition at November 30, 1997
and November 30, 1996.............................................. 64
Consolidated Statement of Changes in Stockholders' Equity for the
Twelve Months Ended November 30, 1997, November 30, 1996 and
November 30, 1995.................................................. 66
Consolidated Statement of Cash Flows for the Twelve Months Ended
November 30, 1997, November 30, 1996 and November 30, 1995......... 67
Notes to Consolidated Financial Statements........................... 69
FINANCIAL STATEMENT SCHEDULE
Schedule I -- Condensed Financial Information of Registrant.......... F-2
</TABLE>
F-1
<PAGE> 20
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF INCOME
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
TWELVE MONTHS
ENDED
NOVEMBER 30
--------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
(IN MILLIONS)
<CAPTION>
<S> <C> <C> <C>
Revenues
Principal transactions......................................... $ 193 $ 23 $ 152
Investment banking............................................. 140 90 90
Interest and dividends......................................... 1,271 882 804
Other.......................................................... 8 6 1
----- ----- -----
Total revenues............................................ 1,612 1,001 1,047
Interest expense............................................... 1,304 966 899
----- ----- -----
Net revenues.............................................. 308 35 148
----- ----- -----
Non-interest expenses
Compensation and benefits...................................... 113 64 70
Other.......................................................... 116 105 87
Management fees................................................ (28) (81) (94)
Severance charge............................................... 50
Restructuring charge........................................... 27
----- ----- -----
Total non-interest expenses............................... 201 138 90
----- ----- -----
Income (loss) before taxes.......................................... 107 (103) 58
Provision for (benefit from) income taxes...................... (48) (65) 47
----- ----- -----
Income (loss) before equity in net income of subsidiaries........... 155 (38) 11
----- ----- -----
Equity in net income of subsidiaries........................... 492 454 231
----- ----- -----
Net income (loss)................................................... $ 647 $ 416 $ 242
----- ----- -----
Net income (loss) applicable to common stock........................ $ 572 $ 378 $ 200
----- ----- -----
</TABLE>
See notes to condensed financial information of Registrant.
F-2
<PAGE> 21
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
NOVEMBER 30
-------------------
1997 1996
------- -------
(IN MILLIONS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
ASSETS
Cash and cash equivalents............................................... $ 675
Securities and other financial instruments owned........................ $ 8,751 3,540
Equity in net assets of subsidiaries.................................... 3,922 3,755
Accounts receivable and accrued interest................................ 596 513
Due from subsidiaries................................................... 17,230 11,048
Other assets............................................................ 693 586
------- -------
Total assets.................................................. $31,192 $20,117
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt.................................... $ 4,472 $ 3,175
Securities and other financial instruments sold but not yet purchased... 122 198
Securities sold under agreements to repurchase.......................... 8,758 2,618
Accrued liabilities, due to subsidiaries and other payables............. 1,586 766
Senior notes............................................................ 11,531 9,286
Subordinated indebtedness............................................... 200 200
------- -------
Total liabilities............................................. 26,669 16,243
------- -------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, $1.00 par value; 38,000,000 shares authorized:
5% Cumulative Convertible Voting, 13,000,000 shares authorized;
$39.10 liquidation preference per share
Series A -- shares issued and outstanding: 33,050 in 1997 and
13,000,000 in 1996........................................... 1 508
Series B -- shares issued and outstanding: 12,966,950 in
1997......................................................... 507
Redeemable Voting, 1,000 shares issued and outstanding; $1.00
liquidation preference per share
Common stock, $0.10 par value; 300,000,000 shares authorized; Shares
issued: 119,513,337 in 1997 and 106,793,538 in 1996; Shares
outstanding: 116,612,074 in 1997 and 100,449,144 in 1996.............. 12 11
Common stock issuable................................................... 155 326
Additional paid-in capital.............................................. 3,436 3,198
Foreign currency translation adjustment................................. 12 20
Retained earnings (accumulated deficit)................................. 498 (43)
Common stock in treasury, at cost: 2,901,263 shares in 1997 and
6,344,394 shares in 1996.............................................. (98) (146)
------- -------
Total stockholders' equity.................................... 4,523 3,874
------- -------
Total liabilities and stockholders' equity.................... $31,192 $20,117
------- -------
</TABLE>
See notes to condensed financial information of Registrant.
F-3
<PAGE> 22
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENT OF CASH FLOWS
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER
30
-----------------------------
1997 1996 1995
------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................................................. $ 647 $ 416 $ 242
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Equity in net income of subsidiaries.................................. (492) (454) (231)
Severance charge...................................................... 50
Restructuring charge.................................................. 27
Other adjustments..................................................... 186 131 126
Net change in:
Securities and other financial instruments owned...................... (5,211) (945) (778)
Accounts receivable and accrued interest, due from subsidiaries and
other assets........................................................ (6,380) (1,262) 945
Securities and other financial instruments sold but not yet purchased
and Securities sold under agreements to repurchase................... 6,064 567 858
Accrued liabilities, due to subsidiaries and other payables........... 770 (84) (576)
Dividends and capital distributions received.......................... 304 609 851
------- ------- -------
Net cash provided by (used in) operating activities.............. (4,112) (972) 1,464
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior notes..................................... 3,925 2,686 4,226
Principal payments of senior notes......................................... (1,689) (1,778) (3,196)
Proceeds from issuance of subordinated indebtedness........................ 200
Principal payments of subordinated indebtedness............................ (150)
Payments for commercial paper and short-term debt, net..................... 1,297 1,073 (1,670)
Payment for repurchase of preferred stock.................................. (200)
Payment for treasury stock purchases....................................... (77) (130) (1)
Dividends paid............................................................. (58) (55) (64)
Issuance of common stock................................................... 23 6 1
------- ------- -------
Net cash provided by (used in) financing activities.............. 3,421 1,802 (854)
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Equity in net assets of subsidiaries....................................... 16 (173) (610)
------- ------- -------
Net cash provided by (used in) investing activities.............. 16 (173) (610)
------- ------- -------
Net change in cash and cash equivalents.......................... (675) 657
Cash and cash equivalents, beginning of period............................. 675 18 18
------- ------- -------
Cash and cash equivalents, end of period......................... $ 0 $ 675 $ 18
------- ------- -------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
Interest paid totaled $1,277 in 1997, $933 in 1996 and $884 in 1995. Income taxes
(received) paid totaled $33 in 1997, $(48) in 1996 and $(163) in 1995.
</TABLE>
See notes to condensed financial information of Registrant.
F-4
<PAGE> 23
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
NOTE 1. BASIS OF PRESENTATION
The condensed financial statements of Lehman Brothers Holdings Inc. (the
"Company") should be read in conjunction with the consolidated financial
statements of Lehman Brothers Holdings Inc. and subsidiaries and the notes
thereto.
Certain amounts reflect reclassifications to conform to the current
period's presentation.
NOTE 2. LONG-TERM DEBT
<TABLE>
<CAPTION>
U.S. DOLLAR NON-U.S. DOLLAR
---------------- ---------------- NOVEMBER 30
FIXED FLOATING FIXED FLOATING -----------------
RATE RATE RATE RATE 1997 1996
------ ------ ------ ------ ------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Senior Notes
Maturing in Fiscal 1997.................... $1,626
Maturing in Fiscal 1998.................... $1,559 $ 371 $ 68 $ 71 $ 2,069 2,051
Maturing in Fiscal 1999.................... 1,516 402 674 20 2,612 2,082
Maturing in Fiscal 2000.................... 2,178 638 32 2,848 1,229
Maturing in Fiscal 2001.................... 440 70 510 91
Maturing in Fiscal 2002.................... 1,132 198 1,330 895
December 1, 2002 and thereafter............ 2,090 33 39 2,162 1,312
------ ------ ------ ------ ------- ------
Senior Notes.......................... $8,915 $1,712 $ 781 $ 123 $11,531 $9,286
------ ------ ------ ------ ------- ------
Subordinated Indebtedness
December 1, 2002 and thereafter............ $ 200 $ 200 $ 200
------ ------ ------ ------ ------- ------
Long-Term Debt............................. $9,115 $1,712 $ 781 $ 123 $11,731 $9,486
====== ====== ====== ====== ======= ======
</TABLE>
Of the Company's long-term debt outstanding as of November 30, 1997, $642
million is repayable prior to maturity at the option of the holder, at par
value. These obligations are reflected in the above table at their put dates,
which range from fiscal 1998 to fiscal 2002, rather than at their contractual
maturities, which range from fiscal 2000 to fiscal 2019. In addition, $415
million of the Company's long-term debt is redeemable prior to maturity at the
option of the Company under various terms and conditions. These obligations are
reflected in the above table at their contractual maturity dates.
As of November 30, 1997, the Company's U.S. dollar and non-U.S. dollar debt
portfolios included approximately $134 million and $54 million, respectively, of
debt for which the interest rates and/or redemption values have been linked to
various indices including industry baskets of stocks or commodities.
END USER DERIVATIVE ACTIVITIES
The Company utilizes a variety of derivative products including interest
rate and currency swaps as an end user to modify the interest rate
characteristics of its long-term debt portfolio. The Company actively manages
the interest rate exposure on its long-term debt portfolio to more closely match
the terms of its debt portfolio to the assets being funded and to minimize
interest rate risk. In addition, the Company utilizes cross-currency swaps to
hedge its exposure to foreign currency risk as a result of its non-U.S. dollar
debt obligations, after consideration of non-U.S. dollar assets which are funded
with long-term debt obligations in the same currency.
F-5
<PAGE> 24
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
At November 30, 1997 and 1996, the notional values of the Company's
interest rate and currency swaps related to its long-term debt obligations were
approximately $10.5 billion and $8.6 billion, respectively. In terms of notional
amounts outstanding, these derivative products mature as follows:
<TABLE>
<CAPTION>
NOVEMBER 30
NON-U.S. CROSS- -----------------
U.S. DOLLAR DOLLAR CURRENCY 1997 1996
----------- -------- -------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Maturing in Fiscal 1997........................ $1,302
Maturing in Fiscal 1998........................ $ 1,640 $120 $ 1,760 1,773
Maturing in Fiscal 1999........................ 1,650 674 2,324 1,992
Maturing in Fiscal 2000........................ 2,422 32 2,454 1,112
Maturing in Fiscal 2001........................ 468 468 56
Maturing in Fiscal 2002........................ 1,167 1,167 845
December 1, 2002 and thereafter................ 2,262 $ 4 35 2,301 1,496
----------- -------- -------- ------- ------
Total.......................................... $ 9,609 $ 4 $861 $10,474 $8,576
----------- -------- -------- ------- ------
Weighted average rate(1).......................
Receive rate................................... 7.21% 3.32% 4.30% 6.97% 6.88%
Pay rate....................................... 6.49% 0.77% 6.43% 6.48% 6.24%
</TABLE>
- ---------------
(1) Weighted average interest rates were calculated utilizing non-U.S. dollar
interest rates, where applicable.
F-6
<PAGE> 25
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
The Company's end user derivative activities resulted in the following
changes to the Company's mix of fixed and floating rate debt and effective
weighted average rates of interest:
<TABLE>
<CAPTION>
NOVEMBER 30, 1997
-----------------------------------------------------
LONG-TERM DEBT WEIGHTED AVERAGE(1)
-------------------- -----------------------------
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
ACTIVITIES ACTIVITIES RATE ACTIVITIES
-------- -------- ----------- --------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
USD Obligations
Fixed Rate................................... $ 9,115 $ 86 7.39% 9.34%
Floating Rate................................ 1,712 11,602 6.03% 6.47%
-------- -------- ----------- -------
10,827 11,688 7.17% 6.50%
Non-USD Obligations............................... 904 43 4.03% 1.12%
-------- -------- ----------- -------
Total............................................. $11,731 $11,731 6.93% 6.48%
-------- -------- ----------- -------
</TABLE>
<TABLE>
<CAPTION>
NOVEMBER 30, 1996
-----------------------------------------------------
LONG-TERM DEBT WEIGHTED AVERAGE(1)
-------------------- -----------------------------
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
ACTIVITIES ACTIVITIES RATE ACTIVITIES
-------- -------- ----------- --------------
(IN MILLIONS)
<S> <C> <C> <C> <C>
USD Obligations
Fixed Rate................................... $ 6,810 $ 122 7.77% 9.22%
Floating Rate................................ 1,566 9,210 5.79% 6.39%
-------- -------- ----------- -------
8,376 9,332 7.40% 6.42%
Non-USD Obligations............................... 1,110 154 3.73% 2.74%
-------- -------- ----------- -------
Total............................................. $ 9,486 $ 9,486 6.97% 6.36%
-------- -------- ----------- -------
</TABLE>
- ---------------
(1) Weighted average interest rates were calculated utilizing non-US dollar
interest rates, where applicable.
NOTE 3. NET REVENUES
Net revenues in 1995 include a special revenue gain of $129 million related
to the sale of the Company's interest in Omnitel Sistemi Radiocellullari
Italiani S.p.A. ("Omnitel"), recognized in the Statement of Income in Principal
transactions. Following recognition of related compensation and taxes, the
Company recognized a $47 million gain in 1995 related to the Omnitel sale
transaction.
NOTE 4. OTHER CHARGES
1996 Severance Charge
In the fourth quarter of 1996, Lehman Brothers Holdings Inc. and
subsidiaries (collectively, "LBHI") recorded an $84 million severance charge
($50 million aftertax) related to certain strategic actions taken to improve
ongoing profitability. The severance charge reflected the culmination of LBHI's
worldwide business unit economic performance review that was undertaken in the
fourth quarter of 1996 to focus LBHI 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 equities businesses, including exiting the
precious metals business in the U.S., Europe and Asia; exiting energy
F-7
<PAGE> 26
SCHEDULE I
LEHMAN BROTHERS HOLDINGS INC.
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(PARENT COMPANY ONLY)
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 Firm's New York Private Client Services offices.
Additionally, the charge reflects various other strategic personnel reductions
aimed at delayering management. The LBHI severance charge has led to personnel
cost savings of approximately $90 million annually. The LBHI severance charge
also resulted in a permanent decrease in nonpersonnel expenses of approximately
$20 million annually. LBHI intends to reinvest substantially all these savings
into certain businesses to expedite LBHI's strategic initiatives; these actions
are expected to result in improved operating revenues.
The Company recorded a $50 million severance charge ($30 million aftertax)
in the fourth quarter of 1996 related to these actions. The Company's cash
outlays relating to the charge were approximately $9 million in the fourth
quarter of 1996 and approximately $38 million during fiscal 1997. The remaining
residual payments will be paid as deferred payment arrangements are completed.
1995 Restructuring Charge
During the fourth quarter of 1995, the Company recorded a charge of $27
million pretax ($16 million aftertax) for occupancy-related real estate
expenses. This charge resulted from a complete global review of the Company and
its affiliates' real estate requirements at current headcount levels and the
elimination of excess real estate primarily in its New York location. The charge
included the cost to write-down the carrying value of leasehold improvements as
well as the difference between expected operating costs and projected sublease
recoveries.
NOTE 5. MANAGEMENT FEES
The Company incurs charges including occupancy, administration and computer
processing, which are related to its activities and that of certain of its
subsidiaries (the "Related Parties"). Such charges are allocated between the
Related Parties, based upon specific identification and allocation methods. The
allocation of such charges to other affiliates is recognized as management fees.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Company has fully guaranteed certain of its subsidiaries and guaranteed
certain unsecured lines of credit and other contractual obligations of other
subsidiaries.
F-8
<PAGE> 27
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------------------------------
<S> <C>
3.1 Restated Certificate of Incorporation of the Registrant dated May 27, 1994
(incorporated by reference to Exhibit 3.1 of the Registrant's Transition Report on
Form 10-K for the eleven months ended November 30, 1994).
3.2 By-Laws of the Registrant, amended as of March 26, 1997 (incorporated by reference
to Exhibit 10 of the Registrant's Quarterly Report on Form 10-Q for the quarter
ended February 28, 1997).
4.1 The instruments defining the rights of holders of the long-term debt securities of
the Registrant and its subsidiaries are omitted pursuant to section (b) (4) (iii)
(A) of Item 601 of Regulation S-K. The Registrant hereby agrees to furnish copies of
these instruments to the Securities and Exchange Commission upon request.
9.1 1997 Trust under Lehman Brothers Holdings Inc. Incentive Plans (incorporated by
reference to the Registrant's Form 8-K dated September 4, 1997).
10.1 Agreement of Tenants-In-Common by and among American Express Company, American
Express Bank Ltd., American Express Travel Related Services Company, Inc., Shearson
Lehman Brothers Inc., Shearson Lehman Government Securities, Inc. and Shearson
Lehman Commercial Paper Incorporated (incorporated by reference to Exhibit 10.1 of
the Registrant's Transition Report on Form 10-K for the eleven months ended November
30, 1994).
10.2 Tax Allocation Agreement between Shearson Lehman Brothers Holdings Inc. and American
Express Company (incorporated by reference to Exhibit 10.2 of the Registrant's
Transition Report on Form 10-K for the eleven months ended November 30, 1994).
10.3 Transaction Support Services Agreement dated as of September 30, 1994 by and between
Bear, Stearns Securities Corp. and Lehman Brothers Inc. (incorporated by reference
to Exhibit 10.15 of the Registrant's Transition Report on Form 10-K for the eleven
months ended November 30, 1994).
10.4 Lease dated as of October 13, 1993 between 101 Hudson Leasing Associates and Lehman
Brothers Holdings Inc. (incorporated by reference to Exhibit 10 of Holdings'
Quarterly Report on Form 10-Q for the quarter ended September 30, 1993).
10.5 Lehman Brothers Inc. Executive and Select Employees Plan (incorporated by reference
to Exhibit 10.4 of the Registrant's Registration Statement on Form S-1 (Reg. No.
33-12976)).
10.6 Lehman Brothers Holdings Inc. Deferred Compensation Plan for Non-Employee Directors
(incorporated by reference to Exhibit 10.11 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-12976)).
10.7 Amended and Restated Agreements of Limited Partnership of Shearson Lehman Hutton
Capital Partners II (incorporated by reference to Exhibit 10.48 of the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1988).
10.8 Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (incorporated by
reference to Exhibit 10.25 of the Registrant's Registration Statement on Form S-1
(Reg. No. 33-52977)).
10.9 Lehman Brothers Holdings Inc. 1996 Management Ownership Plan (incorporated by
reference to Exhibit 10.1 of the Registrant's Quarterly Report on Form 10-Q for the
quarter ended August 31, 1996).
10.10+ Lehman Brothers Holdings Inc. Short-Term Executive Compensation Plan (incorporated
by reference to Exhibit 10.2 of the Registrant's Quarterly Report on Form 10-Q for
the quarter ended August 31, 1996).
10.11+ Lehman Brothers Holdings Inc. 1996 Short-Term Executive Compensation Plan
(incorporated by reference to Exhibit 10.26 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-52977)).
</TABLE>
<PAGE> 28
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------------------------------
<S> <C>
10.12+ Lehman Brothers Holdings Inc. 1994 Employee Stock Purchase Plan (incorporated by
reference to Exhibit 10.27 of the Registrant's Registration Statement on Form S-1
(Reg. No. 33-52977)).
10.13 Purchase and Exchange Agreement dated April 28, 1994, between the Registrant and
American Express Company (incorporated by reference to Exhibit 10.29 of the
Registrant's Transition Report Form 10-K for the Eleven Months ended November 30,
1994).
10.14 Option Agreement, dated May 27, 1994, by and among American Express Company,
American Express Bank Ltd., American Express Travel Related Services Company, Inc.,
Lehman Brothers Inc., Lehman Government Securities, Inc. and Lehman Commercial Paper
Incorporated (incorporated by reference to Exhibit 10.31 of the Registrant's
Transition Report Form 10-K for the Eleven Months ended November 30, 1994).
10.15+ Lehman Brothers Inc. Voluntary Deferred Compensation Plan (For Select Executives)
(incorporated by reference to Exhibit 10.33 of the Registrant's Registration
Statement on Form S-1 (Reg. No. 33-52977)).
10.16+ Lehman Brothers Inc. Voluntary Deferred Compensation Plan (For Transferred
Participants' Vested Amounts as of July 31, 1993) (incorporated by reference to
Exhibit 10.34 of the Registrant's Registration Statement on Form S-1 (Reg. No.
33-52977)).
10.17+ Lehman Brothers Inc. Executive and Select Employees Plan (For Transferred
Participants) (incorporated by reference to Exhibit 10.35 of the Registrant's
Registration Statement on Form S-1 (Reg. No. 33-52977)).
10.18+ Lehman Brothers Holdings Inc. Cash Award Plan. (incorporated by reference to Exhibit
10.36 of the Registrant's Transition Report on Form 10-K for the Eleven Months ended
November 30, 1994).
10.19 Amended and Restated Agreement of Limited Partnership of Lehman Brothers Capital
Partners III, L.P. (incorporated by reference to Exhibit 10.27 to the Registrant's
Annual Report on Form 10-K for the fiscal year ended November 30, 1995).
10.20 Agreement of Limited Partnership of Lehman Brothers Capital Partners IV, L.P.*
11.1 Computation of per share Earnings.*
12.1 Computation in support of ratio of earnings to fixed charges.*
12.2 Computation in support of ratio of earnings to combined fixed charges and preferred
dividends.*
13. The following portions of the Company's 1997 Annual Report to Stockholders, which
are incorporated by reference herein:
13.1 "Management's Discussion and Analysis of Financial Condition and Results of
Operations", pages 36-61.*
13.2 Consolidated Financial Statements of the Registrant and its Subsidiaries together
with the Notes thereto and the Report of Independent Auditors thereon, pages 62-94.*
13.3 "Selected Financial Data", pages 95-96.*
13.4 "Other Stockholder Information" and "Price Range of Common Stock", page 98.*
21.1 List of the Registrant's Subsidiaries.*
23.1 Consent of Ernst & Young LLP.*
24.1 Powers of Attorney.*
</TABLE>
<PAGE> 29
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------------------------------
<S> <C>
27.1 Financial Data Schedule.*
</TABLE>
- ---------------
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this Form 10-K pursuant to Item 14(c).
<PAGE> 1
EXHIBIT 10.20
================================================================================
LEHMAN BROTHERS CAPITAL PARTNERS IV, L.P.
AGREEMENT OF LIMITED PARTNERSHIP
----------------------------
OCTOBER 21, 1997
----------------------------
================================================================================
<PAGE> 2
TABLE OF CONTENTS
Page
ARTICLE 1
Certain Defined Terms ..................................................... 1
ARTICLE 2
Formation, Name and Place of Business;
Purpose and Limitation on Operations; Term;
Conversion to Corporate Form .............................................. 7
2.1. Formation ............................................... 7
2.2. Name .................................................... 7
2.3. Place of Business ....................................... 7
2.4. Purpose ................................................. 7
2.5. Term .................................................... 7
2.6. Conversion to Corporate Form ............................ 7
ARTICLE 3
General Partner; Relationship with Lehman Brothers ........................ 8
3.1. General Partner, Management of General Partner .......... 8
3.2. No Compensation of Officers and Directors; Expenses ..... 8
3.3. Day-to-Day Operations; Acts of Investment Committee ..... 8
3.4. Services by Lehman Brothers; Charges and Expenses ....... 8
3.5. Related Partnerships .................................... 9
ARTICLE 4
Limited Partners .......................................................... 9
4.1. Initial Limited Partner ................................. 9
4.2. Additional Limited Partners ............................. 9
4.3. List of Limited Partners ................................ 9
4.4. No Management by Limited Partners ....................... 9
4.5. Limitation on Transfer of Limited Partners' Units ....... 10
ARTICLE 5
Liability of Partners ..................................................... 10
5.1. General Partner ......................................... 10
5.2. Limited Partners ........................................ 10
ARTICLE 6
Powers of General Partner; Prohibited Transactions
and Restrictions; Duties of General Partner;
Indemnification and Contribution .......................................... 10
6.1. Powers .................................................. 10
6.2. Prohibited Transactions ................................. 11
6.3. Restrictions on the Authority of the General Partner .... 12
6.4. Duties .................................................. 12
6.5. Exculpation, Indemnification and Contribution ........... 12
6.6. General Partner Loans ................................... 12
(i)
<PAGE> 3
Page
ARTICLE 7
Capital Contributions and Accounts; No Further
Contributions Required; Interest; Accounting and Valuation ................ 13
7.1. Capital Contributions and Accounts ...................... 13
7.2. Further Capital Contributions ........................... 14
7.3. Interest ................................................ 15
7.4. Fixed Return ............................................ 15
7.5. Accounting Periods and Taxable Years .................... 15
ARTICLE 8
Allocations ............................................................... 15
8.1. Allocation of Profits and Losses; Other Allocations ..... 15
8.2. Special Allocation Provisions ........................... 16
8.3. Tax Allocations ......................................... 17
8.4. Allocation among Limited Partners, Transfers ............ 17
8.5. Tax Elections ........................................... 17
8.6. Other Allocation Provisions ............................. 17
ARTICLE 9
Distributions; Withdrawal ................................................. 18
9.1. General Partner Discretion .............................. 18
9.2. Distributions ........................................... 18
9.3. Non-Cash Distributions .................................. 18
9.4. Withholding ............................................. 19
9.5. Withdrawal .............................................. 19
ARTICLE 10
Transferability of Interests; Vesting;
Termination of Employment ................................................. 19
10.1. Restrictions and Conditions on Transfers of Units ...... 19
10.2. Assignees .............................................. 20
10.3. Substituted Limited Partners ........................... 20
10.4. Termination of Employment, Death, Disability, Retirement
of Limited Partner ..................................... 21
10.5. Disposition of General Partner's Interest .............. 24
ARTICLE 11
Dissolution and Liquidation of the Partnership ............................ 24
11.1. Events Causing Dissolution ............................. 24
11.2. Liquidation ............................................ 24
ARTICLE 12
Books and Records; Accounting;
Appraisal; Tax Matters and Elections ...................................... 26
12.1. Books and Records ...................................... 26
12.2. Accounting Basis, Fiscal Year .......................... 26
12.3. Bank Accounts .......................................... 26
12.4. Appraisal .............................................. 26
12.5. Reports ................................................ 27
12.6. Tax Matters and Elections .............................. 27
(ii)
<PAGE> 4
Page
ARTICLE 13
Miscellaneous Provisions .................................................. 27
13.1. Appointment of the General Partner as Attorney-in-Fact . 27
13.2. Amendments of this Agreement ........................... 28
13.3. Arbitration ............................................ 29
13.4. Notices ................................................ 29
13.5. Binding Provisions ..................................... 30
13.6. Interest as Security for UCC Purposes .................. 30
13.7. Applicable Law ......................................... 30
13.8. Counterparts ........................................... 30
13.9. Separability of Provisions ............................. 30
13.10. Entire Agreement ...................................... 31
13.11. Section Titles ........................................ 31
13.12. Waiver of Right of Partition .......................... 31
13.13 Effectiveness ......................................... 31
(iii)
<PAGE> 5
AGREEMENT OF LIMITED PARTNERSHIP
LEHMAN BROTHERS CAPITAL PARTNERS IV, L.P.
AGREEMENT OF LIMITED PARTNERSHIP, dated as of October 21, 1997, by and
among LB I Group Inc., a corporation organized under the laws of the State of
Delaware, as general partner hereunder (the "General Partner"), the Initial
Limited Partner (as described in Section 4.1 hereof) and the persons who are
admitted as additional limited partners on the Closing Date (as defined herein)
in accordance with the terms hereof (the "Limited Partners") (the General
Partner and the Limited Partners are collectively referred to as the
"Partners").
ARTICLE 1
CERTAIN DEFINED TERMS
As used in this Agreement, the following terms shall have the following
meanings:
1940 Act The United States Investment Company Act of 1940, as
amended
Act Delaware Revised Uniform Limited Partnership Act, 6
Del. C. ss.ss. 17-101. et seq., as amended from time
to time and any successor to said act
Affiliate Any person or entity that controls, is controlled by,
or is under common control with, any other person or
entity
Agreement This Agreement of Limited Partnership, as the same may
be amended, modified or supplemented from time to time
Capital Account As defined in Section 7.1(f)
Capital Commitment Aggregate amount the Limited Partner has agreed to pay
to the Partnership as the purchase price for his or
her Units
Capital Contributions Amounts contributed to the Partnership by the
Partners, which do not include any amount invested in
the Money Funds or the Escrow Account
Capital Partners III Lehman Brothers Capital Partners III, L.P., a limited
partnership formed under the laws of the State of
Delaware
Carrying Value With respect to any Partnership asset, the asset's
adjusted basis for federal income tax purposes, except
that the Carrying Values of all Partnership assets
shall be adjusted to equal their respective fair
market values (as determined by the General Partner),
in accordance with the rules set forth in Treasury
Regulations Section l.704-1(b)(2)(iv)(f), except as
otherwise provided herein, immediately prior to: (a)
the date of the acquisition of any additional
Partnership
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interest by any new or existing Partner in exchange
for more than a de minimis Capital Contribution or (b)
the date of the distribution of more than a de minimis
amount of Partnership property (other than a pro rata
distribution) to a Partner; provided that adjustments
pursuant to clauses (a) and (b) above shall be made
only if the General Partner determines in its sole
discretion that such adjustments are necessary or
appropriate to reflect the relative economic interests
of the Partners. The Carrying Value of any Partnership
asset distributed to any Partner shall be adjusted
immediately prior to such distribution to equal its
fair market value. In the case of any asset that has a
Carrying Value that differs from its adjusted tax
basis, Carrying Value shall be adjusted by the amount
of depreciation calculated for purposes of the
definition of "Profits and Losses" rather than the
amount of depreciation determined for U.S. federal
income tax purposes
Cause Termination of employment of a Limited Partner by
Lehman Brothers due to a material breach by a Limited
Partner of his or her employment contract or other
agreement with Lehman Brothers, failure by a Limited
Partner to devote substantially all business time
exclusively to the performance of his or her
employment duties for Lehman Brothers, willful
misconduct, dishonesty related to the business and
affairs of Lehman Brothers, commission of a felony,
misdemeanor or any other action which in the opinion
of Lehman Brothers constitutes a statutory
disqualification under U.S. securities laws (or a
failure to contest prosecution for a felony or such
misdemeanor), habitual or gross negligence in the
performance of his or employment duties, engaging in
Detrimental Activity, or a material violation of
Lehman Brothers' conflict of interest, proprietary
information, business ethics policies or other
policies set out in the Code of Conduct of Lehman
Brothers
Closing The admission of Eligible Investors as Limited
Partners of the Partnership following the receipt by
Lehman Brothers of the Exemptive Order
Closing Date The date of the Closing
Code Internal Revenue Code of 1986, as amended
Commitment Period The period from the date hereof until the earlier of
(i) July 25, 2002 or January 31, 2003 (with respect to
any proposed Portfolio Investment for which, on or
prior to July 25, 2002, the Partnership has entered
into a letter of intent, agreement in principle or
definitive agreement to invest) and (ii) any date as
of which the General Partner has determined in its
sole discretion to terminate the obligation of Limited
Partners to make Capital Contributions
Competitive Activity Involvement, at any time following the date of
termination of the Limited Partner's employment with
Lehman Brothers, whether as an
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employee, proprietor, consultant or otherwise, with
any person or entity engaged in any business activity
which is materially competitive with any business
carried on by Lehman Brothers at such time, as
determined in the sole discretion of the General
Partner
Cost of Funds Rate Average daily cost of funds of LBHI as determined by
its Treasurer's Office
Detrimental Activity (a) Using information that was received by or
disclosed to such Limited Partner during his or her
employment with Lehman Brothers relating to the
business affairs of Lehman Brothers or any of its
clients, in breach of his or her undertakings to keep
such information confidential, (b) directly or
indirectly by any means persuading or attempting to
persuade any employee of Lehman Brothers to terminate
his or her employment or any customer or client of
Lehman Brothers to terminate or curtail its business
relationship with Lehman Brothers or to breach any
term of any agreement with Lehman Brothers or (c) any
activity deemed to be detrimental to Lehman Brothers,
in each case as determined in the sole discretion of
the General Partner
Disability A disability which meets the criteria under both the
Lehman Brothers Group Long Term Disability Plan and
the Social Security Disability Act
Eligible Investors (a) Managing directors, senior vice presidents and
certain other key officers, employees, consultants and
directors of Lehman Brothers designated by Lehman
Brothers in its sole discretion, provided such person
has (i) an individual net worth or net worth with his
or her spouse that exceeds $1 million or (ii) an
individual income in excess of $200,000 in each of
1995 and 1996 or joint income with his or her spouse
in excess of $300,000 in each of such years and has a
reasonable expectation of reaching the same income
level in 1997, and (b) any other persons designated by
the General Partner in its sole discretion who are
eligible investors under the Exemptive Order
Escrow Account A segregated interest-bearing deposit account
denominated in U.S. dollars established at an entity
that is not affiliated with Lehman Brothers
Exemptive Order A new order of the SEC to be received by Lehman
Brothers exempting the Partnership and certain other
similar investment partnerships from the registration
and certain other requirements of the 1940 Act
Fixed Return A cumulative annual return equal to the Cost of Funds
Rate plus 0.50% or, if higher, an amount determined by
the General Partner with reference to the applicable
United States federal rate for interest on loans then
utilized by the Internal Revenue Service in connection
with below-market loans to employees with a maturity
date of July 25, 2009
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Follow-on Investment Any Portfolio Investment in an existing Portfolio
Company
General Partner LB I Group Inc., a corporation organized under the
laws of the State of Delaware and a subsidiary of
LBHI, as general partner of the Partnership
Initial Limited Partner First Cap IV, Inc., a corporation organized under the
laws of the State of Delaware, as the Initial Limited
Partner of the Partnership
Initial Payment One-quarter (25%) of the amount of the aggregate
Capital Commitment represented by the Units subscribed
for; except as otherwise provided in the subscription
agreement relating to such Units, the Initial Payment
is unconditionally due and payable upon execution and
delivery of the subscription agreement
Investment Committee The Investment Committee of LBHI
LB Fund II Lehman Brothers Merchant Banking Partners II L.P., a
limited partnership formed under the laws of the State
of Delaware, together with its affiliated investment
entities
LBHI Lehman Brothers Holdings Inc., a corporation organized
under the laws of the State of Delaware
Lehman Brothers LBHI and its subsidiaries
Limited Partners Persons who are admitted as additional limited
partners to the Partnership on the Closing Date, and
any other person who may be admitted as a substituted
or additional Limited Partner of the Partnership in
accordance with this Agreement
Memorandum Confidential Private Placement Memorandum dated
October 1997 relating to the Partnership, as amended
or supplemented from time to time
Merchant Banking Group The Merchant Banking Group of Lehman Brothers
Money Fund Any money market fund or any interest bearing account
denominated in U.S. dollars selected by the General
Partner, in which payments by Limited Partners are
deposited pending contribution to the Partnership
Nonrecourse Deductions As defined in U.S. Treasury Regulations Section
1.704-2(b). The amount of Partnership Nonrecourse
Deductions for a fiscal year equals the net increase,
if any, in the amount of Partnership minimum gain
during that fiscal year, determined according to the
provisions of U.S. Treasury Regulations Section
1.704-2(c)
Partner Nonrecourse Debt
Minimum Gain An amount with respect to each partner nonrecourse
debt (as defined in Treasury Regulations Section
1.704-2(b)(4)) equal to the Partnership Minimum Gain
that would result if such partner
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nonrecourse debt were treated as a nonrecourse
liability (as defined in Treasury Regulations Section
1.752-l(a)(2)) determined in accordance with Treasury
Regulations Section 1.704-2(i)(3)
Partner Nonrecourse
Deductions As defined in U.S. Treasury Regulations Section
l.704-2(i)(2)
Partners Collectively, the General Partner and the Limited
Partners
Partnership Lehman Brothers Capital Partners IV, L.P., the limited
partnership formed by the General Partner and the
Initial Limited Partner and continued by the General
Partner and the parties hereto under the Act in
accordance with this Agreement, under the laws of the
State of Delaware
Partnership Minimum Gain As defined in Treasury Regulations Section
l.704-2(b)(2) and 1.704-2(d)
Portfolio Companies The issuers of the Partnership's Portfolio Investments
Portfolio Investments The securities or rights in which the Partnership
actually has invested or the securities or rights
issued as a dividend or distribution thereon, in a
reclassification with respect thereto or in an
exchange therefor
Profits and Losses For each fiscal year or other period, the taxable
income or loss of the Partnership, or particular items
thereof, determined in accordance with the accounting
method used by the Partnership for federal income tax
purposes with the following adjustments: (a) all items
of income, gain, loss or deduction allocated pursuant
to Section 8.2 shall not be taken into account in
computing such taxable income or loss; (b)any income
of the Partnership that is exempt from federal income
taxation and not otherwise taken into account in
computing Profits and Losses shall be added to such
taxable income or loss; (c) if the Carrying Value of
any asset differs from its adjusted tax basis for
federal income tax purposes, any gain or loss
resulting from a disposition of such asset shall be
determined with reference to such Carrying Value; (d)
upon an adjustment to the Carrying Value of any asset,
pursuant to the definition of Carrying Value (other
than an adjustment in respect of depreciation), the
amount of the adjustment shall be included as gain or
loss in computing such taxable income or loss; (e) if
the Carrying Value of any asset differs from its
adjusted tax basis for U.S. federal income tax
purposes the amount of depreciation, amortization or
cost recovery deductions with respect to such asset
shall for purposes of determining Profits and Losses
be an amount which bears the same ratio to such
Carrying Value as the federal income tax depreciation,
amortization or other cost recovery deductions bears
to such adjusted tax basis (provided that if the
federal income tax depreciation, amortization or other
cost recovery deduction is zero, the General Partner
may use any reasonable method for purposes of
determining depreciation, amortization or other cost
recovery deductions in calculating Profits and
Losses); and
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(f) except for items in (a) above, any expenditures of
the Partnership not deductible in computing taxable
income or loss, not properly capitalizable and not
otherwise taken into account in computing Profits and
Losses pursuant to this definition shall be treated as
deductible items
Representative Any executor, administrator, trustee, committee,
guardian, conservator or representative appointed by a
court of competent jurisdiction to act on behalf of a
Limited Partner or the estate of a Limited Partner
Repurchase Notice Following the termination of a Limited Partner's
employment with Lehman Brothers, a writing in which
the General Partner will notify such Limited Partner
by certified mail (or its equivalent) or via overnight
courier of its determination whether to purchase such
Limited Partner's Units
Retirement Termination of employment with Lehman Brothers which
meets the criteria for retirement under the qualified
defined benefit pension plan of LBHI or the criteria
for retirement under any other pension plan in a
territory outside the United States which is sponsored
by Lehman Brothers, provided the individual has at
least five years of service with Lehman Brothers
Returned Capital
Contributions The sum of (A) the amounts distributed pursuant to
clause (iv) of Section 9.2(a) and (B) the amounts
distributed pursuant to clause (vi) thereunder, but
not in excess of amounts distributed pursuant to
clause (i) thereunder
SEC The United States Securities and Exchange Commission
Transfer As defined in Section 10.1(a)
Transfer Application Written and dated notification of a Transfer of all or
any portion of the Units of a Limited Partner
Transferring Limited
Partner As defined in Section 10.1(c)
Units Units of limited partnership interests in the
Partnership, each Unit representing a Capital
Commitment of $20,000
Unvested Interest The unvested portion of such Limited Partner's
interest in the Partnership, determined in accordance
with Section 10.4
Vesting Schedule The schedule according to which a Limited Partner's
interest in the Partnership generally will vest, as
set forth in Section 10.4(a)
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ARTICLE 2
FORMATION, NAME AND PLACE OF BUSINESS;
PURPOSE AND LIMITATION ON OPERATIONS; TERM;
CONVERSION TO CORPORATE FORM
2.1. Formation. The General Partner and the Initial Limited Partner have
formed the Partnership under the Act. In the event that it shall be necessary
for the Partnership to exist in or qualify to do business under the laws of any
state or states other than, or in addition to, the State of Delaware, the
parties hereby agree that the Partnership shall take such action as may be
necessary to exist or qualify to do business in any state in which such
existence or qualification shall be required, provided that in any such event
the Partnership shall at all times continue to be a limited partnership formed
under and governed by the provisions of the Act.
2.2. Name. The name of the Partnership shall be "Lehman Brothers Capital
Partners IV, L.P." The business of the Partnership may be conducted under any
other name deemed necessary or desirable by the General Partner in order to
comply with local law.
2.3. Place of Business. The principal place of business of the Partnership
shall be at 3 World Financial Center, New York, New York 10285, and/or at such
other place within or without the State of New York as the General Partner
hereafter may designate in writing to the Limited Partners.
2.4. Purpose. (a) The purpose and character of the business of the
Partnership is to achieve capital appreciation through equity-oriented
investments. The Partnership also may make debt investments with a view to a
restructuring in which the Partnership would receive an equity interest, and, in
connection with equity-oriented investments, may make investments in debt
securities or preferred stock. The Partnership may engage in such other
activities as are permitted hereby or are incidental or ancillary to the
foregoing as the General Partner shall deem necessary or appropriate.
(b) The Partnership will invest in all investments to be made by LB Fund
II, subject to the requirement that the Investment Committee determine that the
terms of each Portfolio Investment are fair and reasonable and consistent with
the best interests of the Limited Partners and otherwise are in compliance with
any applicable provisions or requirements of the Exemptive Order. Each Portfolio
Investment by the Partnership generally will be made pro rata with LB Fund II
based on the available and unfunded Capital Commitments to the Partnership
relative to the aggregate amount of unfunded capital commitments to LB Fund II.
2.5. Term. (a) The Partnership shall continue until July 25, 2009 or upon
earlier termination by the General Partner in its sole discretion, unless the
Partnership is dissolved prior to such date or dates pursuant to the provisions
of Article 11 hereof or as otherwise provided by operation of law.
(b) No Limited Partner's death, incapacity or bankruptcy, resignation or
retirement from Lehman Brothers or other termination of employment with Lehman
Brothers shall result in the dissolution or termination of the Partnership as
among the remaining Partners.
2.6 Conversion to Corporate Form. In the event of changes in the law,
regulations or interpretations applicable to the Partnership or its operations
or changes in other circumstances which, in the sole judgment of the General
Partner, render it desirable or helpful for the business of the Partnership to
be conducted in a corporate rather than in a partnership form (including without
limitation a limited liability company), the General Partner, without the
approval of the Limited Partners, shall have the power to incorporate the
Partnership or take such other action as it may deem advisable in light of such
changed conditions, including, without limitation, dissolving the Partnership,
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transferring its assets as an entirety to a successor investment vehicle or
causing it to merge with a successor investment vehicle.
ARTICLE 3
GENERAL PARTNER; RELATIONSHIP WITH LEHMAN BROTHERS
3.1. General Partner; Management of General Partner. LB I Group Inc. is
the sole general partner of the Partnership. The General Partner will have
complete control of the Partnership's business. Such control shall be exercised
by LB I Group Inc., in its capacity as general partner of the Partnership, by
the appropriate officers of the General Partner or their designees.
3.2 No Compensation of Officers and Directors; Expenses. (a) No
compensation shall be paid by the Partnership to the General Partner or to its
officers and directors solely for their services as General Partner and officers
and directors thereof, respectively, other than reimbursement for out-of-pocket
expenses incurred in the course of conducting the business of the Partnership.
The General Partner shall be reimbursed for (i) fees paid to others for
Partnership accounting and communication services and (ii) certain other fees
and expenses (including those paid to consultants, attorneys, accountants or
other professionals) incurred by it on behalf of the Partnership, including, but
not limited to, all fees and expenses of litigation and tax audits of the
Partnership and for the outside valuation of securities or property obtained by
the Partnership, whether in a merger, sale or otherwise. The General Partner
shall not be reimbursed for payroll and other costs of salaried personnel and
rent or general office overhead of the General Partner, which will be borne by
the General Partner.
(b) The costs and expenses incurred on behalf of the Partnership with
respect to the organization of the Partnership, pre-offering activities and
offering activities and the selling of Units including, but not limited to,
travel, telephone, postage, legal and accounting expenses, shall be paid by the
Partnership. Except as otherwise provided herein to the contrary, the
Partnership will bear all other expenses of its operations including fees and
expenses of attorneys, accountants and experts, commitment and investment
banking fees, and interest and all expenses related to Portfolio Investments or
potential Portfolio Investments and to the acquisition, holding and sale or
other disposition of Portfolio Investments.
3.3. Day-to-Day Operations; Acts of Investment Committee. The day-to-day
operations of the Partnership, including the identification, review and
structuring of, and analysis and recommendations with respect to, proposed
Portfolio Investments and realizations will be managed by the Merchant Banking
Group. All final investment and realization decisions will be made on behalf of
the General Partner, in its capacity as general partner of the Partnership, by
members of the Investment Committee. In connection with Partnership matters, the
Investment Committee will operate in accordance with its corporate
authorization.
3.4. Services by Lehman Brothers; Charges and Expenses. (a) Investment
advisory services for the Partnership will be performed by or on behalf of the
General Partner, and brokerage, custody and other administrative and similar
services for the Partnership may be performed by Lehman Brothers, and in
connection therewith no charge shall be made to the Partnership for the time of
any employee of Lehman Brothers although the Partnership may be charged
customary fees for such services.
(b) The Partnership may borrow funds from Lehman Brothers in order to
provide funds for purposes of covering Partnership expenses or providing interim
financing to the extent necessary to consummate the purchase of Portfolio
Investments prior to the receipt of Capital Contributions, and Lehman Brothers
shall be entitled to receive interest on amounts loaned at the prime rate as
charged
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from time to time by a major money center bank or at the Cost of Funds Rate, as
determined by Lehman Brothers in its discretion at the time any such loan is
made (but in no event less than the rate required under United States tax law to
avoid compensation income to the Limited Partners). In connection with the
investment activities of the Partnership, Lehman Brothers and its Affiliates
shall be entitled to receive certain fees, brokerage commissions or other
benefits from purchasers, sellers and Portfolio Companies in connection with
services rendered to these companies, which fees may be higher or lower than
market rates for similar services to third parties.
3.5. Related Partnerships. A portion of the available capital of Capital
Partners III will be invested side by side with LB Fund II and the Partnership.
With the exception of Capital Partners III, Lehman Brothers will not originate
or offer to its employees another employee investment vehicle during the
Commitment Period which has an investment objective substantially similar to
that of the Partnership unless at least 50% of the aggregate Capital Commitments
have been called. Any employee investment vehicle that is established primarily
to make investments restricted by or otherwise excluded from LB Fund II
(including without limitation venture capital or real estate investments) is not
subject to the foregoing limitation.
ARTICLE 4
LIMITED PARTNERS
4.1. Initial Limited Partner. (a) The Initial Limited Partner has become
such only for the purpose of organizing the Partnership. Immediately subsequent
to the admission of one or more additional Limited Partners on the Closing Date,
the Initial Limited Partner shall withdraw from the Partnership, the Initial
Limited Partner's capital contribution, if any, shall be returned and it shall
have no other rights or liabilities with respect to the Partnership in its
capacity as Initial Limited Partner.
(b) Unless the context otherwise specifically requires, references in this
Agreement to the Limited Partners, their capital and their rights and
obligations shall not be references to the Initial Limited Partner.
4.2. Additional Limited Partners. Following receipt by Lehman Brothers of
the Exemptive Order, the General Partner is authorized to admit Eligible
Investors as additional Limited Partners to the Partnership pursuant to the
terms of the Memorandum and this Agreement and upon execution and delivery by
each Eligible Investor of a subscription agreement and such other documents as
the General Partner deems necessary or advisable, each in form satisfactory to
the General Partner, relating to the Units. The manner of the offering of the
Units, the terms and conditions under which subscriptions for such Units will be
accepted, and the manner of and conditions to the sale of Units to subscribers
therefor will be as provided in this Agreement and in the Memorandum and the
various subscription agreements between the Partnership and each Limited
Partner, and subject to any provisions of any of them. A person shall be
admitted as a Limited Partner on the day his or her admission is reflected on
the books and records of the Partnership.
4.3. List of Limited Partners. The name, residence and business address of
each additional Limited Partner and the aggregate amount of such Limited
Partner's Capital Commitment is set forth on Schedule A hereto, as amended from
time to time.
4.4. No Management by Limited Partners. No Limited Partner as such shall
take part in the management of the Partnership's business, transact any business
in the Partnership's name or have the power to sign documents for or otherwise
bind the Partnership. Limited Partners will not participate in any investment
decisions made on behalf of the Partnership, although members of the Merchant
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Banking Group and the Investment Committee may invest in the Partnership if they
are Eligible Investors.
4.5. Limitation on Transfer of Limited Partners' Units. Except as set
forth in Article 10 herein, no Limited Partner shall, directly or indirectly,
Transfer any Units.
ARTICLE 5
LIABILITY OF PARTNERS
5.1. General Partner. Except as provided in Section 11.2(e), the General
Partner shall not be required to contribute to the capital of, or lend, the
Partnership any funds other than the General Partner's Capital Contribution.
Neither the General Partner nor any of its Affiliates shall have any personal
liability for the return or repayment of the aggregate Capital Contributions of
any Limited Partner.
5.2. Limited Partners. Except as otherwise provided under Delaware law, no
Limited Partner shall be liable for the debts, liabilities, contracts or any
other obligations of the Partnership, except to the extent of such Limited
Partner's Capital Commitment, or for the debts or liabilities of any other
Partner. No Limited Partner shall be required to lend the Partnership any funds.
ARTICLE 6
POWERS OF GENERAL PARTNER; PROHIBITED TRANSACTIONS
AND RESTRICTIONS; DUTIES OF GENERAL PARTNER;
INDEMNIFICATION AND CONTRIBUTION
6.1. Powers. (a) In addition to and not in limitation of any rights and
powers conferred by law or other provisions of this Agreement, and except as
limited, restricted or prohibited by the express provisions of this Agreement,
the General Partner shall have and may exercise on behalf of the Partnership all
powers and rights necessary, proper, convenient or advisable to effectuate and
carry out the purpose and business of the Partnership. These powers shall
include, without limitation, the following powers:
(i) to borrow money in the name of the Partnership from any person,
including Lehman Brothers, or guarantee loans or other extensions of
credit for purposes of covering Partnership expenses or providing
interim financing to the extent necessary to consummate the purchase
of Portfolio Investments prior to the receipt of Capital
Contributions, and, if security is required therefor, to mortgage or
subject to any other security device any portion of the assets of
the Partnership, to obtain replacements of any mortgage or other
security device, and to prepay, in whole or in part, refinance,
increase, modify, consolidate or extend any mortgage or other
security device;
(ii) to enter into transactions and make investments with or through
Affiliates of the General Partner, including LB Fund II, and to
participate in investment transactions sponsored, managed or
underwritten by Affiliates of the General Partner, including LB Fund
II, or in entities as to which Affiliates of the General Partner
serve as investment adviser or placement agent;
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(iii) prior to making Portfolio Investments or pending cash distributions
to the Partners, to make temporary investments of Partnership
capital in all types of securities, including, without limitation,
short-term United States government and agency securities,
certificates of deposit, interest-bearing deposits in United States
banks, securities issued by or on behalf of states, municipalities
and their instrumentalities, the interest from which is exempt from
federal income tax, prime-grade commercial paper, repurchase
agreements with respect to any of the foregoing, securities
prime-grade commercial paper issued by other investment companies
(including unit investment trusts and taxable and tax-exempt money
market funds sponsored and/or advised by Affiliates of the General
Partner);
(iv) to enter into contracts (including, without limitation, insurance
policies and contracts, of any type and coverage) and make
commitments on behalf of the Partnership and, in general, to do and
perform everything which may be necessary, advisable, suitable or
proper for the conduct of the Partnership's business and for the
carrying out of the purposes and objects herein before enumerated,
including the delegation to any person or persons of such functions
and authority as the General Partner may determine; and
(v) to employ attorneys and accountants to represent and audit the books
of the Partnership, which attorneys and accountants may also serve
as counsel and auditors to the General Partner and any of its
Affiliates.
(b) Any person not a party to this Agreement dealing with the Partnership
shall be entitled to rely conclusively upon the power and authority of any
officer or director of the General Partner to bind the Partnership in all
respects, and to execute agreements, instruments and other writings on behalf of
and in the name of the Partnership.
6.2. Prohibited Transactions. Notwithstanding anything to the contrary
contained herein, the following transactions are specifically prohibited to the
Partnership:
(i) the Partnership shall not engage in any transaction otherwise
prohibited by Section 17(a) or Section 17(d) of the 1940 Act and
Rule 17d-1 thereunder unless the following conditions are satisfied:
(A) the Investment Committee shall have determined, on behalf
of the Partnership, that the terms of the transaction, including the
consideration to be paid, are fair and reasonable to the Limited
Partners and do not involve overreaching of the Partnership or the
Limited Partners on the part of any person concerned, and that the
transaction is consistent with the interests of the Limited
Partners, this Agreement and the Partnership's reports to the
Limited Partners; and
(B) affiliated co-investors of the Partnership give the
General Partner at least one day's notice of their intent to dispose
of any joint investment with the Partnership and refrain from
disposing of their joint investment unless the Partnership has the
opportunity to dispose of its investment prior to or concurrently
with, and on the same terms as, the co-investors; and
(ii) the Partnership shall not engage in any other transaction prohibited
by the 1940 Act unless such transaction is permitted by the
Exemptive Order or an exemption therefor has otherwise been duly
obtained.
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6.3. Restrictions on the Authority of the General Partner. Without the
approval of a majority in interest of the Limited Partners, the General Partner
shall not have the authority to alter the purpose of the Partnership.
6.4. Duties. (a) Other than with respect to temporary investments, and
after setting aside suitable reserves, the General Partner shall invest the
Capital Contributions of the Partners in Portfolio Investments in accordance
with the purposes of the Partnership, monitor and dispose of such Portfolio
Investments and manage the related affairs of the Partnership.
(b) Except as otherwise expressly provided herein, the General Partner
shall take all action that may be necessary or appropriate for the continuation
of the Partnership's valid existence as a limited partnership under the laws of
the State of Delaware, and for the acquisition, holding and disposition, in
accordance with the provisions of this Agreement and applicable laws and
regulations, of the Portfolio Investments and any other investments of the
Partnership.
(c) The General Partner shall prepare or cause to be prepared and shall
file on or before the due date (or any extension thereof) any United States
federal, state or local tax returns required to be filed by the Partnership. The
General Partner shall cause the Partnership to pay, from Partnership funds, any
taxes payable by the Partnership.
(d) The General Partner shall be under a fiduciary duty and obligation to
conduct the affairs of the Partnership in the best interest (or not opposed to
the best interest) of the Partnership, including the safekeeping and use of all
Partnership funds and assets (whether or not in the immediate possession or
control of the General Partner) for the benefit of the Partnership.
(e) The General Partner may delegate or assign any action which may be or
is required to be taken by the General Partner to any third party, including
without limitation, an Affiliate of the General Partner.
6.5. Exculpation, Indemnification and Contribution. Neither the General
Partner, any of its officers, directors, agents or representatives (including
any members of the Merchant Banking Group or the Investment Committee) nor any
person who controls the General Partner (a "control person") within the meaning
of Section 15 of the Securities Act of 1933, as amended, shall be liable to the
Partnership or the Limited Partners for any act or failure to act relating in
any way to the Partnership, its assets, business or affairs so long as such act
or failure to act does not constitute such person's willful misconduct, bad
faith or gross negligence or reckless disregard of the duties involved in the
conduct of the Partnership or such person's office. The General Partner and its
officers, directors, agents, representatives (including members of the Merchant
Banking Group and the Investment Committee) and control persons shall be
indemnified by the Partnership to the fullest extent permitted by law for any
and all losses, claims, damages and expenses arising out of or incurred in
connection with any claim, action or demand against the General Partner, the
Partnership or any such indemnified person relating to the Partnership, its
assets, business or affairs (including, without limitation, attorneys' fees and
expenses and any amounts paid in settlement or compromise of any such claim,
action or demand); provided, however, that the foregoing indemnification shall
not apply if a court of competent jurisdiction makes a final decision that such
claim, action or demand resulted directly from such indemnified person's willful
misconduct, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of the Partnership or such person's office.
6.6. General Partner Loans. Subject to the provisions of Sections 3.4 and
6.2, in the event that the Partnership at any time lacks sufficient funds to
meet its financial obligations, the General Partner shall have the right to, but
shall not be required to, lend money to the Partnership at an interest rate
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<PAGE> 17
equal to the prime rate as charged from time to time by a major money center
bank or at the Cost of Funds Rate, as determined by Lehman Brothers in its
discretion at the time any such loan is made (but in no event less than the rate
required under United States tax law to avoid compensation income to the Limited
Partners) and on other terms that are fair and reasonable to the Partnership
without any approval of the Limited Partners. The General Partner may execute
written agreements governing any such loans on behalf of the Partnership.
ARTICLE 7
CAPITAL CONTRIBUTIONS AND ACCOUNTS; NO FURTHER
CONTRIBUTIONS REQUIRED; INTEREST; ACCOUNTING AND VALUATION
7.1. Capital Contributions and Accounts. (a) Subscriptions for Units shall
be accepted or rejected by the General Partner as it determines in its sole
discretion. The minimum Capital Commitment of each Limited Partner is one Unit
($20,000). Additional whole Units may be purchased up to a maximum Capital
Commitment as determined on a case-by-case basis by the General Partner in its
sole discretion. Unless otherwise provided in the Eligible Investor's
subscription agreement, the Initial Payment for each Unit is unconditionally due
and payable upon execution and delivery of the related subscription agreement
and shall be deposited by the General Partner in the Escrow Account pending
receipt by Lehman Brothers of the Exemptive Order. Upon receipt of the Exemptive
Order by Lehman Brothers, such funds shall be transferred by the General Partner
to the Money Fund until needed to fund one or more Portfolio Investments or to
pay any Partnership expenses. The balance of the Capital Commitment is due at
any time upon subsequent call dates to be determined by the General Partner upon
30 days' prior written notice to the Limited Partners. Any Capital Contributions
made to the Partnership by a Limited Partner must be paid in cash. The
obligation of a Limited Partner to make Capital Contributions in respect of such
Limited Partner's Units shall be limited by the provisions of Section 10.4.
(b) Except as provided below with respect to Follow-on Investments, the
Limited Partners' commitment to provide funds for Portfolio Investments will
expire upon the expiration or termination of the Commitment Period. Upon the
expiration or termination of the Commitment Period, the Limited Partners shall
not be required to make any further Capital Contributions to the Partnership,
except to the extent necessary to (i) cover Partnership expenses and (ii) make
Follow-on Investments in an aggregate amount of up to 10% of the Partnership's
initial Capital Commitments for a period of two years after the expiration or
termination of the Commitment Period; provided that in no event will a Limited
Partner be required to make a Capital Contribution at any time in excess of the
unpaid portion of his or her Capital Commitment at such time.
(c) In the event that any Limited Partner fails to pay in full any Capital
Contribution as the installment becomes due, the General Partner shall send to
the Limited Partner a written notice by certified mall (or its equivalent) or
via overnight courier stating that the installment is overdue. If the Limited
Partner fails to pay the installment in full within ten business days following
the General Partner's mailing of the notice, the Limited Partner will be in
breach of this Agreement and:
(i) such Limited Partner's entire interest in any Money Fund, if
any, shall be applied in partial satisfaction of such installment;
(ii) the General Partner will have the right, exercisable in its
sole discretion at any time thereafter, to require that such Limited
Partner's entire interest in the Partnership, including the positive
balance of his or her Capital Account, be reduced by one-fourth (1/4) as
liquidated damages;
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<PAGE> 18
(iii) the General Partner will have the right, exercisable in its
sole discretion at any time thereafter, to terminate such defaulting
Limited Partner's right or obligation to make future Capital
Contributions; and
(iv) except as required under the Act, any vote, approval or
decision by the Limited Partners provided for in this Agreement shall be
tabulated or made as though such defaulting Limited Partner were not a
Limited Partner.
The defaulting Limited Partner shall continue to share in allocations of
Partnership income, gain, loss, deduction or credit with respect to his or her
remaining three-fourths (3/4) interest in the Partnership. The powers conferred
upon the General Partner in this Article 7 shall not limit any actions available
at law or in equity or by statute that the General Partner may undertake against
a defaulting Limited Partner.
(d) Pending the making of Portfolio Investments for which the Partnership
requires capital, installment payments for the purchase price of each Limited
Partner's Units will be invested in the Money Fund. Shares in the Money Fund may
not be redeemed by Limited Partners, although dividends paid by the Money Fund
will be paid to the Limited Partners periodically. The General Partner will
redeem Money Fund shares from time to time as needed to fund specific Portfolio
Investments. Amounts remaining in the Money Fund at the end of the Commitment
Period that have not been used for Partnership purposes and which the
Partnership has not committed for future use (including for potential Follow-on
Investments) shall be distributed to the Limited Partners in proportion to their
allocable share of amounts remaining in the Money Fund.
(e) The General Partner shall contribute to the capital of the Partnership
an amount equal to 25% of the aggregate amount contributed by the Limited
Partners ($5,000 per Unit). The General Partner shall make its Capital
Contributions in installments by contributing 25% of the aggregate amounts
withdrawn from the Money Funds and the contributions by Limited Partners which
are funded by Lehman Brothers from time to time to fund specific Portfolio
Investments or pay Partnership expenses.
(f) A separate capital account (the "Capital Account") shall be
established and maintained for each Partner. The Capital Account of each Partner
shall be credited with such Partner's aggregate Capital Contributions, all
Profits allocated to such Partner pursuant to Section 8.1 and any items of
income or gain which are specially allocated pursuant to Section 8.2; and shall
be debited with all Losses allocated to such Partner pursuant to Section 8.1,
any items of loss or deduction of the Partnership specially allocated to such
Partner pursuant to Section 8.2, and all cash and the Carrying Value of any
property (net of liabilities assumed by such Partner and the liabilities to
which such property is subject) distributed by the Partnership to such Partner.
To the extent not provided for in the preceding sentence, the Capital Accounts
of the Partners shall be adjusted and maintained in accordance with the rules of
Treasury Regulations Section 1.704-l(b)(2)(iv), as the same may be amended or
revised, provided that such adjustment and maintenance does not have a material
adverse effect on the economic interests of the Partners. Any references in any
section of this Agreement to the Capital Account of a Partner shall be deemed to
refer to such Capital Account as the same may be credited or debited from time
to time as set forth above. In the event of any Transfer of any interest in the
Partnership in accordance with the terms of this Agreement, the transferee shall
succeed to the Capital Account of the transferor to the extent it relates to the
transferred interest.
7.2. Further Capital Contributions. No Limited Partner shall be required
to purchase additional Units or make any Capital Contribution to the Partnership
at any time in excess of such Limited Partner's Capital Commitment at such time.
After all Capital Contributions in respect of Capital
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<PAGE> 19
Commitments have been made and all contributions, including required General
Partner contributions, have been invested by the Partnership, if the General
Partner determines it to be in the best interests of the Partnership, the
Partnership may offer all Limited Partners the opportunity to make additional
contributions to the Partnership's capital on a pro rata basis, as determined by
the General Partner.
7.3. Interest. No Limited Partner shall receive interest on amounts
credited to such Limited Partner's Capital Account.
7.4. Fixed Return. The General Partner shall determine the amount of the
Fixed Return using the Cost of Funds Rate plus 0.50% per annum for the
applicable period of time or, if higher, an amount determined by the General
Partner with reference to the applicable United States federal rate for interest
on loans then utilized by the Internal Revenue Service in connection with
below-market loans to employees with a maturity date of July 25, 2009. The
General Partner's determination of the Fixed Return shall be final and binding
on the Partners absent a finding of manifest error.
7.5. Accounting Periods and Taxable Years. An accounting period and
taxable year shall mean the calendar year, except that the last accounting
period and taxable year shall mean the period ending with the termination of the
Partnership.
ARTICLE 8
ALLOCATIONS
8.1. Allocation of Profits and Losses; Other Allocations. Except as
otherwise provided in this Agreement, Profit or Loss of the Partnership for each
taxable year shall be allocated annually at the end of the Partnership's fiscal
year in the following order and priority:
(i) Profits shall be allocated as follows:
(A) first, if on a cumulative basis the General Partner has had
Losses previously allocated to it pursuant to clause (ii)(D)
below in excess of Profits previously allocated to it pursuant
to this clause (i)(A), to the General Partner to the extent of
such excess;
(B) then, if on a cumulative basis the Limited Partners have had
Losses previously allocated to them pursuant to clause (ii)(C)
below in excess of Profits previously allocated to them
pursuant to this clause (i)(B), to the Limited Partners to the
extent of such excess;
(C) then, if on a cumulative basis the General Partner has had
Losses previously allocated to it pursuant to clause (ii)(B)
below in excess of Profits previously allocated to it pursuant
to this clause (i)(C), to the General Partner to the extent of
such excess;
(D) then, to the General Partner until it has been allocated an
aggregate amount of Profits in excess of Losses equal to the
Fixed Return on its aggregate unreturned Capital
Contributions;
(E) then, to the Limited Partners until they have received an
aggregate amount of Profits in excess of Losses equal to the
Fixed Return on (x) 75% of their
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<PAGE> 20
aggregate Capital Contributions less (y) the amount of their
Returned Capital Contributions; and
(F) thereafter, any remaining Profits shall be allocated 90% to
the Limited Partners and 10% to the General Partner.
(ii) Losses of the Partnership shall be allocated as follows:
(A) first, 90% to the Limited Partners and 10% to the General
Partner in an amount equal to the excess, if any, of (x) the
cumulative Profits previously allocated to the Partners
pursuant to clause (i)(F) above over (y) the cumulative Losses
previously allocated to the Partners pursuant to this clause
(ii)(A);
(B) then, 100% to the General Partner until the Capital Account of
the General Partner is reduced to zero;
(C) then, 100% to the Limited Partners until the Capital Accounts
of the Limited Partners are reduced to zero; and
(D) thereafter, 100% to the General Partner;
provided, however, that in no event shall Losses be allocated to a Limited
Partner if the effect of such allocation would be to cause a negative
balance in such Limited Partner's Capital Account. Any such Losses shall
be allocated to the other Limited Partners to the extent of their positive
Capital Account balances and thereafter to the General Partner.
8.2. Special Allocation Provisions. Notwithstanding anything to the
contrary in this Agreement, the following special allocations shall be made:
(a) Minimum Gain Chargeback. Notwithstanding any other provision in
this Article 8, if there is a net decrease in Partnership minimum gain or
partner nonrecourse debt minimum gain (determined in accordance with the
principles of U.S. Treasury Regulations Sections 1.704-2(d) and
1.704-2(i)) during any Partnership taxable year, the Partners shall be
specially allocated items of Partnership income and gain for such year
(and, if necessary, subsequent years) in an amount equal to their
respective shares of such net decrease during such year, determined
pursuant to U.S. Treasury Regulations Sections 1.704-2(g) and
1.704-2(i)(5). The items to be so allocated shall be determined in
accordance with U.S. Treasury Regulations Section 1.704-2(f). This Section
8.2(a) is intended to comply with the minimum gain chargeback requirements
in such U.S. Treasury Regulations Sections and shall be interpreted
consistently therewith; including that no chargeback shall be required to
the extent of the exceptions provided in U.S. Treasury Regulations
Sections 1.704-2(f) and 1.704-2(i)(4).
(b) Qualified Income Offset. In the event any Limited Partner
unexpectedly receives any adjustments, allocations, or distributions
described in Treasury Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5) or
(6), items of Partnership income and gain shall be specially allocated to
such Limited Partner in an amount and manner sufficient to eliminate the
deficit balance in his or her Capital Account created by such adjustments,
allocations or distributions as promptly as possible.
(c) Gross Income Allocation. In the event any Limited Partner has a
deficit Capital Account at the end of any Fiscal Year which is in excess
of the amount such Partner is deemed to be
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<PAGE> 21
obligated to restore pursuant to the penultimate sentences of Treasury
Regulations Section 1.704-2(g)(1) and 1.704-2(i)(5), each such Limited
Partner shall be specially allocated items of Partnership income and gain
in the amount of such excess as quickly as possible, provided that an
allocation pursuant to this Section 8.2(c) shall be made only if and to
the extent that a Limited Partner would have a deficit Capital Account in
excess of such amount after all other allocations provided for in this
Article 8 have been tentatively made as if Section 8.2(a) and this Section
8.2(c) were not in this Agreement.
(d) Nonrecourse Deductions. Nonrecourse Deductions shall be
allocated 10% to the General Partner and 90% among the Limited Partners in
accordance with their respective Capital Account balances.
(e) Partner Nonrecourse Deductions. Partner Nonrecourse Deductions
for any taxable period shall be allocated to the Partner who bears the
economic risk of loss with respect to the liability to which such Partner
Nonrecourse Deductions are attributable in accordance with U.S. Treasury
Regulations Section 1.704-2(j).
8.3. Tax Allocations. For income tax purposes only, each item of income,
gain, loss and deduction of the Partnership shall be allocated among the
Partners in the same manner as the corresponding items of Profits and Losses and
specially allocated items are allocated for Capital Account purposes; provided
that in the case of any Partnership asset the Carrying Value of which differs
from its adjusted tax basis for United States federal income tax purposes,
income, gain, loss and deduction with respect to such asset shall be allocated
solely for income tax purposes in accordance with the principles of Sections
704(b) and (c) of the Code (in any manner determined by the General Partner) so
as to take account of the difference between Carrying Value and adjusted basis
of such asset.
8.4. Allocation among Limited Partners, Transfers. (a) Profits and Losses
allocated to Limited Partners will be apportioned among each Limited Partner
based upon a fraction, the numerator of which is the Capital Account balance of
such Limited Partner (or his or her predecessor in interest) and the denominator
of which is the aggregate Capital Account balances of all Limited Partners,
taking into account any change in such ratio during the period.
(b) In the event of a permitted Transfer of a Unit or the termination or
reduction of a Partner's interest in his or her Capital Account in the
Partnership during a taxable year of the Partnership, allocations of income,
gain, loss, deductions and credits of the Partnership will be based on an
interim closing of the Partnership's books or such other method as is determined
by the General Partner.
8.5. Tax Elections. The General Partner is hereby authorized and empowered
to make on behalf and in the name of the Partnership any election, and to
prepare or have prepared, to execute or have executed and to file, on behalf and
in the name of the Partnership, any returns, applications and other instruments
and documents, under the Code and the regulations thereunder, as in effect from
time to time, which the General Partner determines in its sole discretion are
desirable or advisable in connection with determining such allocations.
8.6. Other Allocation Provisions. The foregoing provisions and the other
provisions of this Agreement relating to the maintenance of Capital Accounts are
intended to comply with U.S. Treasury Regulations Section 1.704-1(b) and shall
be interpreted and applied in a manner consistent with such regulations.
Sections 8.1 to 8.5 may be amended at any time by the General Partner, if
necessary, in the view of the General Partner, to comply with such regulations.
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<PAGE> 22
ARTICLE 9
DISTRIBUTIONS; WITHDRAWAL
9.1. General Partner Discretion. Distributions may be made at any time as
determined by the General Partner. The General Partner in its sole discretion
will determine the aggregate amount of and payment dates for any cash and
non-cash distributions to Partners after establishing such reasonable reserves
as the General Partner deems appropriate in its sole discretion for working
capital, vesting or other contingencies or other items and for the satisfaction
of liabilities (including, without limitation, contingent liabilities) as they
come due or may come due.
9.2. Distributions. (a) Distributions from the Partnership shall be made
in the following order and priority:
(i) first, to the Limited Partners to the extent of available cash in an
amount equal to 35% of the taxable ordinary income and capital gain
allocated by the Partnership to them pursuant to clauses (i)(E) and
(F) under Section 8.1 above for the current taxable year; provided
that the General Partner in its sole discretion may adjust the rate
at which such distributions are made to take into account changes in
tax rates applicable to individuals or for any other reason;
(ii) then, to the General Partner until it has received cumulative
distributions equal to the Fixed Return on its aggregate unreturned
Capital Contributions;
(iii) then, to the Limited Partners until they have received cumulative
distributions (excluding amounts distributed pursuant to clause (i))
equal to the Fixed Return on (x) 75% of their aggregate Capital
Contributions less (y) the amount of their Returned Capital
Contributions;
(iv) then, to the Limited Partners until they have received cumulative
distributions (other than pursuant to clause (iii)) equal to the sum
of their aggregate Capital Contributions;
(v) then, to the General Partner until it has received cumulative
distributions (other than pursuant to clause (ii)) equal to the sum
of its aggregate Capital Contributions; and
(vi) thereafter, to the Limited Partners and to the General Partner in
accordance with the ratio which each Partner's positive Capital
Account balance bears to the sum of all Partners' positive Capital
Account balances.
(b) Distributions to Limited Partners will be apportioned among each
Limited Partner based upon a fraction, the numerator of which is the Capital
Account balance of such Limited Partner (or his or her predecessor in interest)
and the denominator of which is the aggregate Capital Account balances of all
Limited Partners, taking into account any change in such ratio during the
period.
9.3. Non-Cash Distributions. Distributions from the Partnership may be
made in cash or in kind in the General Partner's sole discretion. The General
Partner may in its sole discretion offer Limited Partners the right to elect
whether to receive cash or in kind distributions in connection with any
distribution and, following any such election, may (but shall not be required
to) make a distribution to some Limited Partners in cash and to others in kind.
The value of any non-cash assets that are distributed shall be determined by the
General Partner in accordance with Section 12.4 hereof.
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<PAGE> 23
9.4. Withholding. The Partnership shall withhold from any amounts
otherwise distributable to any Partner the amounts required by law to be
withheld for income tax or other purposes; any amounts so withheld shall be
treated as having been distributed to such Partner for all purposes of this
Agreement.
9.5. Withdrawal. No Partner shall have the right to withdraw such
Partner's Capital Contribution or any part thereof from the Partnership or to
receive a return of such Partner's Capital Contribution or any part thereof
except upon termination and dissolution of the Partnership, except as may be
permitted by the General Partner in its sole discretion.
ARTICLE 10
TRANSFERABILITY OF INTERESTS; VESTING;
TERMINATION OF EMPLOYMENT
10.1. Restrictions and Conditions on Transfers of Units. (a) Except for
Transfers permitted under Section 10.4, no direct or indirect sale, exchange,
transfer, assignment, pledge, creation of a security interest in, or encumbrance
on, or other disposition by a Limited Partner of all or any portion of such
Limited Partner's Units or any economic interest therein (including without
limitation by means of any participation or swap transaction) (each, a
"Transfer") shall be made without the prior written consent of the General
Partner (which consent may be withheld in the sole discretion of the General
Partner). Any Units acquired by the General Partner may be transferred to any
Eligible Investor, subject to the restrictions contained in Section 10.1(b),
provided that the General Partner does not own more than 80% of the Units.
(b) Any Transfer otherwise permitted under this Article 10 may only be
made if:
(i) such Transfer, when added to the total of all other Transfers of
Units within the preceding twelve months, would not result in the Partnership
being considered to have terminated within the meaning of Section 708 of the
Code;
(ii) such Transfer would not violate any United States securities
laws, or any state securities or "blue sky" laws (including any investor
suitability standards) or the laws of any jurisdiction outside the United States
applicable to the Partnership or the Units to be Transferred;
(iii) such Transfer would not cause the Partnership to lose its
status as a partnership for United States federal income tax purposes;
(iv) such Transfer would not in the judgement of the General
Partner, pose a risk that the Partnership would be treated as a publicly traded
partnership; and
(v) such Transfer is made to an eligible investor under the terms of
the Exemptive Order.
(c) The General Partner, each Limited Partner, the Partnership and their
respective officers, directors, agents and control persons shall be indemnified
by a Limited Partner (the "Transferring Limited Partner") to the fullest extent
permitted by law for any and all losses, claims, damages and expenses arising
out of or reasonably incurred in connection with any claim, action or demand
against the General Partner, the Partnership or any such indemnified person
relating to the Partnership, its properties, business or affairs (including,
without limitation, attorneys' fees and expenses and any amounts paid in
settlement or compromise of any such claim, action or demand) for which the
Partnership, the General Partner or such other person has not otherwise been
reimbursed actually and
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<PAGE> 24
reasonably incurred by them in connection with such action, suit or proceeding
and arising out of, relating to, or in connection with, any Transfer of all or
any portion of such Transferring Limited Partner's Units, or in connection with
the admission of a substituted Limited Partner to the Partnership; provided,
however, that the foregoing indemnification shall not apply if a court of
competent jurisdiction makes a final decision that such claim, action or demand
resulted primarily from such indemnified person's willful misconduct, bad faith,
gross negligence or reckless disregard of the duties involved in the conduct of
the Partnership or such person's office.
(d) Subject to Section 10.4, no Unit may be subdivided into fractional
Units.
10.2. Assignees. (a) The Partnership shall not recognize for any purpose
any purported Transfer of all or any portion of the Units of a Limited Partner
unless the provisions of Section 10.1 shall have been complied with and there
shall have been filed with the Partnership a Transfer Application, in form
satisfactory to the General Partner, executed and acknowledged by both the
seller, transferor or assignor and the purchaser, transferee or assignee and
such Transfer Application (i) contains the acceptance by the purchaser,
transferee or assignee of all of the terms and provisions of this Agreement,
(ii) contains an assumption by the purchaser, transferee or assignee of the
obligations of the Transferring Limited Partner to pay any unpaid portion of his
or her Capital Commitment, (iii) contains a representation of the seller,
transferor or assignor that such Transfer was made in accordance with all
applicable laws and regulations, (iv) contains a representation of the
purchaser, transferee or assignee that he or she is an eligible investor under
the terms of the Exemptive Order and (v) contains the purchaser's, transferee's
or assignee's power of attorney identical to that provided in Section 13.1 and,
in addition, appoints the General Partner his or her attorney-in-fact to execute
this Agreement on behalf of such purchaser, transferee or assignee. Any Transfer
shall be recognized by the Partnership as effective as of the date on which such
Transfer Application is filed with the Partnership.
(b) Any Limited Partner who shall assign all of his or her Units shall not
cease to be a Limited Partner unless and until a substituted Limited Partner is
admitted in his or her stead.
(c) A person who is the assignee of all or any portion of the Units of a
Limited Partner, but does not become a substituted Limited Partner and desires
to make a further assignment of such Units, shall be subject to all the
provisions of this Article 10 to the same extent and in the same manner as any
Limited Partner desiring to effect a Transfer of his or her Units.
10.3. Substituted Limited Partners. (a) No Limited Partner shall have the
right to substitute a purchaser, assignee, transferee, donee, heir, legatee,
distributee or other recipient of all or any portion of such Limited Partner's
Units as a Limited Partner in his or her place. Any such purchaser, assignee,
transferee, donee, heir, legatee, distributee or other recipient of Units shall
be admitted to the Partnership as a substituted Limited Partner only (i) with
the consent of the General Partner, which consent shall be granted or withheld
in the sole and absolute discretion of the General Partner and may be
arbitrarily withheld, and (ii) by an amendment to Schedule A to this Agreement
executed by all necessary parties and recorded, as and to the extent required by
law, in the proper records of each jurisdiction in which such recordation is
necessary to qualify the Partnership to conduct business or to preserve the
limited liability of the Limited Partners. The Limited Partners hereby consent
to the admission of a substituted Limited Partner whose admission has been
consented to by the General Partner. Any such consent by the General Partner and
the Limited Partners may be evidenced by the execution by the General Partner of
an amendment to this Agreement on its behalf and on behalf of all Limited
Partners evidencing the admission of such person as a Limited Partner and the
making of any filing required by law.
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<PAGE> 25
(b) To the extent required by law, the General Partner shall file an
amended certificate of limited partnership with the appropriate authorities of
each state in which the Partnership transacts business for the purpose of adding
as substituted Limited Partners all assignees of Units previously approved by
the General Partner for admission as substituted Limited Partners and deleting
any person who is no longer a Limited Partner or reflecting accurately Capital
Contributions of the Limited Partners or to receive any interest thereon.
(c) No person shall become a substituted Limited Partner until such person
shall have delivered a Transfer Application as provided in Section 10.2(a) and
become a party to this Agreement; provided, however, that for the purpose of
allocating profits, losses and distributable cash, a person shall be treated as
having become, and as appearing in the records of the Partnership as, a Limited
Partner on such date as the Transfer to such person was recognized by the
Partnership pursuant to Section 10.2(a).
10.4. Termination of Employment, Death, Disability, Retirement of Limited
Partner.
(a) Vesting Schedule. To the extent a Limited Partner's interest in his or
her Capital Account has vested, such Limited Partner will be entitled to
continue to share in allocations of Partnership income, gain, expense, loss or
deduction. As more fully described below, a Limited Partner's interest generally
will vest according to the following schedule (the "Vesting Schedule"):
(i) In the case of a Limited Partner's voluntary resignation from Lehman
Brothers or termination of employment by Lehman Brothers without
Cause, provided the Limited Partner is not determined to have
engaged in Competitive Activity or Detrimental Activity in the case
of voluntary resignation or Detrimental Activity in the case of a
termination without Cause:
<TABLE>
<CAPTION>
PERCENTAGE OF INTEREST
ON OR AFTER BUT PRIOR TO THAT IS VESTED UNVESTED INTEREST
- -------------------------- ----------------- ---------------------- -----------------
<S> <C> <C> <C>
The date of this Agreement November 30, 1998 0% 100%
November 30, 1998 November 30, 1999 50% 50%
November 30, 1999 100% 0%
</TABLE>
(ii) In the case of a Limited Partner's voluntary resignation involving
Competitive Activity or Detrimental Activity, or it otherwise being
determined that the Limited Partner engaged in such activity, or
termination of employment by Lehman Brothers for Cause:
<TABLE>
<CAPTION>
PERCENTAGE OF INTEREST
ON OR AFTER BUT PRIOR TO THAT IS VESTED UNVESTED INTEREST
- -------------------------- ----------------- ---------------------- -----------------
<S> <C> <C> <C>
The date of this Agreement November 30, 1998 0% 100%
November 30, 1999 100% 0%
</TABLE>
provided that the General Partner shall have authority to accelerate (but not
otherwise modify) the Vesting Schedule at any time, for any and all of the
Limited Partners, in its sole discretion.
(b) Voluntary Resignation; Competitive Activity and Detrimental Activity.
(i) In the event that a Limited Partner voluntarily resigns his or her
employment with Lehman Brothers at any time, (A) such Limited Partner shall not
have any obligation to make and shall not have any right or otherwise be
permitted to make any additional Capital Contributions on and after the date of
such resignation, and (B) the General Partner shall have the right, exercisable
in its sole discretion by written notice sent by certified mail (or its
equivalent) or via overnight courier (the "Repurchase Notice") to such Limited
Partner (or his or her Representative) within 60 days following such resignation
(which right may be assigned by the General Partner in its sole discretion to
any of its Affiliates, including the Partnership),
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to purchase the unvested portion, if any, of such Limited Partner's Capital
Account (the "Unvested Interest") as of the date of such resignation determined
in accordance with the Vesting Schedule. The purchase price of such Unvested
Interest shall be an amount payable in cash equal to the sum of (x) the
aggregate amount of such Limited Partner's Capital Contributions, less the
amount of his or her Returned Capital Contributions, in respect of such Unvested
Interest plus (y) a rate of return on the amount determined in clause (x) equal
to the Fixed Return to (but not including) the date the Unvested Interest is
purchased.
(ii) If at any time following such resignation and prior to November 30,
1999, the General Partner determines in good faith that such Limited Partner has
engaged in any Competitive Activity or any Detrimental Activity, whether before
or after such resignation, the General Partner shall have the right, exercisable
in its sole discretion by delivering a Repurchase Notice to such Limited Partner
(or his or her Representative) within 60 days following such determination
(which right may be assigned by the General Partner in its sole discretion to
any of its Affiliates, including the Partnership), to purchase the entire
interest of such Limited Partner in his or her Capital Account as of the date of
such determination. The purchase price of such interest shall be an amount
payable in cash equal to the sum of (x) the aggregate amount of such Limited
Partner's Capital Contributions, less the amount of his or her Returned Capital
Contributions, in respect of such interest plus (y) a rate of return on the
amount determined in clause (x) equal to the Fixed Return to (but not including)
the date such interest is purchased.
(c) Termination by Lehman Brothers Without Cause. (i) In the event that
the employment of a Limited Partner is terminated by Lehman Brothers without
Cause at any time, (A) such Limited Partner shall not have any obligation to
make and shall not have any right or otherwise be permitted to make any
additional Capital Contributions on and after the date of such termination, and
(B) the General Partner shall have the right, exercisable in its sole discretion
by delivering a Repurchase Notice to such Limited Partner (or his or her
Representative) within 60 days following such termination (which right may be
assigned by the General Partner in its sole discretion to any of its Affiliates,
including the Partnership), to purchase such Limited Partner's Unvested Interest
as of the date of such termination at the purchase price specified in paragraph
(b)(i) above.
(ii) If at any time following termination of such Limited Partner's
employment without Cause and prior to November 30, 1999, the General Partner
determines in good faith that such Limited Partner has engaged in any
Detrimental Activity, whether before or after such termination, the General
Partner shall have the right, exercisable in its sole discretion by delivering a
Repurchase Notice to such Limited Partner (or his or her Representative) within
60 days following such determination (which right may be assigned by the General
Partner in its sole discretion to any of its Affiliates, including the
Partnership), to purchase the entire interest of such Limited Partner in his or
her Capital Account as of the date of such determination at the purchase price
specified in paragraph (b)(ii) above.
(d) Termination by Lehman Brothers for Cause. (i) In the event that the
employment of a Limited Partner is terminated by Lehman Brothers for Cause at
any time, such Limited Partner shall not have any obligation to make and shall
not have any right or otherwise be permitted to make any additional Capital
Contributions on and after the date of such termination.
(ii) If such Limited Partner's employment is terminated by Lehman Brothers
for Cause prior to November 30, 1999, the General Partner shall have the right,
exercisable in its sole discretion by delivering a Repurchase Notice to such
Limited Partner (or his or her Representative) within 60 days following such
termination (which right may be assigned by the General Partner in its sole
discretion to any of its Affiliates, including the Partnership), to purchase the
entire interest of such Limited
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Partner in his or her Capital Account as of the date of such termination at the
purchase price specified in paragraph (b)(ii) above.
(e) Termination Due to Death, Disability or Retirement. (i) In the event
that a Limited Partner's employment with Lehman Brothers is terminated due to
such Limited Partner's death, Disability or Retirement, (A) such Limited
Partner's Units will immediately become fully vested and (B) such Limited
Partner or his or her Representative will have the right (but not the
obligation) to continue making Capital Contributions as required pursuant to
this Agreement. In such case, promptly following any such termination of
employment, the General Partner will send such Limited Partner or his or her
Representative a notice by certified mail (or its equivalent) or via overnight
courier requesting such Limited Partner's election with respect to whether such
Limited Partner wishes to continue making Capital Contributions in the future
pursuant to this Agreement. If such Limited Partner or his or her
Representative, as the case may be, does not elect, by notice to the General
Partner within the time specified for acceptance in such notice (which date will
not be less than 30 days from the date of the notice (or, if earlier, the date
the next Capital Contribution is due)), to continue making Capital
Contributions, such Limited Partner or his or her Representative will be deemed
to have elected not to exercise such right and will not be permitted to make any
further Capital Contributions and the Partnership will return any of such
Limited Partner's remaining interest in any Money Fund.
(ii) Notwithstanding the foregoing, if at any time following such
termination of employment and prior to November 30, 1999, the General Partner
determines in good faith that such Limited Partner has engaged in any
Competitive Activity or any Detrimental Activity, whether before or after such
termination, (A) such Limited Partner shall not have any obligation to make and
shall not have any right or otherwise be permitted to make any additional
Capital Contributions on and after the date of such termination, and (B) the
General Partner shall have the right, exercisable in its sole discretion by
delivering a Repurchase Notice to such Limited Partner or his or her
Representative within 60 days following such determination (which right may be
assigned by the General Partner in its sole discretion to any of its Affiliates,
including the Partnership), to purchase the entire interest of such Limited
Partner in his or her Capital Account as of the date of such determination at
the purchase price specified in paragraph (b)(ii) above.
(f) Required Affidavit. In the event that a Limited Partner's employment
with Lehman Brothers is terminated for any reason, from time to time thereafter,
Lehman Brothers may require such Limited Partner to complete and sign an
affidavit with respect to whether such Limited Partner has engaged in any
Competitive Activity or Detrimental Activity. Such affidavit would include
certain representations by the Limited Partner and authorize Lehman Brothers to
verify such representations. In the event that such Limited Partner fails to
complete, sign and return such affidavit within 60 days, the General Partner may
conclusively presume that such Limited Partner has engaged in Competitive
Activity or Detrimental Activity and, accordingly, will have the right to
repurchase the entire interest of such Limited Partner in his or her Capital
Account as provided above.
(g) Repurchases Generally. In the event the General Partner or its
assignee acquires the interest (or the unvested portion thereof) of a Limited
Partner in his or her Capital Account pursuant to this Section 10.4, the General
Partner will pay for such interest (or such unvested portion) in cash as soon as
practicable but in no event later than 30 days following the date of the
Repurchase Notice. The determination of the General Partner of the purchase
price for such interest (or such unvested portion) shall be determined in good
faith by the General Partner and shall be final and binding on the Limited
Partner. The General Partner in its sole discretion may assign all or any part
of its right to purchase such interest (or such unvested portion) to any of its
Affiliates or any Eligible Investor (including, without limitation, any Limited
Partner) or, if the General Partner determines a purchase of such interest by
the Partnership to be in the best interests of the Partnership, to the
Partnership. Units
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representing any Partnership interests (or portions thereof) which are acquired
for the account of the Partnership will be retired.
(h) Death; Incompetency; Bankruptcy. If a Limited Partner dies or becomes
an adjudicated incompetent (or equivalent under the laws of any jurisdiction
other than the United States) or bankrupt, as the case may be, then for purposes
of this Agreement the Representative shall have all the rights of a Limited
Partner for the purpose of settling or managing the Units of such Limited
Partner, and such power as such Limited Partner possessed to assign all or any
part of such Limited Partner's Units and to join with such assignee in
satisfying conditions precedent to such assignee becoming a substituted Limited
Partner as provided in Section 10.3.
10.5. Disposition of General Partner's Interest. The General Partner shall
not dispose of its interest in the Partnership as a general partner except to an
entity controlled by, or affiliated with, Lehman Brothers, executive officers
and directors of which are Eligible Investors. No disposition of the General
Partner's interest shall be effective, and the General Partner shall not cease
to be a general partner of the Partnership, unless and until the transferee
thereof is admitted as a general partner of the Partnership and agrees in
writing to continue the business of the Partnership with itself as general
partner and to be bound by the provisions of this Agreement.
ARTICLE 11
DISSOLUTION AND LIQUIDATION OF THE PARTNERSHIP
11.1 Events Causing Dissolution. The Partnership shall be dissolved upon
the expiration of its term as set forth in Section 2.5 hereof, or sooner upon
the happening of any of the following events:
(a) the resignation, withdrawal, dissolution or bankruptcy of the General
Partner or the occurrence of any other event that causes the General Partner to
cease to be a general partner of the Partnership under the Act; provided that
the Partnership shall not be dissolved or required to be wound up upon the
happening of such event if within 90 days after such event, all remaining
Partners agree in writing to continue the business of the Partnership and to the
appointment, effective as of the date of such event, of one or more additional
general partners;
(b) the insolvency or bankruptcy of the Partnership;
(c) the sale of all or substantially all of the Partnership's assets other
than in the ordinary course of business; or
(d) the conversion of the Partnership to corporate form pursuant to
Section 2.6 hereof.
Dissolution of the Partnership shall be effective, on the date on which the
event occurs giving rise to the dissolution, but the Partnership shall not
terminate until the Partnership's certificate of limited partnership has been
canceled and the assets of the Partnership have been distributed as provided in
Section 11.2.
11.2. Liquidation. (a) Upon dissolution of the Partnership, its
liabilities shall be paid in the order provided herein. The General Partner
shall cause Partnership assets to be sold in such manner as the General Partner,
in its sole discretion, shall determine. The General Partner or its Affiliates
may, to the extent permitted by applicable law, purchase from the Partnership
any Partnership investments upon which there are significant restrictions or for
which another purchaser willing to pay fair market value is not readily
obtainable. Payment of the fair market value of any such investment at the time
of
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the transfer determined by the General Partner in accordance with this Section
11.2 shall be deemed fair and reasonable and not a violation of the General
Partner's fiduciary duty to the Partnership. Pending sale of Partnership assets,
the General Partner shall have the right to continue to operate and otherwise to
deal with Partnership assets. In the event that the General Partner has
resigned, withdrawn, dissolved or is bankrupt, or has otherwise ceased to be a
general partner of the Partnership. The majority in interest of the Limited
Partners shall elect a person (the "liquidating trustee") who is hereby
authorized to perform the functions of the General Partner in liquidating the
assets of the Partnership and in winding up its affairs.
(b) Profits and Losses arising from sales (or distributions) upon
liquidation shall be allocated in the manner set forth in Article 8. If, over
the term of the Partnership, (i) the amounts distributed to the General Partner
in respect of the Fixed Return pursuant to Sections 9.2(a)(ii) and 11.2(c)(ii)
exceed the profits allocated to the General Partner pursuant to Section
8.1(i)(D) or (ii) the amounts distributed to a Limited Partner in respect of the
Fixed Return pursuant to Sections 9.2(a)(iii) and 11.2(c)(iii) exceed the
Profits allocated to such Limited Partner pursuant to Section 8.1(i)(E), then
the amount of such excess shall be treated as a guaranteed payment and the
Partners' Capital Accounts shall be adjusted accordingly.
(c) Proceeds received upon the liquidation of Partnership assets shall be
applied and distributed in the following order:
(i) to the payment of debts and liabilities of the Partnership (whether
by payment or establishment of reasonable reserves), including those
to Partners who are creditors, to the extent required by law, in the
order of priority as provided by law, and to the payment of the
expenses of liquidation;
(ii) then, to the payment to the General Partner until it has received an
aggregate amount equal to the Fixed Return on its aggregate
unreturned Capital Contributions;
(iii) then, to the payment to the Limited Partners until they have
received an aggregate amount equal to the Fixed Return on (x) 75% of
their aggregate Capital Contributions less (y) the amount of their
Returned Capital Contributions;
(iv) then, to the Limited Partners until they have received cumulative
distributions pursuant to this clause (iv) and clauses (i), (iv) and
(vi) of Section 9.2(a) equal to their aggregate Capital
Contributions;
(v) then, to the General Partner until it has received cumulative
distributions pursuant to this clause (v) and clauses (v) and (vi)
of Section 9.2(a) equal to its aggregate Capital Contributions;
(vi) then, to the Partners pro rata in accordance with their positive
Capital Account balances to the extent thereof (after giving effect
to any allocation of Profits or Losses arising from sales (or
distributions) on liquidation); and
(vii) thereafter 100% to the Limited Partners pro rata in accordance with
their positive Capital Account balances immediately prior to any
distributions pursuant to clause (vi).
(d) In the sole discretion of the General Partner, payments in liquidation
may be made either in cash or in non-cash assets designated by the General
Partner, or partly in cash and partly in non-cash assets. If payment is made in
non-cash assets, the value of such assets shall be determined by the
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General Partner in accordance with Section 12.4 hereof. In the event of any
distribution of non-cash assets to any Limited Partner, such Limited Partner
agrees, if requested by the General Partner at the time of such distribution, to
deliver to the Partnership a letter in form and substance satisfactory to the
General Partner, or which may be deemed necessary or desirable by the General
Partner, to comply with any legal requirements or governmental regulations,
including restrictions on the resale of securities.
(e) In the event that following the final distribution under Section
11.2(c) above, the General Partner has a deficit balance in its capital account
balance, the General Partner shall contribute cash to the Partnership in an
amount equal to the deficit balance.
ARTICLE 12
BOOKS AND RECORDS; ACCOUNTING;
APPRAISAL; TAX MATTERS AND ELECTIONS
12.1. Books and Records. The books and records of the Partnership,
including information relating to the sale by the General Partner or any of its
Affiliates of securities, property, goods or services to the Partnership, and a
list of the name, residence or business address and Units of each Limited
Partner, shall be maintained by the General Partner at the office of the
Partnership or of the General Partner and shall be available for examination
there by any Limited Partner or his or her duly authorized Representatives at
any and all reasonable times for any purpose reasonably related to the Limited
Partner's interest as a limited partner of the Partnership. Any Limited Partner,
or his or her duly authorized Representatives, upon paying the costs of
collection, duplication and mailing, shall be entitled to a copy of the list of
the names, residence or business addresses and Units of the Limited Partners.
Such information shall be used only for a purpose reasonably related to the
Limited Partner's interest as a limited partner of the Partnership. The
Partnership may maintain such other books and records and may provide such
financial or other statements as the General Partner in its sole discretion
deems advisable.
12.2. Accounting Basis, Fiscal Year. The books and records and the
financial statements and reports of the Partnership shall be kept on such basis
as the General Partner shall determine. The fiscal year of the Partnership shall
be the calendar year.
12.3. Bank Accounts. The General Partner shall maintain the Partnership
bank account, and withdrawals shall be made only in the regular course of the
Partnership business on such signature or signatures as the General Partner may
determine. Temporary investments are deemed activities in the ordinary course of
Partnership business.
12.4. Appraisal. If at any time the value of one or more non-cash assets
of the Partnership is required to be determined under this Agreement, the
General Partner shall value such assets, taking into account all relevant
factors, including without limitation restrictions on transfer, other legal or
contractual restrictions and the costs and expenses of disposition of such
assets. In the sole discretion of the General Partner, the valuation of any
non-cash assets may be made by independent third parties appointed by the
General Partner and deemed qualified by the General Partner to render an opinion
as to the value of Partnership assets, using such methods and considering such
information relating to such assets as such persons may deem appropriate. The
valuation of Partnership assets reflected in an appraisal made in good faith by
the General Partner or any adviser or consultant retained for such purpose shall
be conclusive and binding on the Limited Partners.
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12.5. Reports. Within 90 days after the end of each fiscal year, or as
soon as practicable thereafter, the General Partner shall send to each person
who was a Limited Partner at any time during the fiscal year then ended (i) a
statement (which shall be audited by independent certified public accountants)
showing the cash (or assets distributed in kind) distributed in respect of such
year; (ii) such tax information as shall be necessary for the preparation by
such Limited Partner of his or her United States federal and state income tax
returns; (iii) a report of the investment activities of the Partnership during
such year, and (iv) financial statements of the Partnership audited by its
accountants.
12.6 Tax Matters and Elections. (a) Each Limited Partner hereby appoints
and designates the General Partner as tax matters partner of the Partnership, as
such term is defined under the Code, and hereby agrees that any action taken by
the General Partner in connection with audits of the Partnership under the Code
will be binding upon the Limited Partners. Each Limited Partner further agrees
that he or she will not treat any Partnership item on his or her individual
income tax return in a manner inconsistent with the treatment of the item on the
Partnership's tax return and that he will not act independently with respect to
tax audits or tax litigation affecting the Partnership, unless, in either case,
previously authorized to do so in writing by the General Partner, which
authorization may be withheld in the sole discretion of the General Partner.
(b) As such tax matters partner, the General Partner may cause the
Partnership to make all elections required or permitted to be made by the
Partnership under the Code (including an election under Section 754 thereof
permitting the adjustment in basis of Partnership assets upon the occurrence of
certain events, such as a sale of Units or the death of a Limited Partner) and
not otherwise expressly provided for in this Agreement in the manner that the
General Partner believes will be most advantageous to individual taxpayers who
(i) are married and filing joint United States federal income tax returns and
(ii) are not "dealers" for United States federal income tax purposes.
ARTICLE 13
MISCELLANEOUS PROVISIONS
13.1. Appointment of the General Partner as Attorney-in-Fact. (a) Each
Limited Partner, by his or her execution of this Agreement (which execution may
be by his or her attorney-in-fact pursuant to a power of attorney contained in a
subscription agreement or Transfer Application), hereby makes, constitutes and
appoints the General Partner, acting by any of its officers or their designees,
his or her true and lawful agent and attorney-in-fact, with full power of
substitution and full power and authority in his or her name, place and stead to
make, execute, sign, acknowledge, swear to, record and file, on his or her
behalf and on behalf of the Partnership such documents, instruments and
conveyances that may be necessary or appropriate to carry out the provisions or
purposes of this Agreement, including, without limitation:
(i) the original certificate of limited partnership of the Partnership
and all amendments thereto required or permitted by law or the
provisions of this Agreement including, without limitation, the
admission to the Partnership of additional Limited Partners and
substituted Limited Partners, and any certificate of cancellation
with respect thereto and modifications of Schedule A hereto and all
other instruments that the General Partner deems appropriate to
reflect a change or modification or amendment of this Agreement, in
accordance with this Agreement;
(ii) all certificates and other instruments deemed advisable by the
General Partner to carry out the provisions of this Agreement or to
permit the Partnership to become or to
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continue in the jurisdictions where the Partnership may be doing
business as a limited partnership or partnership wherein the Limited
Partners have limited liability;
(iii) all conveyances and other instruments or papers deemed advisable by
the General Partner to effect the dissolution and termination of the
Partnership;
(iv) all fictitious or assumed name certificates required or permitted to
be filed on behalf of the Partnership; and
(v) all other instruments, documents, undertakings, certificates,
agreements or papers which may be required or permitted by law to be
filed on behalf of the Partnership.
(b) The foregoing power of attorney:
(i) is coupled with an interest, shall be irrevocable, shall not be
affected by and shall survive the subsequent death, disability,
incapacity or incompetence of each Limited Partner;
(ii) may be exercised by the General Partner either by signing separately
as attorney-in-fact for each Limited Partner or by a single
signature of the General Partner acting as attorney-in-fact for all
of them or by any other legally acceptable means; and
(iii) shall survive the delivery of an assignment by a Limited Partner of
the whole or any portion of his or her Units; except that, where the
assignee of the whole of such Limited Partner's Units has been
approved by the General Partner for admission to the Partnership as
a substituted Limited Partner, the power of attorney of the assignor
shall survive the delivery of such assignment for the sole purpose
of enabling the General Partner to execute, swear to, acknowledge
and file any instrument necessary or appropriate to effect such
substitution.
(c) Each Limited Partner shall execute and deliver to the General Partner
within five days after receipt of the General Partner's request therefor such
further designations, powers-of-attorney and other instruments as the General
Partner deems necessary or appropriate to carry out the terms of this Agreement.
13.2. Amendments of this Agreement. (a) An amendment to this Agreement may
be proposed by the General Partner by submitting to all Limited Partners (i) the
text of such amendment and (ii) a statement of the purpose of such amendment.
Subject to paragraph (d) below, the proposed amendment shall be deemed adopted
(A) 30 days after the General Partner submits such notice, unless Limited
Partners holding two-thirds of the outstanding Units have, by the end of such
notice period, delivered their written disapproval thereof to the General
Partner or (B) if earlier, upon the delivery by Limited Partners holding a
majority of the outstanding Units of their written approval thereof to the
General Partner.
(b) An amendment to this. Agreement may be proposed by Limited Partners
holding 25% of the outstanding Units. The Limited Partner or Limited Partners
proposing such amendment shall submit to the General Partner (i) the text of
such amendment, (ii) a statement of the purpose of such amendment, (iii) an
opinion of counsel obtained by the Limited Partner or Partners proposing such
amendment to the effect that such amendment is permitted by the Act and the laws
of any other jurisdiction where the Partnership is qualified to do business,
will not impair the limited liability of the Limited Partners and will not
adversely affect the classification of the Partnership as a partnership for
United States federal income tax purposes. The General Partner shall, within 20
days after receipt of any proposal
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under this Section 13.2, give notice to all Limited Partners of such proposed
amendment, which notice shall include all items submitted by the Limited
Partners with respect to such proposed amendment and a statement of the General
Partner with respect to such proposed amendment. Subject to paragraph (d) below,
the proposed amendment shall be deemed adopted upon the written consent of the
General Partner and upon the delivery by Limited Partners holding two-thirds of
the outstanding Units of their written approval thereof to the General Partner.
(c) This Agreement and the terms of the offering of Units may be amended
by the General Partner without the consent of any Limited Partner to conform any
of the provisions of this Agreement to any requirements or conditions that may
be imposed by the SEC under the terms of the Exemptive Order.
(d) Notwithstanding any other provision of this Section to the contrary,
no amendment may:
(i) expand the obligations of any Partner under this Agreement or
convert the Units of any Limited Partner into the interest of a
General Partner or adversely affect the limited liability of any
Limited Partner, in each case without the approval of such Partner;
(ii) amend Section 6.3 or this Section 13.2; or
(iii) subject to Section 8.6, modify the method provided in Article 8 or 9
of determining and allocating or distributing, as the case may be,
Profits and Losses and distributable cash;
without the approval of the General Partner and Limited Partners holding 75% of
the outstanding Units that are adversely affected by such modification.
(e) Notwithstanding the foregoing, this Agreement may be amended by the
General Partner without the consent of the Limited Partners (i) to cure any
ambiguity or correct or supplement any provision hereof which is incomplete or
inconsistent with any other provision hereof or correct any printing,
stenographic or clerical error or omissions or (ii) to amend Sections 8.1 to 8.5
pursuant to Section 8.6.
(f) Upon the adoption of any amendment to this Agreement, the amended
Agreement shall be executed by the General Partner for itself and on behalf of
the Limited Partners pursuant to the power of attorney granted in Section 13.1,
and, if such amendment affects the certificate of limited partnership of the
Partnership under the Act, or any other filing made in any other state, the
General Partner, pursuant to the power of attorney granted in Section 13.1,
shall execute and file proper amendments and filings in the State of Delaware
and in each jurisdiction in which such action is necessary for the Partnership
to conduct business or to preserve the limited liability of the Limited
Partners.
13.3 Arbitration. Any dispute, controversy or claim arising out of or in
connection with or relating to this Agreement or any breach or alleged breach
hereof shall (to the extent not prohibited by governing law) be determined and
settled by arbitration in The City of New York pursuant to the rules then in
effect of the American Arbitration Association. Any award rendered shall be
final and conclusive upon the parties and a judgment thereon may be entered in
the highest court of the forum, state or federal, having jurisdiction.
13.4. Notices. Except as otherwise specifically provided herein, all
notices, requests, demands and other communications hereunder shall be in
writing and shall be deemed to have been duly given if (i) delivered or mailed,
certified or registered mail, first-class postage paid or via overnight courier
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or (ii) transmitted via facsimile, if to any Limited Partner, at such Limited
Partner's business address, or to such Limited Partner's facsimile number, set
forth in the Partnership's records, and if to the Partnership, to the General
Partner at the General Partner's address, or to the General Partner's facsimile
number, set forth on Schedule A, Attention: Fred Steinberg, or to such other
person or address as any Partner shall have last designated by notice to the
Partnership, and in the case of a change in address by the General Partner, by
notice to the Limited Partners. Any notice shall be deemed to have been duly
given if personally delivered or sent by the mails or by facsimile and will be
deemed received, unless earlier received, (i) if sent by certified or registered
mail, return receipt requested, or via overnight courier, one business day after
mailing, (ii) if sent by overnight mail or courier, when actually received,
(iii) if sent by facsimile transmission, on the date sent provided confirmatory
notice is sent by first-class mail, postage prepaid, and (iv) if delivered by
hand, on the date of receipt.
13.5. Binding Provisions. The covenants and agreements contained herein
shall be binding upon and inure to the benefit of the heirs, executors,
administrators, successors and assigns of the respective parties hereto.
13.6. Interest as Security for UCC Purposes. Pursuant to section 8-103(c)
of the New York Uniform Commercial Code (and any analogous provision of any
other applicable law), the Partnership interests are hereby expressly declared
to be securities governed by Article 8 of the New York Uniform Commercial Code
(and any analogous provision of any other applicable law).
13.7. Applicable Law. This Agreement shall be construed and enforced in
accordance with the laws of the State of Delaware. Notwithstanding the
foregoing, the law of the State of New York shall govern:
(a) the rights and duties of the Partnership with respect to registration
of transfer (as defined in Article 8 of the New York Uniform Commercial Code) of
Partnership interests;
(b) the effectiveness of registration of transfer (as defined in Article 8
of the New York Uniform Commercial Code) of Partnership interests;
(c) whether the Partnership owes any duties to an adverse claimant to any
Partnership interests; and
(d) whether an adverse claim can be asserted against a person to whom
transfer (as defined in Article 8 of the New York Uniform Commercial Code) of
Partnership interests is registered or who obtains control (as defined in
Article 8 of the New York Uniform Commercial Code) of any Partnership interests.
13.8 Counterparts. This Agreement may be executed in several counterparts,
all of which together shall constitute one agreement binding on all parties
hereto, notwithstanding that not all the parties have signed the same
counterpart. The General Partner may execute any document by facsimile signature
of a duly authorized officer.
13.9. Separability of Provisions. If for any reason any provision or
provisions hereof that are not material to the purposes or business of the
Partnership or the Limited Partners' Units are determined to be invalid and
contrary to any existing or future law, such invalidity shall not impair the
operation of or affect those portions of this Agreement that are valid.
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13.10. Entire Agreement This Agreement constitutes the entire agreement
among the parties. This Agreement supersedes any prior agreement or
understanding among the parties and may not be modified or amended in any manner
other than as set forth herein.
13.11. Section Tides. Article, section and paragraph titles are for
descriptive purposes only and shall not control or alter the meaning of this
Agreement as set forth in the text.
13.12. Waiver of Right of Partition. Each Partner hereby waives its right
of partition.
13.13. Effectiveness. This Agreement shall become effective as of the day
and year first above written upon execution hereof by the General Partner and
the Initial Limited Partner and, as to each additional Limited Partner, when the
prescribed subscription hereto by such party has been accepted by the General
Partner.
-31-
<PAGE> 36
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the date first above written.
GENERAL PARTNER
LB I GROUP INC.
By: /s/ Karen M. Muller
-----------------------------------
Vice President
INITIAL LIMITED PARTNER:
FIRST CAP IV, INC.
By: /s/ Jennifer Marre
-----------------------------------
Vice President
ADDITIONAL LIMITED PARTNERS:
All Limited Partners now and hereafter
admitted as limited partners of the
Partnership pursuant to powers of
attorney now and hereafter executed in
favor of and delivered to the General
Partner.
By: GENERAL PARTNER, as Attorney-in-Fact:
LB I GROUP INC.
By: /s/ Karen M. Muller
------------------------------
Vice President
-32-
<PAGE> 37
SCHEDULE A
GENERAL PARTNER:
Name: LB I Group Inc.
Registered Office:
c/o Prentice-Hall Corporation System, Inc.
1013 Center Road
Wilmington, Delaware 19805
Business Address:
3 World Financial Center
New York, New York 10285
INITIAL LIMITED PARTNER:
First Cap IV, Inc.
Registered Office:
c/o Prentice-Hall Corporation System, Inc.
1013 Center Road
Wilmington, Delaware 19805
Business Address:
3 World Financial Center
New York, New York 10285
-33-
<PAGE> 1
EXHIBIT 11.1
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
NOVEMBER 30
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(IN MILLIONS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
PRIMARY:
Weighted average shares outstanding:
Common stock..................................... 105,193,272 101,548,947 104,535,218
Common stock issuable............................ 13,812,029 13,779,315 8,420,122
Common stock equivalents......................... 2,059,628 1,045,323 459,344
----------- ----------- -----------
Total common stock and common stock
equivalents.................................... 121,064,929 116,373,585 113,414,684
----------- ----------- -----------
Net income............................................ $ 647 $ 416 $ 242
Preferred dividends................................... (75) (38) (42)
----------- ----------- -----------
Net income applicable to common stock................. $ 572 $ 378 $ 200
----------- ----------- -----------
Earnings per common share............................. $ 4.72 $ 3.24 $ 1.76
----------- ----------- -----------
FULLY DILUTED:
Weighted average shares outstanding:
Common stock..................................... 105,193,272 101,548,947 104,535,218
Common stock issuable............................ 13,919,446 13,779,315 8,420,122
Common stock equivalents......................... 2,256,587 1,252,138 551,936
----------- ----------- -----------
Total common stock and common stock
equivalents.................................... 121,369,305 116,580,400 113,507,276
----------- ----------- -----------
Net income............................................ $ 647 $ 416 $ 242
Preferred dividends................................... (75) (38) (42)
----------- ----------- -----------
Net income applicable to common stock................. $ 572 $ 378 $ 200
----------- ----------- -----------
Earnings per common share............................. $ 4.71 $ 3.24 $ 1.76
----------- ----------- -----------
</TABLE>
<PAGE> 1
EXHIBIT 12.1
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE FOR THE FOR THE
TWELVE ELEVEN TWELVE TWELVE TWELVE
MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
DECEMBER 31 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30
1993 1994 1995 1996 1997
----------- ----------- ----------- ----------- -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Fixed Charges:
Interest expense:
Subordinated indebtedness....... $ 144 $ 158 $ 206 $ 220 $ 240
Bank loans and other
borrowings*................... 5,224 6,294 10,199 10,596 12,770
Interest component of rentals of
office and equipment.......... 76 42 44 34 32
Other adjustments**............. 7 4 28 16 9
----------- ----------- ----------- ----------- -----------
TOTAL (A).................. $ 5,451 $ 6,498 $10,477 $10,866 $13,051
----------- ----------- ----------- ----------- -----------
Earnings:
Pretax income (loss) from
continuing operations......... $ 27 $ 193 $ 369 $ 637 $ 937
Fixed charges................... 5,451 6,498 10,477 10,866 13,051
Other adjustments***............ (6) (4) (28) (14) (8)
----------- ----------- ----------- ----------- -----------
TOTAL (B).................. $ 5,472 $ 6,687 $10,818 $11,489 $13,980
----------- ----------- ----------- ----------- -----------
(B / A).............................. 1.00 1.03 1.03 1.06 1.07
</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.
<PAGE> 1
EXHIBIT 12.2
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
COMPUTATION IN SUPPORT OF RATIO OF EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED DIVIDENDS
<TABLE>
<CAPTION>
FOR THE FOR THE FOR THE FOR THE FOR THE
TWELVE ELEVEN TWELVE TWELVE TWELVE
MONTHS MONTHS MONTHS MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
DECEMBER 31 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30 NOVEMBER 30
1993 1994 1995 1996 1997
----------- ----------- ----------- ----------- -----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Combined Fixed Charges and Preferred
Dividends:
Interest expense:
Subordinated
indebtedness............. $ 144 $ 158 $ 206 $ 220 $ 240
Bank loans and other
borrowings*.............. 5,224 6,294 10,199 10,596 12,770
Interest component of
rentals of office and
equipment................ 76 42 44 34 32
Other adjustments**............. 7 4 28 16 9
----------- ----------- ----------- ----------- -----------
Total fixed charges............. 5,451 6,498 10,477 10,866 13,051
Preferred dividends (tax
equivalent basis)............. 48 58 64 58 109
----------- ----------- ----------- ----------- -----------
TOTAL (A).................. $ 5,499 $ 6,556 $10,541 $10,924 $13,160
----------- ----------- ----------- ----------- -----------
Earnings:
Pretax income (loss) from
continuing operations......... $ 27 $ 193 $ 369 $ 637 $ 937
Fixed charges................... 5,451 6,498 10,477 10,866 13,051
Other adjustments***............ (6) (4) (28) (14) (8)
----------- ----------- ----------- ----------- -----------
TOTAL (B).................. $ 5,472 $ 6,687 $10,818 $11,489 $13,980
----------- ----------- ----------- ----------- -----------
(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 $27 million in 1993 in order to cover the
deficiency.
<PAGE> 1
EXHIBIT 13.1
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.
The favorable market and economic conditions that characterized fiscal 1996
continued throughout most of 1997, leading to increased industrywide revenues
and to record levels of earnings and net revenues for the Company. Similar to
the 1996 market environment, improved valuations and strong investor demand in
worldwide equity markets led to a second consecutive year of record levels of
corporate finance advisory activities and near-record underwriting volumes.
During 1997, however, volatility became more persistent than in either 1996 or
1995. Investors focused more than ever on worldwide market conditions and
uncertainty about future valuation levels for their investments. The unraveling
of deep-seated structural and financing problems in Asia, which for years had
been masked by strong economic growth, sent stock markets and currencies
plummeting. The year 1997 ended with uncertainty surrounding the world markets.
Bond markets in the developed countries were strong, while the equity markets
were hesitant with investors still assessing the impact that events in Asia had
on the rest of the world.
Fixed Income > During 1997, global fixed income markets were robust, with heavy
trading volumes in both the U.S. and Europe. The year began with fears of a
rate hike in the U.S. which kept global bond markets in retreat until mid-year.
Ultimately, there was only one rate action by the U.S. Federal Reserve Board
("Fed") during 1997 which occurred in March when the overnight lending rate was
raised by 0.25% to 5.50%. There were no long-term effects from this event. For
most of 1997, trading activity in the U.S. continued to reflect investor
optimism that the environment of sustained growth and low levels of inflation
would continue. During this period, 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. However, by the end of
1997, the forced devaluation of Thailand's currency during July triggered a
chain reaction of currency depreciations across the Asian region. Heightened
uncertainty about the extent of the exchange rate volatility caused foreign and
domestic investors to sell their Asian holdings and move into U.S.
dollar-denominated assets which, in turn, led to further pressure on Asian
exchange rates. Consequently, the fixed income markets suffered as credit
spreads on corporate, Eurobonds and emerging market issuers widened
dramatically. Issuers sat on the sidelines as spreads became unattractive. By
the end of 1997, investors' flight to quality caused the 30-year U.S. treasury
bond to rally to rates not seen since 1993.
While many of the peripheral European bond markets outperformed the U.S. market
in local currency terms in 1997, only the U.K. gilt market did so in U.S.
dollar terms. In the U.K., the yield curve flattened dramatically. This was in
response to the new Labour government granting independence to the Bank of
England which then implemented four interest rate increases. In Germany, an
interest rate hike in October 1997, combined with the Asian crisis, led to a
flattening of the German yield curve. For 1997, this amounted to just under one
percentage point between 10-year and two-year bonds. Also, several countries
seeking to enter the EMU on January 1, 1999 (e.g., Italy, Spain and Finland)
exhibited strength during 1997 as a result of reduced inflation and budget
deficits during the year.
LEHMAN BROTHERS 1997 ANNUAL REPORT
36
<PAGE> 2
During 1997, yields in Japan fell as a recovery in domestic demand following an
April tax hike proved elusive, Japanese banking problems intensified, and the
Asian crisis spread. By November 1997, yields on 10-year bonds had fallen to
below 2% -- a decline of 50 basis points for the year. Fixed income markets in
Southeast Asia were highly volatile in 1997 as the Asian crisis depressed
trading volumes and prices. By mid-December 1997, the International Monetary
Fund had negotiated medium-term funding agreements with Thailand, Indonesia and
Korea to supply much-needed foreign exchange liquidity. However, this failed to
stabilize Asia's currency markets; and the major rating agencies lowered the
bond ratings of several Asian nations to below investment grade levels.
Equity > During 1997, all major U.S. equity indices established new records,
although they ended the year off from these highs. For fiscal 1997, the S&P 500
return was 29%, making it the third consecutive year of double-digit returns.
Equity prices were helped by a benign inflation and interest rate environment
accompanied by good corporate earnings growth; inflation fell below 2% for the
year; long-term interest rates declined to below 6%; and profit growth was
double-digit. However, the equity market was also more volatile in 1997,
suffering through two corrections. The first one in March reflected the interest
rate hike by the Fed combined with investor concerns about earnings performance
in the technology sector. After the markets recovered strongly, the Asian crisis
occurred and the market suffered a second correction, culminating in a record
drop of more than 550 points in the Dow Jones Industrial Average on October 27.
By the end of 1997, the markets had recovered once again, but worries about the
fallout from the Asian crisis persisted. Equity trading volumes remained brisk
as did inflows of capital into mutual funds.
The European equity markets performed extremely well during 1997, with returns
from the region as a whole much in line with those of the U.S. markets. The
Financial Times-S&P European Index rose 20% in dollar terms, supported by
currency depreciation, which strengthened expectations of economic recovery and
boosted corporate earnings prospects, and by falling bond yields. Within Europe,
the smaller markets achieved the highest returns, reflecting narrowing bond
spreads over German yields and declines in short-term interest rates. Healthy
market conditions were reflected in strong trading volumes.
The situation in Asia, however, sharply contrasted with the performance of the
U.S. and European equity markets. In Japan, the Nikkei 225 Index fell by 17% due
to a deteriorating banking environment, major corporate bankruptcies, and an
economy on the verge of a recession. Similar to 1996, the Japanese market rose
over the first half of 1997 as investors looked for the economic recovery to
continue, but recorded losses in the second half as it became clear that the
fiscal tightening hurt economic growth and the banking crisis was intensifying.
Excluding Australia, the markets of southeast Asia were even more turbulent, as
one country after another became embroiled in the region's crisis. In local
currency terms, the worst-hit markets (e.g., Thailand, Malaysia, Indonesia,
Philippines and Korea) fell between 35% and 60% versus the prior year, with
returns in dollar terms recording even weaker results.
Latin American EMG markets, which realized a broad recovery in 1996, posted very
strong gains through much of 1997. These gains resulted from a continuation of
the process of economic reform and financial consolidation coupled with an
acceleration of economic growth in the region. As compared to the end of 1996,
Latin American equities rose over 50% in dollar terms to a peak during October
1997, as measured by the IFC Latin American Investable Index. However, the
escalating Asian crisis negatively impacted performance towards the end of 1997,
as global investors reined in their appetite for emerging markets. Despite the
year end weakening, these markets returned over 25% for the year.
Investment Banking > Combined worldwide underwriting volumes for fixed income
and equities continued on a torrid pace during 1997. Despite the turbulence of
the global stock markets in 1997, global equity underwritings reached new highs.
Significant merger and acquisition activity and continued inflows into equity
mutual funds led to a record $156 billion of common stock underwritings.
Worldwide fixed income underwriting surpassed 1996 levels led by the issuance of
corporate, asset-backed and mortgage-backed bonds. Issuers came to market to
take advantage of the historically attractive yields as well as favorable
LEHMAN BROTHERS 1997 ANNUAL REPORT
37
<PAGE> 3
pricing in the spread sectors. However, as with many other businesses, the Asian
crisis caused credit spreads to widen, leading issuers to postpone offerings in
the latter part of the year.
Corporate Finance Advisory activities set another record in 1997, with the level
of announced merger and acquisition activity reaching historic levels following
strong performances in both 1996 and 1995. The increased activity reflected the
continuing trend of consolidation and globalization across industry sectors and
the overall strength in the global capital markets. Reflecting the strength of
advisory activities was the wide range of industry sectors participating and the
broad global and cross-border orientation of that activity. Furthermore, the
scale of advisory activity was unprecedented. Four of the top ten domestic M&A
deals of all time were announced in the past twelve months and three of the top
seven announced worldwide M&A transactions involved a foreign target.
Fiscal 1997 was characterized by strong financial markets, nevertheless, the
financial services industry is cyclical. As a result the Company's businesses
are evaluated across market cycles for operating profitability and their
contribution to the Company's long-term strategic objectives. The Company
strives to minimize the effects of economic downturns through its diversified
product base, stringent cost controls, global presence and 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.
================================================================================
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
[Line Graph Omitted]
RESULTS OF OPERATIONS
Summary > The Company reported record net income of $647 million and earnings
per share of $4.72 for 1997, driven by continued strength in all of the
Company's major businesses including equities, fixed income and investment
banking. These results were achieved in worldwide markets which were extremely
favorable during the early portion of the year and became volatile in the latter
portion of the year. Despite market volatility, many equity indices in the U.S.
and Europe reached all-time highs during 1997. The overall favorable market
conditions led to a second straight year of near-record industrywide
underwriting volumes and a record year in worldwide merger and acquisition
activity.
The Company's continued focus on growing higher margin businesses contributed to
record revenues and a return on common equity of 15.6% and a pretax margin of
24.2% for 1997 compared to 12.1% and 18.5%, respectively, in 1996. Also
contributing to these record results was the Company's continued aggressive
management of expenses. Nonpersonnel expenses decreased even though revenues
increased significantly. The compensation and benefits ratio remained constant
at 50.7% of net revenues.
The Company's 1996 net income was $416 million, including a $50 million after
tax severance charge. The Company's 1996 results reflect strong performances
across all of the Company's major businesses. The fixed income sales and trading
and investment banking activities were responsible for the majority of the
increased net revenues and net income compared to 1995. The Company's results
were positively affected by favorable market conditions, which
LEHMAN BROTHERS 1997 ANNUAL REPORT
38
<PAGE> 4
led to near record underwriting volumes, record levels for many worldwide equity
indices and a record year in worldwide merger and acquisition activity.
The Company reported net income of $242 million for 1995, including a $47
million after tax gain related to the Company's sale of its interest in Omnitel
Sistemi Radiocellullari Italiani S.p.A. ("Omnitel") and a $58 million after tax
charge for occupancy-related real estate expenses and severance. The Company's
1995 results reflect improved performance in corporate finance advisory activity
and in fixed income and equity origination as well as higher levels of customer
activity in a number of businesses. The Company benefited from the continuing
increase in merger and acquisition activity throughout 1995 and from a stronger
market climate beginning in the second quarter of the year.
Net Revenues > Net revenues were $3,873 million for 1997, $3,444 million for
1996 and $3,071 million for 1995. During 1997, the Company continued to build
its global franchise. Net revenues increased from 1996 levels in all of the
major business units led by increased customer related trading activity, a
strong global market for mergers and acquisitions and increased levels of
worldwide debt and equity underwriting. During the second half of 1997, the
Company recorded net revenues of $2,094 million, its highest level of net
revenues for any six-month period since becoming a public company. The increase
in net revenues in 1996 reflected a general strengthening in customer related
trading activities in a number of fixed income product areas, increased levels
of worldwide debt and equity underwriting, and improved corporate finance
advisory results. Net revenues in 1995, excluding a special revenue item of $129
million from the sale of the Company's investment in Omnitel, were $2,942
million. Revenues in 1995 were positively affected by increased underwriting
volumes and customer flow activity due to strong rallies in the stock and bond
markets during the last three quarters of the year.
Net revenues from international sources as a percentage of total net revenues
(excluding Omnitel in 1995) were 30% for 1997, 41% for 1996 and 44% for 1995,
reflecting the global scope of the Company's business activities. This includes
approximately $432 million, $363 million and $368 million of revenues that were
associated with domestic products and services in 1997, 1996 and 1995,
respectively, that the Company estimates resulted from relationships with
international clients and customers. The decreased level of international
revenues for 1997 was directly correlated to the severe market depression in
Asia and the resulting contagion it had on worldwide markets which occurred in
the second half of the year. As a result of these market events, Asia and Europe
generated fewer revenue opportunities than in both 1996 and 1995.
Since 1990, Lehman Brothers has focused on a "client/customer-driven" strategy.
Under this strategy, Lehman Brothers concentrates on serving the needs of major
issuing and advisory clients and investing customers worldwide to build an
increasing flow of business that leverages the Company's research, underwriting
and distribution capabilities. Customer flow continues to be the primary source
of the Company's net revenues. In addition to its customer flow activities, the
Company also takes proprietary positions based upon expected movements in
interest rate, foreign exchange, equity and commodity markets in both the
short- and long-term. The Company's success in this area is dependent upon its
ability to anticipate economic and market trends and to develop trading
strategies that capitalize on these anticipated changes. Consistent with the
Company's client/customer-driven strategy, proprietary trading activities
accounted for approximately 14% of net revenues in 1997, 14% in 1996 and 9% in
1995. The Company believes its client/customer-driven strategy has historically
mitigated the level of net trading revenue volatility.
The Company, through its subsidiaries, is a market-maker in all major equity
and fixed income products in both the domestic and international markets. In
order to facilitate its trading activities, the Company is a member of all
principal securities and commodities exchanges in the United States and holds
memberships or associate memberships on several principal inter-
LEHMAN BROTHERS 1997 ANNUAL REPORT
39
<PAGE> 5
national securities and commodities exchanges, including the London, Tokyo, Hong
Kong, Frankfurt, Milan and Paris stock exchanges. As part of its market-making
activities, the Company maintains inventory positions of varying amounts across
a broad range of financial instruments, which are marked-to-market on a daily
basis and, along with the Company's proprietary trading positions, give rise to
principal transactions revenues. The Company utilizes various hedging strategies
to minimize its exposure to significant movements in interest and foreign
exchange rates and the equity markets.
Net revenues from the Company's market-making and trading activities in fixed
income and equity products are recognized as either principal transactions or
net interest revenues, depending upon the method of financing and/or hedging
related to specific inventory positions. The Company evaluates its trading
strategies on an overall profitability basis which includes both principal
transaction 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. Combined principal transactions and net interest
revenues were relatively flat in 1997 as compared to 1996. Increased principal
transactions and net interest revenues across many of the Company's fixed income
and equity product lines were offset by lower results in certain fixed income
and equity derivative products in Europe and Asia and with higher interest
expenses resulting from the Company's increased level of long-term debt
outstanding.
During 1996, combined principal transactions and net interest revenues increased
$285 million from 1995, resulting from a shift in the composition of the
Company's fixed income portfolio, an increase in net dividend revenue related to
certain structured transactions in equity derivatives, and improved spreads an
certain higher margin matched book financing 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 Income. Net revenues by business unit
contain certain internal allocations, including funding costs, which are
centrally managed.
LEHMAN BROTHERS 1997 ANNUAL REPORT
40
<PAGE> 6
<TABLE>
<CAPTION>
================================================================================
TWELVE MONTHS ENDED NOVEMBER 30, 1997
- --------------------------------------------------------------------------------
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
================================================================================
<S> <C> <C> <C> <C> <C>
Fixed Income $1,749 $ 41 $ 380 $16 $2,186
Equity 296 365 342 7 1,010
Corporate Finance
Advisory (5) 328 323
Merchant Banking (6) 266 260
Other 9 17 2 66 94
- --------------------------------------------------------------------------------
$2,043 $423 $1,318 $89 $3,873
================================================================================
</TABLE>
<TABLE>
<CAPTION>
================================================================================
TWELVE MONTHS ENDED NOVEMBER 30, 1996
- --------------------------------------------------------------------------------
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST COMMISSIONS BANKING OTHER TOTAL
================================================================================
<S> <C> <C> <C> <C> <C>
Fixed Income $1,793 $57 $307 $8 $2,165
Equity 275 286 280 3 844
Corporate Finance
Advisory 249 249
Merchant Banking (18) 138 120
Other 11 19 7 29 66
- --------------------------------------------------------------------------------
$2,061 $362 $981 $40 $3,444
================================================================================
</TABLE>
<TABLE>
<CAPTION>
================================================================================
TWELVE MONTHS ENDED NOVEMBER 30, 1995
- --------------------------------------------------------------------------------
PRINCIPAL
TRANSACTIONS AND INVESTMENT
NET INTEREST* COMMISSIONS BANKING OTHER TOTAL
================================================================================
<S> <C> <C> <C> <C> <C>
Fixed Income $1,373 $ 92 $178 $ 8 $1,657
Equity 418 330 215 3 964
Corporate Finance
Advisory 231 231
Merchant Banking (26) 172 146
Other 11 28 5 29 73
- --------------------------------------------------------------------------------
$1,776 $450 $801 $40 $3,071
================================================================================
</TABLE>
* 1995 equity revenues include $129 million from the sale of Omnitel.
The following discussion provides an analysis of the Company's net revenues
based upon the various business units which generated these revenues.
Fixed Income. The Company's fixed income 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. Lehman Brothers is one of the leading primary
dealers in U.S. government securities and is a market-maker in the government
securities of all major industrial countries. The Company, through its
subsidiaries, is also a dominant market-maker for a broad range of fixed income
products.
LEHMAN BROTHERS 1997 ANNUAL REPORT
41
<PAGE> 7
Fixed income revenues were $2,186 million for 1997, $2,165 million for 1996 and
$1,657 million for 1995. During 1997, the Company continued to focus its
resources and efforts towards growing its market share in higher margin
products. The Company's fixed income business benefited in 1997 from active
customer trading combined with increased levels of worldwide debt underwriting
which resulted from the favorable U.S. macroeconomic environment. Mortgage
revenues increased significantly during 1997 as the Company profited from its
diversified product mix including several large conduit transactions, commercial
mortgage-backed deals and real estate transactions. High yield benefited from an
increased volume of lead-managed underwritings and syndicated loans. The Company
lead-managed over $4.3 billion of offerings in fiscal 1997 up from $2.3 billion
in fiscal 1996. Revenues from the emerging markets business improved
significantly during 1997 as a result of the Company's successful expansion
into new European markets. These improvements were partially offset by reduced
contributions from fixed income derivatives and foreign exchange which were
negatively impacted by significant volatility in the Asian markets.
Lehman Brothers lead-managed fixed income offerings in fiscal 1997 increased 29%
with the underwritings of $132 billion compared to underwritings of $102 billion
in fiscal 1996 based on information supplied by Securities Data Company.
During 1996, fixed income revenues increased from 1995, primarily as a result of
stronger customer trading volumes reflecting a strengthening in the global
economy, a reduced U.S. federal deficit and relatively low levels of inflation.
The improved market conditions in both the U.S. and Europe led to a significant
increase in worldwide debt underwriting revenues and greater contributions from
customer flow and trading activities in a number of fixed income products
including mortgages, emerging markets, fixed income derivatives and high yield
and high-grade corporate bonds. The Company's emerging markets and high yield
revenues increased during 1996, primarily as a result of increased debt
underwritings compared to 1995. Fixed income derivative revenues in 1996 were
driven by improved results in Europe, as the Company continued to benefit from
its concerted effort to globalize this business.
Equity. Equity net revenues reflect customer flow activities (both institutional
and high-net-worth retail), secondary trading, equity underwriting, equity
finance, equity derivatives and arbitrage activities.
Equity revenues were $1,010 million for 1997, $844 million for 1996 and $964
million for 1995. Included in the 1995 results were net revenues of $129 million
resulting from the Company's sale of its stake in Omnitel. Excluding the Omnitel
transaction, equity revenues were $835 million for 1995.
The results for the Company's equity business increased 20% versus 1996
primarily due to the continued favorable worldwide equity markets which existed
for most of the year combined with the successful redirection of the Company's
resources into higher margin products. Worldwide equity underwriting volumes for
1997 were at an all-time high for the securities industry. Equity underwriting,
equity arbitrage and improved customer flow activities were the primary
contributors to the increase in revenues for 1997, while equity derivative
revenues trailed 1996 levels.
The improvement in equity underwriting revenues during fiscal 1997 resulted from
an improved product mix as the Company increased its common stock lead-managed
underwriting volume by 27% with a 4.6% market share which was improved from the
3.7% market share attained in fiscal 1996.
Equity cash products benefited in 1997 from the record-setting year in many of
the world's financial markets which was fueled by a benign inflation and
interest rate environment accompanied by strong earnings growth in the U.S. In
particular, the Company's equity cash product revenues improved in 1997
primarily from an increased level of institutional and retail customer flow.
During 1997, the revenues from the Company's equity financing business also
improved as a result of successful trading strategies implemented in the United
Kingdom. The equity derivative revenues in 1997 were reduced from the prior
year's level due to the market volatility experienced in Asia.
LEHMAN BROTHERS 1997 ANNUAL REPORT
42
<PAGE> 8
Equity revenues increased slightly in 1996 (as compared to the 1995 amount
excluding Omnitel) as a result of improved underwriting results combined with
increased contributions from the equity derivative business, convertible
securities and international equities. The improved underwriting volumes
reflected the favorable global economic environment in 1996, with generally
increased trading volumes on most major domestic and international listed
exchanges and record flows of capital into U.S. equity mutual funds. The
improved equity derivatives results in 1996 were primarily from the Company's
Asian business activities, reflecting the continued emphasis on the
globalization of certain high margin businesses. During the second half of 1996,
the Company's efforts to reposition its equity business resulted in the
realization of stronger results as it lead-managed transactions valued at over
$5 billion, representing an 87% increase over the comparable amount for the
first half of 1996. The Company ranked third in total NYSE listed trading volume
throughout all of 1997, 1996 and 1995.
Corporate Finance Advisory. Corporate finance advisory net revenues, classified
in the Consolidated Statement of Income as a component of investment banking
revenues, result primarily from fees earned by the Company in its role as
strategic advisor to its clients. This role primarily consists of advising
clients on mergers and acquisitions, divestitures, leveraged buyouts, financial
restructurings, and a variety of cross-border transactions. The net revenues for
corporate finance advisory increased in 1997 to $323 million from $249 million
in 1996 and from $231 million in 1995. The increased revenues reflected the
closing of several large deals in 1997 and continued strength in the overall
merger and acquisition market environment. The Company ended fiscal 1997 with a
strong transaction pipeline which stood at $81 billion in terms of total dollar
value based on information supplied by Securities Data Company.
Merchant Banking. The Company is the general partner for nine active merchant
banking partnerships. Current merchant banking investments held by the
partnerships include both publicly traded and privately held companies. Merchant
banking net revenues primarily represent the Company's proportionate share of
net realized and unrealized gains and losses from the sale and revaluation of
investments held by the partnerships. Such amounts are classified in the
Consolidated Statement of Income 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 $260 million, $120 million and $146 million for 1997, 1996 and
1995, respectively. The increase in 1997 compared to 1996 was principally due to
realized gains on the sales of the partnerships' interests in certain
investments. The decrease in 1996 compared to 1995 was principally due to a
reduction in the net gains recognized on the publicly traded investments held by
the partnerships.
Non-Interest Expenses > During 1997, the Company's non-interest expenses totaled
$2,936 million. Non-interest expenses were $2,807 million for 1996, including a
severance charge of $84 million. Non-interest expenses were $2,702 million for
1995, including a restructuring charge of $97 million and compensation and
benefits expenses of $50 million attributable to Omnitel. Excluding these
special charges, non-interest expenses were $2,723 million for 1996, and $2,555
million for 1995.
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-----------------------------------
(in millions) 1997 1996 1995(1)
================================================================================
<S> <C> <C> <C>
Compensation and benefits $1,964 $1,747 $1,494
Nonpersonnel(2) 972 976 1,061
Severance and restructuring charges 84 97
- --------------------------------------------------------------------------------
Total non-interest expenses $2,936 $2,807 $2,652
================================================================================
Compensation and benefits/Net revenues 50.7% 50.7% 50.8%
Nonpersonnel expenses(2)/Net revenues 25.1% 28.3% 36.1%
================================================================================
</TABLE>
(1) 1995 amounts exclude revenues and expenses related to the Omnitel
transaction.
(2) Nonpersonnel expenses excluding severance and restructuring charges.
LEHMAN BROTHERS 1997 ANNUAL REPORT
43
<PAGE> 9
Compensation and benefits expenses increased in 1997 to $1,964 million from
$1,747 million in 1996 as a result of higher revenues. However, the Company
maintained its compensation and benefits expense to net revenue ratio at 50.7%
for both 1997 and 1996. Nonpersonnel expenses were relatively unchanged at $972
million for 1997 compared to $976 million for 1996. More significantly, the
Company was able to effectively control its level of nonpersonnel expenses as
evidenced by a decline in the nonpersonnel expense to net revenue ratio to 25.1%
for 1997 from 28.3% for 1996.
Professional services expenses increased to $173 million in 1997 from $150
million in 1996 as a result of increased system development costs which includes
costs associated with the Year 2000 initiative. Brokerage, commissions and
clearance fees declined to $224 million in 1997 from $241 million in 1996 as a
result of the renegotiation of certain contracts partially off-set by increased
customer trading volumes.
Compensation and benefits expenses increased in 1996 to $1,747 million from
$1,494 million in 1995 as a result of higher revenues. Excluding severance and
restructuring charges, nonpersonnel expenses decreased 8% to $976 million in
1996 as compared to $1,061 million in 1995. The Company's nonpersonnel expense
to net revenue ratio dropped dramatically to 28.3% for 1996 versus 36.1% for
1995 reflecting the continued focus on expense management as well as cost
savings realized from the 1995 restructuring charge.
Cost Reduction Effort. At year-end 1994, the Company announced a cost reduction
program aimed at reducing its expenses by a target of $300 million on an
annualized basis. The targets included personnel cost savings of $100 million,
nonpersonnel cost savings of $150 million and interest and tax expense savings
of $50 million. By year-end 1995, the Company surpassed its targets and achieved
$326 million of cost savings. During 1996, the Company achieved an additional
$56 million of cost savings across numerous expense categories as a result of
the continued systematic and comprehensive global review of all major expense
categories.
During 1997, the Company continued to closely monitor its expense levels and
maintain strong controls over its cost structure. This is best evidenced by the
reduction of nonpersonnel expenses in 1997 to $972 million versus $976 million
for 1996 while net revenues increased 12% during the same period. The benefits
of the Company's reduction of its nonpersonnel expense level are that profit
margins and earnings have improved significantly.
The Company believes that while the absolute level of its expense base may
increase in response to related increases in revenue levels (due to the
variability of certain expenses), the cost savings achieved as a result of its
cost reduction efforts are permanent.
1996 Severance Charge. The Company recorded an $84 million severance charge ($50
million after tax) 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 that 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 aimed at delayering management. The 1996 severance charge has led to
LEHMAN BROTHERS 1997 ANNUAL REPORT
44
<PAGE> 10
personnel cost savings of approximately $90 million annually. The charge also
resulted 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 $59 million during 1997. The remaining
residual payments will be paid as deferred payment arrangements are completed.
1995 Restructuring Charge. The restructuring charge in 1995 included an $80
million occupancy-related real estate charge and a $17 million severance charge.
The real estate component of the charge resulted from a complete review of the
Company's real estate requirements at current headcount levels and the
elimination of excess real estate, primarily in New York, London and Tokyo. This
charge included costs to write-down the carrying value of leasehold
improvements, as well as projected shortfalls of sublease rentals versus
expected operating costs related to the Company's excess capacity. The excess
real estate capacity resulted from headcount reductions associated with the
Company's cost reduction efforts. The severance component of the charge related
to payments made to terminated personnel arising from a formalized fourth
quarter business unit productivity review.
Income Taxes > The Company had an income tax provision of $290 million, $221
million and $127 million for 1997, 1996 and 1995, respectively. The effective
tax rate for the Company was 31% for 1997, 35% for 1996 and 34% for 1995. The
lower tax rate in 1997 versus 1996 reflects an increase in tax-exempt income as
well as a reduction in the state and local effective tax rate. The 1996 income
tax provision includes a tax benefit of $34 million related to the 1996
severance charge. The higher rate in 1996 versus 1995 reflects a decrease in tax
exempt income partially offset by benefits generated from the restructuring of
certain legal entities to assure that the Company operates in the most tax
efficient manner. The 1995 income tax provision includes a $32 million charge
related to the sale of the Company's investment in Omnitel and a tax benefit of
$39 million related to the restructuring charge.
The Company's net deferred tax asset increased by $61 million to $315 million at
November 30, 1997 from $254 million at November 30, 1996. It is anticipated that
the Company's net deferred tax asset will be realized through future earnings.
The Company's net deferred tax asset decreased by $55 million to $254 million at
November 30, 1996 from $309 million at November 30, 1995.
As of November 30, 1997, the Company had approximately $44 million of net
operating loss carryforwards available to offset future taxable income.
================================================================================
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
inventories, underwriting activities, principal investments, merchant banking
activities and investments in fixed assets.
The Company's balance sheet is liquid and 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 Company's primary activities are based on the execution of
customer-related transactions. This flow of customer business supports the rapid
asset turnover rate of the Company's inventory.
LEHMAN BROTHERS 1997 ANNUAL REPORT
45
<PAGE> 11
The Company's total assets increased to $151.7 billion at November 30, 1997 from
$128.6 billion at November 30, 1996 reflecting the strategic expansion of
certain business lines. This increase in total assets is consistent with the
growth of stockholders' equity and, accordingly, did not significantly change
the level of balance sheet leverage. In addition, the Company's continued focus
on growing higher margin businesses resulted in increased levels of mortgages,
corporate bonds and stocks, and derivative inventory positions at November 30,
1997 compared to November 30, 1996. The Company also positioned itself to
benefit from favorable conditions in the worldwide fixed income markets by
increasing its government and agency inventory and increasing its customer
financing activities.
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.
Under the authority of the Finance Committee, members of the Company's treasury
department work with Regional Asset and Liability Committees to ensure
coordination of global funding efforts and implementation of the funding and
liquidity policies. The Regional Asset and Liability Committees are aligned with
the Company's geographic funding centers and 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 across a wide range of market
environments. There are five key elements of its funding strategy that the
Company attempts to achieve:
(1) Maintain an appropriate Total Capital structure to support the business
activities in which the Company is engaged.
The Company is one of the most highly capitalized global investment banking
firms with $24.8 billion in Total Capital. The Company manages Total Capital,
defined as long-term debt, preferred stock and common stockholders' equity, on a
business and product level. The determination of the amount of Total Capital
assigned to each business and product is a function of asset quality, market
risk, liquidity and regulatory capital requirements. The Company reallocates its
capital to businesses based upon their ability to obtain targeted returns,
perceived opportunities in the marketplace and the Company's long-term strategy.
The Company strives to have sufficient Total Capital to meet its anticipated
long-term capital needs which are driven by cash capital (liquidity), regulatory
capital and market and credit risk requirements, and continually monitors its
Total Capital needs by employing models which measure its market, credit and
liquidity risks.
(2) Minimize liquidity and refinancing risk by funding the Company's assets on a
global basis with secured and unsecured liabilities, which have maturities equal
to or exceeding the anticipated liquidation period of the assets.
The Company continually reviews its mix of long- and short-term borrowings as it
relates to maturity matching and the availability of secured and unsecured
financing. In general, the Company finances its equity investments in its
subsidiaries with stockholders' equity and the subordinated capital of
subsidiaries is financed with a combination of subordinated and senior long-term
debt. Inventories and other short-term assets are financed with a combination of
short-term funding, floating rate long-term debt and stockholders' equity. Fixed
assets, property, plant and equipment are generally financed with longer-dated
fixed rate debt.
TOTAL CAPITAL
[Bar Graph Omitted]
LEHMAN BROTHERS 1997 ANNUAL REPORT
46
<PAGE> 12
Where the Company deems it to be appropriate and to minimize currency risks,
foreign currency denominated assets are financed with corresponding foreign
currency denominated liabilities.
(3) Maintain sufficient financial resources to enable the Company to meet its
obligations in a period of financial stress through a combination of
collateralized short-term financings and Total Capital, as well as the
implementation of a contingency funding plan. Financial stress is defined as any
event which severely constrains the Company's access to unsecured funding
sources.
To achieve this objective, the Company strives to maximize its use of global
collateralized borrowing sources and reduce its reliance upon short-term
unsecured borrowings. In addition, the Company's liquidity policies include
maintaining sufficient excess unencumbered securities to use as collateral, if
necessary, to obtain secured financing to meet maturities of short-term
unsecured liabilities as well as current maturities of long-term debt. Also, the
Company strives to maintain a sufficient amount of Total Capital to enable the
Company to support all assets not readily pledgeable to counterparties and to
meet secured borrowing advance rates as determined by reference to the Company's
bank lenders and other secured lending counterparties, should unsecured sources
of borrowings no longer be available. In this regard, the Company believes that
increasing Total Capital will provide additional liquidity to cover periods of
financial stress and further advance the Company's liquidity management
objectives. Lastly, the Company periodically tests its secured and unsecured
credit facilities to ensure availability and operational readiness. These
policies position the Company to meet its liquidity requirements in all periods
including those of financial stress. The Company maintains a comprehensive
one-year contingency funding plan. The plan is reviewed and approved by the
Company's Finance Committee annually.
(4) Obtain diversified funding through a global investor base which maximizes
liquidity and reduces concentration risk.
The Company obtains global funding from both the banking community and short-
and long-term investors through its centers in New York, London, Tokyo, Hong
Kong and Frankfurt. In addition to maintaining geographic diversification, the
Company also utilizes a broad range of debt instruments, which it issues in
varying maturities and currencies.
The Company issues both commercial paper and other short-term debt instruments,
including master notes, corporate and retail deposits, and bank borrowings under
uncommitted lines of credit and other uncommitted arrangements. To reduce
liquidity and concentration risk, the Company carefully manages its maturities
to avoid large refinancings on any one given day, and limits its exposure to any
single investor or type of investor.
(5) Maintain funding availability in excess of actual utilization.
The Company maintains sizable uncommitted lines of credit from a broad range of
banks and financial institutions from which it draws funds in a variety of
currencies and which provide an additional source of liquidity. Uncommitted
lines consist of facilities that the Company has been advised are available but
for which no contractual lending obligations exist. Additionally, the Company
maintains secured and unsecured committed revolving credit facilities as
discussed in the following section.
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 cash market 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 certain other types of collateralized borrowing sources are
less credit-sensitive and have historically been a more stable financing source
under adverse market conditions.
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. The majority of the
Company's assets are
LEHMAN BROTHERS 1997 ANNUAL REPORT
47
<PAGE> 13
funded with collateralized borrowing sources. At November 30, 1997 and 1996, $94
billion and $82 billion, respectively, of the Company's total balance sheet was
financed using collateralized borrowing sources.
As of November 30, 1997 and 1996, commercial paper and short-term debt
outstanding was $7.8 billion and $8.2 billion, respectively. Of these amounts,
commercial paper outstanding as of November 30, 1997 was $3.9 billion with an
average maturity of 73 days, compared to $3.1 billion with an average maturity
of 64 days as of November 30, 1996.
At November 30, 1997, Holdings maintained a Revolving Credit Agreement (the
"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 be extended
to 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.
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 six
months on a secured basis. Any loans outstanding on the commitment termination
date may be extended to the first anniversary of the commitment termination date
at the option of LBIE. 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, as requested. The Facility 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 either the Credit Agreement or the
Facility at November 30, 1997. The Company may use the Credit Agreement and the
Facility for general corporate purposes from time to time. The Company
maintained compliance with the applicable covenants for both the 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 $24.8 billion at November 30, 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.
<TABLE>
<CAPTION>
NOVEMBER 30
-------------------------------------
(in millions) 1997 1996 1995
================================================================================
<S> <C> <C> <C>
Long-term Debt
Senior Notes $17,049 $12,571 $10,505
Subordinated Indebtedness 3,212 3,351 2,260
- --------------------------------------------------------------------------------
20,261 15,922 12,765
- --------------------------------------------------------------------------------
Stockholders' Equity
Preferred Equity 508 508 708
Common Equity 4,015 3,366 2,990
- --------------------------------------------------------------------------------
4,523 3,874 3,698
- --------------------------------------------------------------------------------
Total Capital $24,784 $19,796 $16,463
================================================================================
</TABLE>
LEHMAN BROTHERS 1997 ANNUAL REPORT
48
<PAGE> 14
LONG-TERM DEBT
[Bar Graph Omitted]
During 1997, the Company issued $7.6 billion in long-term debt, which was $4.6
billion in excess of its maturing debt. Long-term debt increased to $20.3
billion at November 30, 1997 from $15.9 billion at November 30, 1996 with a
weighted average maturity of 4.1 years at November 30, 1997 and 1996.
At November 30, 1997, the Company had approximately $7.3 billion available for
the issuance of debt securities under various shelf registrations and debt
programs.
The increase in Total Capital also reflects an increase in stockholders' equity
to $4.5 billion at November 30, 1997 from $3.9 billion at November 30, 1996. The
net increase in stockholders' equity was primarily due to the retention of
earnings and the amortization of RSU awards under the Company's employee stock
award plans, partially offset by the repurchase of treasury stock and the
payment of both common and preferred dividends.
To broaden and increase the level of employee ownership in Holdings, the
Company utilizes several stock-based compensation plans. Since 1994, the Company
has made Restricted Stock Unit ("RSU") awards to its employees as a portion of
total compensation in lieu of cash, subject to vesting and transfer
restrictions. Approximately 3.8 million, 5.2 million and 6.1 million RSUs were
amortized into stockholders' equity in 1997, 1996 and 1995, respectively. As a
result of the RSU amortization, stockholders' equity increased by approximately
$162 million, $136 million and $124 million in 1997, 1996 and 1995,
respectively, net of cancellations. During 1997, the Company repurchased or
acquired shares of its Common Stock in the open market at an aggregate cost of
$77 million (approximately 1.6 million shares). These shares are being reserved
for future issuances under employee stock-based compensation plans.
During January 1998, the Company's Board of Directors authorized the repurchase
of up to 4.5 million common shares in 1998 as part of its ongoing program to
actively manage its capital position and common shares outstanding. In addition,
the Company announced that it increased its annual dividend rate by 25% to $0.30
per common share. During 1997, the Company established a trust (the "RSU Trust")
in order to provide common stock voting rights to employees who hold outstanding
RSUs, in furtherance of the Company's stated goal when RSU awards were initiated
in June 1994, to encourage employees to think and act like owners. The RSU Trust
was initially funded with a total of 16 million shares consisting of 5 million
treasury shares for RSU awards under the Employee Incentive Plan and 11 million
new issue shares of Common Stock, for RSU awards under the 1994 Management
Ownership Plan. There was no effect on total stockholders' equity as the
decrease in common stock issuable and treasury stock was offset by a
corresponding increase in common stock and additional paid-in capital.
Capital Resources and Capital Adequacy > Balance sheet leverage ratios are one
measure used to evaluate the capital adequacy of a company. Leverage ratios are
commonly calculated using either total assets or adjusted total assets divided
by total stockholders' equity. The Company's gross leverage ratios, based on
total assets, were 33.5x and 33.2x at November 30, 1997 and 1996, respectively.
The Company believes that the adjusted leverage ratio, rather than the gross
leverage ratio, is a more effective measure of financial risk when comparing
companies in the securities industry. Adjusted total assets represent total
assets less the lower of securities purchased under agreements to resell or
securities sold under agreements to repurchase. The Company's adjusted leverage
ratios based on adjusted total assets were 23.9x and 24.8x at November 30, 1997
and 1996, respectively.
LEHMAN BROTHERS 1997 ANNUAL REPORT
49
<PAGE> 15
Due to the nature of the Company's sales and trading activities, the overall
size of the Company's assets and liabilities fluctuates from time to time and at
specific points in time may be higher than the fiscal quarter ends or the
quarterly average. The Company's average gross leverage ratio and average
adjusted leverage ratio for the year ended November 30, 1997 were 41.3x and
28.9x, respectively.
In early 1997, the Company implemented a business performance measurement
system. This system is a management reporting tool which charges for capital
utilization across the Company's products. It provides detailed profitability
and return on equity information for each of the Company's lines of business.
The results of charging each of the respective businesses for its capital
utilization are that businesses have begun to optimize their use of balance
sheet and capital resources resulting in an improved return on assets and
decreased levels of both quarterly average gross and adjusted leverage.
QUARTERLY AVERAGE
GROSS LEVERAGE
Fiscal Quarters
[Bar Graph Omitted]
QUARTERLY AVERAGE
ADJUSTED LEVERAGE
Fiscal Quarters
[Bar Graph Omitted]
The Company also closely monitors its primary double leverage ratio. A double
leverage ratio in excess of 1.0 arises from the funding of equity investments in
subsidiaries with the debt of the parent. One of the Company's objectives is to
maintain its primary double leverage ratio at no more than 1.0. Primary double
leverage, defined as Holdings' investment in subsidiaries divided by Holdings'
stockholders' equity, was 0.87 at November 30, 1997 compared to 0.97 at November
30, 1996.
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. In November 1997, Fitch IBCA, Inc.
upgraded its long-term debt rating of Holdings to "A" from "A-". Additionally,
during January 1998, S&P upgraded its ratings outlook on the Company to "stable"
and reaffirmed the Company's long-term debt rating. As of November 30, 1997, the
short- and long-term senior debt ratings of Holdings and Lehman Brothers Inc.
("LBI") were as follows:
<TABLE>
<CAPTION>
HOLDINGS LBI
--------------------- ---------------------
SHORT-TERM LONG-TERM SHORT-TERM LONG-TERM**
================================================================================
<S> <C> <C> <C> <C>
Duff & Phelps Credit Rating Co. D-1 A D-1 A/A-
Fitch IBCA, Inc. F-1 A F-1 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-
</TABLE>
* Provisional ratings on shelf registration
** Senior/subordinated
LEHMAN BROTHERS 1997 ANNUAL REPORT
50
<PAGE> 16
Regulatory Capital > The Company operates globally through a network of
subsidiaries with several 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 November 30, 1997, LBI's regulatory net
capital, as defined, of $1,484 million exceeded the minimum requirement by
$1,359 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 November 30, 1997, LBIE's financial resources of approximately $2.3
billion exceeded the minimum requirement by approximately $500 million. 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 November 30,
1997, had net capital of approximately $400 million which was approximately $100
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 November 30,
1997, these other subsidiaries were in compliance with their applicable local
capital adequacy requirements. The Company's "AAA" rated derivatives subsidiary,
Lehman Brothers Financial Products Inc. ("LBFP"), has established certain
capital and operating restrictions which are reviewed by various rating
agencies. At November 30, 1997, LBFP had capital which exceeded the requirement
of the most stringent rating agency by approximately $100 million.
The regulatory rules referred to above, and certain covenants contained in
various debt agreements may restrict Holdings' ability to withdraw capital from
its regulated subsidiaries, which in turn could limit its ability to pay
dividends to shareholders. At November 30, 1997, approximately $2.9 billion of
net assets of subsidiaries were restricted as to the payment of dividends to
Holdings.
Cash Flows > Cash and cash equivalents decreased $464 million in 1997 to $1,685
million, as the net cash used in operating and investing activities exceeded the
net cash provided by financing activities. Net cash used in operating activities
of $4,445 million included income adjusted for non-cash items of $675 million
for 1997. Net cash provided by financing activities was $4,055 million and net
cash used in investing activities was $74 million.
Cash and cash equivalents increased $1,275 million in 1996 to $2,149 million, as
the net cash provided by financing activities exceeded the net cash used in
operating and investing activities. Net cash used in operating activities of
$3,397 million included income adjusted for non-cash items of $889 million for
1996. Net cash provided by financing activities was $4,730 million and net cash
used in investing activities was $58 million.
Cash and cash equivalents decreased $90 million in 1995 to $874 million, as the
net cash used in financing and investing activities exceeded the net cash
provided by operating activities. Net cash provided by operating activities of
$1,854 million included income adjusted for non-cash items of $439 million for
1995. Net cash used in financing and investing activities was $1,892 million and
$52 million, respectively.
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
LEHMAN BROTHERS 1997 ANNUAL REPORT
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<PAGE> 17
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
Income. The Company's portfolio of such securities at November 30, 1997 and 1996
included long positions with an aggregate market value of approximately $3.2
billion and $1.7 billion, respectively, and short positions with an aggregate
market value of approximately $172 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 $438 million at November
30, 1997. The Company, subsequent to year end, participated a significant
portion of this position.
Lending Activities > The Company, through its high yield sales and trading
activities, makes commitments to extend credit in loan syndication transactions
principally to below investment grade borrowers and participates a significant
portion of these commitments. These commitments, which totaled $1.4 billion at
November 30, 1997, are typically secured against the borrower's assets and have
fixed maturity dates. The draw down of these facilities is generally contingent
upon certain representations, warranties and contractual conditions of the
borrower. The total commitments may not be indicative of actual funding
requirements as they may expire without being drawn upon and the Company may
participate additional amounts in the normal course of its business.
Merchant Banking and Related Lending Activities > The Company's merchant banking
activities include investments in nine partnerships, for which the Company acts
as general partner, as well as direct investments. At November 30, 1997, the
investment in merchant banking partnerships was $167 million and direct
investments were $75 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.
In September 1997, the Company established a $2.0 billion fund for which the
Company will act as general partner. The Company has commitments to invest up to
an additional $498 million in the partnerships, which in turn will make direct
merchant banking related investments. These commitments will be funded as
required through the end of the respective partnerships' investment periods,
principally expiring in 2004.
The Company is also a sponsor of a fund to provide interim acquisition
facilities. In connection therewith, the Company may provide up to $150 million
to be used by the fund to provide short-term acquisition financing. Any draw
downs under the facility are expected to be repaid within a short-term period.
In addition, at November 30, 1997, the Company had no direct short-term bridge
financings outstanding.
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
or co-general partner for approximately $2.3 billion of partnership investment
capital and manages the remaining real estate investment portfolio. At November
30, 1997, the Company had $48 million of net exposure to these real estate
activities, including investments, commitments and contingent liabilities under
guarantees and credit enhancements. 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.
Management's intention with regard to non-core assets is the prudent liquidation
of these investments as and when possible.
LEHMAN BROTHERS 1997 ANNUAL REPORT
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<PAGE> 18
================================================================================
OFF BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
- --------------------------------------------------------------------------------
Overview > Derivatives are financial instruments, which include swaps, options,
futures, forwards and warrants, whose value is based upon an underlying asset
(e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A
derivative contract may be traded on an exchange or negotiated in the
over-the-counter markets. Exchange-traded derivatives are standardized and
include futures, warrants and certain option contracts listed on an exchange.
Over-the-counter ("OTC") derivative contracts are individually negotiated
between contracting parties and include forwards, swaps and certain options,
including caps, collars and floors. The use of derivative financial instruments
has expanded significantly over the past decade. One reason for this expansion
is that derivatives provide a cost effective alternative for managing market
risk. In this regard, derivative contracts provide a reduced funding alternative
for managing market risk since derivatives are based upon notional values, which
are generally not exchanged, but rather are used merely as a basis for
exchanging cash flows during the duration of the contract. Derivatives are also
utilized extensively as highly effective tools that enable users to adjust risk
profiles, such as interest rate, currency, or other market risks, or to take
proprietary trading positions, since OTC derivative instruments can be tailored
to meet individual client needs. Additionally, derivatives provide users with
access to market risk management tools which are often unavailable in
traditional cash instruments.
Derivatives are subject to various risks similar to non-derivative financial
instruments including market, credit and operational risk. Market risk is the
potential for a financial loss due to changes in the value of derivative
financial instruments due to market changes, including changes in interest
rates, foreign exchange rates and equity and commodity prices. Credit risk
results from the possibility that a counterparty to a derivative transaction may
fail to perform according to the terms of the contract. Therefore, the Company's
exposure to credit risk is represented by its net receivable from derivative
counterparties, after consideration of collateral. Operational risk is the
possibility of financial loss resulting from a deficiency in the Company's
systems for executing derivative transactions. In addition to these risks,
counterparties to derivative financial instruments may also be exposed to legal
risks related to derivative activities, including the possibility that a
transaction may be unenforceable under applicable law. The risks of derivatives
should not be viewed in isolation but rather should be considered on an
aggregate basis along with the Company's other trading-related activities.
As derivative products have continued to expand in volume, so has market
participation and competition. As a result, additional liquidity has been added
into the markets for conventional derivative products, such as interest rate
swaps. Competition has also contributed to the development of more complex
products structured for specific clients. It is this rapid growth and complexity
of certain derivative products which has led to the perception, by some, that
derivative products are unduly risky to users and the financial markets. In
order to remove the public perception that derivatives may be unduly risky and
to ensure ongoing liquidity of derivatives in the marketplace, the Company
supports the efforts of the regulators in striving for enhanced risk management
disclosures which consider the effects of both derivative products and cash
instruments. In addition, the Company supports the activities of regulators
which are designed to ensure that users of derivatives are fully aware of the
nature of risks inherent within derivative transactions. As evidence of this
support, the Company is an active participant in the Derivative Policy Group and
has been actively involved with the various regulatory and accounting
authorities in the development of additional enhanced reporting requirements
related to derivatives. The Company strongly believes that derivatives provide
significant value to the financial markets and is committed to providing its
clients with innovative products to meet their financial needs.
Lehman Brothers' Use of Derivative Instruments > In the normal course of
business, the Company enters into derivative transactions both in a trading
capacity and as an end user. As an end user, the Company utilizes derivative
products to adjust the
LEHMAN BROTHERS 1997 ANNUAL REPORT
53
<PAGE> 19
interest rate nature of its funding sources from fixed to floating interest
rates and vice versa, and to change the index upon which floating interest rates
are based (e.g., Prime to LIBOR) (collectively, "End User Derivative
Activities"). For a further discussion of the Company's End User Derivative
Activities see Note 11 to the Consolidated Financial Statements.
The Company utilizes derivative products in a trading capacity both as a dealer
to satisfy the financial needs of its clients and in each of its trading
businesses (collectively, "Trading-Related Derivative Activities"). The
Company's use of derivative products in its trading businesses is combined with
cash instruments to fully execute various trading strategies.
The Company conducts its derivative activities through a number of wholly owned
subsidiaries. The Company's fixed income derivative products business is
conducted through its special purpose subsidiary, Lehman Brothers Special
Financing Inc., and a separately capitalized "AAA" rated subsidiary, Lehman
Brothers Financial Products Inc. The Company's equity derivative product
business is conducted through Lehman Brothers Finance S.A. In addition, as a
global investment bank, the Company is also a market-maker in a number of
foreign currencies and actively trades in the global commodity markets.
Counterparties to the Company's derivative product transactions are primarily
financial intermediaries (U.S. and foreign banks), securities firms,
corporations, governments and their agencies, finance companies, insurance
companies, investment companies and pension funds.
The Company manages the risks associated with derivatives on an aggregate basis,
along with the risks associated with its proprietary trading and market-making
activities in cash instruments, as part of its firmwide risk management
policies. For a further discussion of the Company's risk management policies
refer to Management's Discussion and Analysis pages 55-58.
The Company's Trading-Related Derivative Activities have increased during the
current year to a notional value of $1,855 billion at November 30, 1997 from
$1,517 billion at November 30, 1996, primarily as a result of growth in the
Company's activities as a dealer in fixed income derivative products. Notional
values are not recorded on the balance sheet and are not indicative of actual or
potential risk, but rather they provide a measure of the Company's involvement
with such instruments.
As a result of the Company's Trading-Related Derivative activities, the Company
is subject to credit risk. With respect to OTC derivative contracts, the
Company's credit exposure is directly with its counterparties and extends
through the duration of the derivative contracts. The Company views its net
credit exposure to be $5,252 million at November 30, 1997, representing the fair
value of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral and master netting agreements. Collateral held
related to OTC contracts generally includes cash and U.S. government and federal
agency securities. At November 30, 1997 approximately 77% of the Company's net
credit risk exposure related to OTC contracts was with counterparties rated "A-"
or better.
Additionally, the Company is exposed to credit risk related to its
exchange-traded derivative contracts. Exchange-traded derivative contracts
include futures contracts, warrants and certain options. Futures contracts and
options on futures are transacted on the respective exchange. The exchange
clearing house is a counterparty to the futures contracts and options. As a
clearing member firm, the Company is required by the exchange clearing house to
deposit cash or other securities as collateral for its obligation upon the
origination of the contract and for any daily changes in the market value of
open futures contracts. Unlike OTC derivatives which involve numerous
counterparties, the number of counterparties from exchange-traded derivatives
includes only those exchange clearing houses of which the Company is a clearing
member firm or other member firms the Company utilizes as agents. Substantially
all of the Company's exchange-traded derivatives are transacted on exchanges of
which the Company is a clearing member firm. To protect against the potential
for a default, all exchange clearing houses
LEHMAN BROTHERS 1997 ANNUAL REPORT
54
<PAGE> 20
impose net capital requirements for their membership. Therefore, the potential
for losses from exchange-traded products is limited. As of November 30, 1997,
the Company had approximately $1,177 million on deposit with futures exchanges
consisting of cash and securities (customer and proprietary), and had posted
approximately $221 million of letters of credit. Included within these amounts
was $458 million and $719 million of cash and securities related to domestic and
foreign futures exchanges, respectively, and $157 million and $64 million of
letters of credit to domestic and foreign exchanges, respectively. As of
November 30, 1997, the following significant amounts of cash and securities were
on deposit with foreign futures exchanges: $206 million with the Tokyo Stock
Exchange, $136 million with Deutsche Termin Boerse, $132 million with the Osaka
Securities Exchange, $69 million with the Singapore International Monetary
Exchange, $42 million with the London Clearing House, and $21 million with the
Marche a Terme International de France. In addition, the Company had letters of
credit of approximately $49 million on deposit with the London Clearing House.
See Note 11 to the Consolidated Financial Statements for a further discussion of
the Company's Trading-Related Derivative Activities.
Accounting and Valuation > The Company's accounting methodology for derivatives
depends on both the type and purpose of the derivative financial instrument. The
Company records its Trading-Related Derivative Activities on a mark-to-market or
fair value basis. Under mark-to-market or fair value accounting, realized and
unrealized gains and losses are recognized currently in Principal transactions,
and resulting assets and liabilities are recorded in the Consolidated Statement
of Financial Condition as Derivatives and other contractual agreements, as
applicable. Derivative assets and liabilities are netted by counterparty, when
permitted under a legally enforceable master netting agreement. Derivatives
utilized in conjunction with the Company's End User Derivative Activities are
generally recorded on an accrual basis. Interest is accrued into income or
expense over the life of the contract, resulting in the net interest impact of
the derivative and the underlying hedged item being recognized in income
throughout the hedge period.
Market or fair value for Trading-Related Derivative Activities is generally
determined by either quoted market prices or pricing models. Pricing models
utilize a series of market inputs to determine the present value of future cash
flows, with adjustments, as required, for credit risk, liquidity risk, and
ongoing costs. Further valuation adjustments may be recorded, as deemed
appropriate, for new or complex products or for significant positions. These
adjustments are integral components of the mark-to-market process.
================================================================================
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, information technology infrastructure
and systems.
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
LEHMAN BROTHERS 1997 ANNUAL REPORT
55
<PAGE> 21
concentrations. The Company seeks to achieve adequate returns from each of its
businesses commensurate with the risks that they assume. The Company
periodically reallocates capital to its businesses based on their ability to
obtain returns consistent with the established guidelines, opportunities in the
marketplace and the Company's long term strategy.
The Company's risk management strategy is headed by a Risk Management Committee
(the "Committee") comprised of the Chief Executive Officer, the Chief
Administrative Officer, Global Equity Division Head, Global Fixed Income
Division Head, European Senior Manager, Asian Senior Manager, Chief Financial
Officer, and Global Risk Manager. 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 reviews risk exposures, ratifies division risk limits and
signs-off on risk management guidelines. 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. Senior
management plays a critical role in the ongoing evaluation of risks and adjusts
risk management policies when necessary.
Overall risk management is based on a multi-tiered approach which includes many
independent groups (i.e., the Risk Management Committee, the Global Risk
Management Group, Operations, Audit, Finance, Legal and Treasury) that assist in
the identification, assessment and control of risk. Senior representatives from
these groups meet formally on a regular basis and on an ad hoc basis as
necessary.
Global Risk Management Group > The Global Risk Management Group (the "Group") is
independent of the trading areas and reports directly to the Chief Executive
Officer. The Group combines two disciplines, market risk management and credit
risk management, into one unit. This facilitates the analysis of market and
counterparty credit risk exposures and leverages personnel and information
technology resources in a cost-efficient manner. The Group also functions as the
executive branch of the Risk Management Committee. In addition to regular
meetings at the senior management level, the Group operates 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.
The Group 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. These methodologies have been
financially engineered across a global technology platform, enabling the Company
to view risk from a number of perspectives, from the trade level to the desk
level and, ultimately, across the Company. To ensure high standards of
qualitative analysis, the Company has retained seasoned market and credit risk
managers with the requisite experience, academic and professional credentials.
The Company is committed to ensuring that individuals within the Group are
qualified with the skills necessary to assess the Company's risk exposures.
The Group is responsible for the preparation and dissemination of risk reports,
developing and implementing the firmwide Risk Management Guidelines and
evaluating adherence to these guidelines. The purpose of market risk management
guidelines is to address the review and approval of risk limits, the monitoring
and reporting of risks against such limits, the reporting of risk limit
exceptions, the review and approval of risk limit exceptions, as well as
identifying the requisite authorities governing these processes. These
guidelines provide a clear framework for risk management decision-making. To
that end, the Group 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 Group also evaluates liquidity risks, credit and
sovereign concentrations.
LEHMAN BROTHERS 1997 ANNUAL REPORT
56
<PAGE> 22
Credit risk management is an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department"),
part of the Global Risk Management Group, has global responsibility for
establishing credit risk standards and defining the Company's overall credit
risk management framework. The Company recognizes that the credit "risk
appetite" is a finite resource and emphasizes the importance of allocating this
resource in such a way as to maximize the Company's profitability.
The CRM Department is independent from the business units and reports directly
to the Global Risk Manager, who, in turn, reports to the Chief Executive
Officer. Corporate Credit is a global department centered in and managed from
New York, with credit officers operating in each of the Company's regional
trading centers.
The CRM Department manages the credit exposure related to its 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 counterparty creditworthiness.
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 is present in cash products, derivatives, and
contingent claim structures that exhibit linear as well as nonlinear 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 equity division
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.
Interest Rate Risk. The Company incurs short-term interest rate risk when
facilitating the orderly flow of customer transactions through the management 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. 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.
Equity Price Risk. The Company is a significant intermediary in the global
equity markets by making markets 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
LEHMAN BROTHERS 1997 ANNUAL REPORT
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<PAGE> 23
its market valuation. Equity market risk is actively managed through the use of
index futures, exchange-traded and OTC options, swaps and cash investments.
Equity risk exposures are aggregated and reported to management on a regular
basis.
Foreign Exchange Risk. 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 German mark, Japanese
yen, British pound, Swiss franc, French franc, Canadian dollar and Italian lira.
The Company hedges its risk exposures primarily through the use of currency
forwards, swaps, futures, and options.
Value at Risk > For purposes of new Securities and Exchange Commission
disclosure requirements, the Company has elected to disclose an entity-wide
value at risk analysis of virtually all of the Company's trading activities. The
value at risk related to non-trading financial instruments has been excluded
from this analysis and not reported separately because the amounts were not
material. The value at risk calculation measures potential losses in expected
revenues and is based on a methodology which uses a one-day holding period and a
95% confidence level. Value at risk was measured by analyzing the distribution
of actual trading revenues during the year and assumes a relatively consistent
portfolio mix.
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. 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.
At November 30, 1997, the Company's value at risk for each component of market
risk, and in total was as follows (in millions):
<TABLE>
<CAPTION>
================================================================================
<S> <C>
Interest rate risk $12.2
Equity price risk 7.1
Foreign exchange risk 4.5
Diversification benefit (9.0)
- --------------------------------------------------------------------------------
Total Company $14.8
- --------------------------------------------------------------------------------
</TABLE>
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. The Company's
performance in mitigating this volatility is illustrated by the chart which
depicts the distribution of 1997 weekly trading revenue. The chart was prepared
from the weekly operating and financial performance report, one of the tools
used by senior management in the risk control process. Average weekly trading
revenue was $48.3 million in 1997. 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.
DISTRIBUTION OF 1997 WEEKLY TRADING REVENUE
In Millions
[Bar Graph Omitted]
LEHMAN BROTHERS 1997 ANNUAL REPORT
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<PAGE> 24
================================================================================
OTHER
- --------------------------------------------------------------------------------
Impact of the Year 2000 > The Year 2000 issue is the result of many computer
programs being written using two digits rather than four to define the
applicable year. Any of the Company's computer programs that have date-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions or engage in normal business activities.
The Company has determined that it will be required to modify or replace
portions of its software so that its computer systems will properly utilize
dates beyond December 31, 1999. The Company presently believes that with
modifications to existing software and conversions to new software, the Year
2000 issue will be mitigated. However, if such modifications and conversions are
not made, or are not completed on a timely basis, the Year 2000 issue could have
a material impact on the operations of the Company.
The Company has initiated formal communications with all of its suppliers
(hardware, software, market data, voice and data communications, facility
components and services) to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their respective Year
2000 issue. The Company has taken a lead in industry efforts to deal with the
Year 2000 issue by actively participating in the planning of industrywide
testing in 1998 and 1999. Industrywide testing is the forum in which firms
within the financial industry test the applications that transfer data between
them. However, there can be no guarantee that the systems of other companies on
which the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have a material adverse effect on the Company.
The Company will utilize both internal and external resources to reprogram, or
replace, and test software for Year 2000 modifications. The Company plans to
complete the Year 2000 project, including industrywide testing, no later than
August 1999.
The Company's total Year 2000 project cost includes the estimated costs and time
associated with the impact of a third party's Year 2000 issue, and are based on
presently available information. The total remaining cost of the Year 2000
project is estimated at approximately $60 million which will be funded through
operating cash flows and expensed as incurred over the next two and one-half
years. To date, the Company has incurred and expensed approximately $16 million
related to the Year 2000 project.
The costs of the project and the date on which the Company plans to complete the
Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
New Accounting Developments > In June 1996, the Financial Accounting Standards
Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS")
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" ("SFAS No. 125"), which is effective for
transactions occurring after December 31, 1996. In
LEHMAN BROTHERS 1997 ANNUAL REPORT
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<PAGE> 25
December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB Statement No. 125," which defers the effective date
until January 1, 1998 for certain provisions of SFAS No. 125.
SFAS No. 125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. Those
standards are based on consistent application of a financial component's
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes the financial assets
when control has been surrendered, and derecognizes liabilities when
extinguished. This statement provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings.
The Company expects that the full adoption of SEAS No. 125 will not result in
the material recognition of additional assets and liabilities on its
Consolidated Statement of Financial Condition, and will have no effect on the
equity or results of operations of the Company.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share" ("SFAS No.
128"). SFAS No. 128 simplifies the standards for computing earnings per share
and is effective for financial statements for both interim and annual periods
ending after December 15, 1997. Earlier application is not permitted. SFAS No.
128 will require the Company to present basic and dilutive earnings per share;
see Note 7 to the Consolidated Financial Statements for a discussion about the
impact.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
("SEAS No. 130"). SFAS No. 130 establishes standards for the reporting and
display of comprehensive income and its components in the financial statements.
SFAS No. 130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The adoption of SFAS No. 130 will have no
impact on the Company's consolidated statement of income, financial condition or
cash flows.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. Financial statement disclosures for prior
periods are required to be restated. The adoption of SFAS No. 131 will have no
impact on the Company's consolidated statement of income, financial condition or
cash flows.
In August 1997, the FASB released for comment portions of its proposed standard
entitled "Accounting for Derivative Instruments and for Hedging Activities" (the
"Draft Standard"). The Draft Standard provides comprehensive accounting guidance
for the recognition and measurement of derivatives and other similar financial
instruments used in hedging activities (collectively referred to as
"derivatives"). The Draft Standard also would require all derivatives to be
recorded on the Consolidated Statement of Financial Condition as assets or
liabilities at fair value. The Draft Standard also would require recognition of
changes in the fair value of derivatives either in net income or in a separate
component of stockholders' equity, depending on the designation of the
derivative. The accounting basis for the hedged item would be adjusted,
depending on
LEHMAN BROTHERS 1997 ANNUAL REPORT
60
<PAGE> 26
the designation of the derivative, by an amount offsetting the gain or loss on
the derivative instrument to the extent it is considered an effective hedge. As
currently proposed, the Company would be required to adopt this Draft Standard
in fiscal year 2000. The Company is monitoring the development of final rules
and their potential impact on the Company's accounting for its end user
activities.
In December 1996, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants released for comment a proposed
statement of position "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use" (the "Proposed SOP"). In December 1997, the FASB
gave approval for its final issuance, which is expected in the first calendar
quarter of 1998. The Proposed SOP would require the capitalization of certain
costs, incurred in connection with developing or obtaining software for internal
use. The Proposed SOP would be effective for years ending after December 15,
1998 with earlier application encouraged. When adopted, the rule would be
applied prospectively as of the beginning of an entity's fiscal year. The
Company is currently considering early adoption of these rules once they become
finalized.
Recent Developments > In December 1997, the Company, without admitting or
denying any wrongdoing, announced that it, along with 29 other broker-dealers
settled a class action alleging violations of the antitrust law with respect to
certain practices on the NASDAQ market, in the late 1980's and early 1990's,
primarily when the Firm operated as Shearson Lehman Brothers. The Company's
share of the settlement cost was approximately $95 million and was charged
against existing reserves. In addition, this amount may be reduced by a recovery
from a third party.
Effects of Inflation > Because the Company's assets are, to a large extent,
liquid in nature, they are not significantly affected by inflation. However, the
rate of inflation affects the Company's expenses, such as employee compensation,
office space leasing costs and communications charges, which may not be readily
recoverable in the price of services offered by the Company. To the extent
inflation results in rising interest rates and has other adverse effects upon
the securities markets, it may adversely affect the Company's financial position
and results of operations in certain businesses.
LEHMAN BROTHERS 1997 ANNUAL REPORT
61
<PAGE> 1
EXHIBIT 13.2
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of
Lehman Brothers Holdings Inc.
We have audited the accompanying consolidated statement of financial condition
of Lehman Brothers Holdings Inc. and Subsidiaries (the "Company") as of November
30, 1997 and 1996, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended November 30, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Lehman Brothers
Holdings Inc. at November 30, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
November 30, 1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
New York, New York
January 7, 1998
LEHMAN BROTHERS 1997 ANNUAL REPORT
62
<PAGE> 2
CONSOLIDATED STATEMENT OF INCOME
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------
1997 1996 1995
(in millions, except per share data)
==========================================================================================
<S> <C> <C> <C>
Revenues
Principal transactions $ 1,418 $ 1,579 $ 1,393
Investment banking 1,318 981 801
Commissions 423 362 450
Interest and dividends 13,635 11,298 10,788
Other 89 40 44
- ------------------------------------------------------------------------------------------
Total revenues 16,883 14,260 13,476
Interest expense 13,010 10,816 10,405
- ------------------------------------------------------------------------------------------
Net revenues 3,873 3,444 3,071
- ------------------------------------------------------------------------------------------
Non-interest expenses
Compensation and benefits 1,964 1,747 1,544
Brokerage, commissions and clearance fees 224 241 241
Professional services 173 150 159
Occupancy and equipment 141 151 174
Communications 141 147 180
Business development 103 101 110
Depreciation and amortization 86 91 105
Other 104 95 92
Severance charge 84
Restructuring charge 97
- ------------------------------------------------------------------------------------------
Total non-interest expenses 2,936 2,807 2,702
- ------------------------------------------------------------------------------------------
Income before taxes 937 637 369
Provision for income taxes 290 221 127
- ------------------------------------------------------------------------------------------
Net income $ 647 $ 416 $ 242
- ------------------------------------------------------------------------------------------
Net income applicable to common stock $ 572 $ 378 $ 200
- ------------------------------------------------------------------------------------------
Average common and common equivalent shares outstanding 121.1 116.4 113.4
- ------------------------------------------------------------------------------------------
Earnings per common share $ 4.72 $ 3.24 $ 1.76
- ------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
63
<PAGE> 3
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
NOVEMBER 30
------------------
(in millions) 1997 1996
================================================================================
<S> <C> <C>
Assets
Cash and cash equivalents $ 1,685 $ 2,149
Cash and securities segregated and on deposit
for regulatory and other purposes 1,149 688
Securities and other financial instruments owned:
Governments and agencies 33,037 26,638
Corporate stocks 10,877 6,937
Corporate debt and other 10,892 8,821
Mortgages and mortgage-backed 11,455 8,314
Derivatives and other contractual agreements 8,353 6,909
Certificates of deposit and other money market instruments 2,248 3,834
- --------------------------------------------------------------------------------
76,862 61,453
- --------------------------------------------------------------------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 43,606 32,340
Securities borrowed 14,146 20,651
Receivables:
Brokers, dealers and clearing organizations 2,193 2,878
Customers 9,105 5,813
Others 1,540 1,253
Property, equipment and leasehold improvements
(net of accumulated depreciation and amortization
of $735 in 1997 and $668 in 1996) 468 477
Other assets 787 722
Excess of cost over fair value of net assets
acquired (net of accumulated amortization
of $111 in 1997 and $103 in 1996) 164 172
- --------------------------------------------------------------------------------
Total assets $151,705 $128,596
================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
64
<PAGE> 4
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
NOVEMBER 30
-----------------------
(in millions, except share data) 1997 1996
=================================================================================================
<S> <C> <C>
Liabilities and Stockholders' Equity
Commercial paper and short-term debt $ 7,818 $ 8,202
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 16,201 13,202
Corporate stocks 4,293 4,971
Corporate debt and other 2,219 1,375
Derivatives and other contractual agreements 7,367 6,816
- -------------------------------------------------------------------------------------------------
30,080 26,364
- -------------------------------------------------------------------------------------------------
Collateralized short-term financing:
Securities sold under agreements to repurchase 63,204 56,119
Securities loaned 7,846 6,296
Payables:
Brokers, dealers and clearing organizations 2,155 1,004
Customers 11,702 7,582
Accrued liabilities and other payables 4,116 3,233
Long-term debt:
Senior notes 17,049 12,571
Subordinated indebtedness 3,212 3,351
- -------------------------------------------------------------------------------------------------
Total liabilities 147,182 124,722
- -------------------------------------------------------------------------------------------------
Commitments and contingencies
Stockholders' Equity
Preferred stock, $1.00 par value; 38,000,000 shares authorized:
5% Cumulative Convertible Voting, 13,000,000 shares authorized;
$39.10 liquidation preference per share
Series A - shares issued and outstanding: 33,050 in 1997
and 13,000,000 in 1996 1 508
Series B - shares issued and outstanding: 12,966,950 in 1997 507
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: 119,513,337 in 1997 and 106,793,538 in 1996;
shares outstanding: 116,612,074 in 1997 and 100,449,144 in 1996 12 11
Common stock issuable 155 326
Additional paid-in capital 3,436 3,198
Foreign currency translation adjustment 12 20
Retained earnings (accumulated deficit) 498 (43)
Common stock in treasury, at cost: 2,901,263 shares in 1997
and 6,344,394 shares in 1996 (98) (146)
- -------------------------------------------------------------------------------------------------
Total stockholders' equity 4,523 3,874
- -------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 151,705 $ 128,596
=================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
65
<PAGE> 5
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------
(in millions) 1997 1996 1995
========================================================================================
<S> <C> <C> <C>
Preferred Stock
5% Cumulative Convertible Voting, Series A:
Beginning balance $ 508 $ 508 $ 508
Series A exchanged for Series B (507)
- ----------------------------------------------------------------------------------------
Ending balance 1 508 508
- ----------------------------------------------------------------------------------------
5% Cumulative Convertible Voting, Series B:
Beginning balance
Series A exchanged for Series B 507
- ----------------------------------------------------------------------------------------
Ending balance 507
- ----------------------------------------------------------------------------------------
8.44% Cumulative Voting:
Beginning balance 200 200
Repurchase (200)
- ----------------------------------------------------------------------------------------
Ending balance 200
- ----------------------------------------------------------------------------------------
Redeemable Voting:
Beginning and ending balance
- ----------------------------------------------------------------------------------------
Total Preferred Stock, ending balance 508 508 708
- ----------------------------------------------------------------------------------------
Common stock
Beginning balance 11 11 11
Shares issued to RSU Trust 1
- ----------------------------------------------------------------------------------------
Ending balance 12 11 11
- ----------------------------------------------------------------------------------------
Common stock issuable
Beginning balance 326 211 87
RSUs amortized, net of cancellations 162 136 124
RSUs exchanged for Common Stock (8) (21)
Shares issued to RSU Trust (325)
- ----------------------------------------------------------------------------------------
Ending balance 155 326 211
- ----------------------------------------------------------------------------------------
Additional paid-in capital
Beginning balance 3,198 3,172 3,172
RSUs exchanged for Common Stock 8 21
Stock options exercised 33 6 1
Employee stock purchase plan (3) (3) (1)
Shares issued to RSU Trust 199
Other, net 1 2
- ----------------------------------------------------------------------------------------
Ending balance 3,436 3,198 3,172
- ----------------------------------------------------------------------------------------
Foreign currency translation adjustment
Beginning balance 20 9 6
Translation adjustment, net (1) (8) 11 3
- ----------------------------------------------------------------------------------------
Ending balance 12 20 9
- ----------------------------------------------------------------------------------------
Retained earnings (accumulated deficit)
Beginning balance (43) (397) (574)
Net income 647 416 242
Dividends declared:
5% Cumulative Convertible Voting Preferred Stock (25) (25) (25)
8.44% Cumulative Voting Preferred Stock (3) (17)
Redeemable Voting Preferred Stock (50) (8)
Common Stock (31) (24) (23)
Premium for repurchase of 8.44% Cumulative Voting
Preferred Stock (2)
- ----------------------------------------------------------------------------------------
Ending balance 498 (43) (397)
- ----------------------------------------------------------------------------------------
Common stock in treasury, at cost
Beginning balance (146) (16) (15)
Treasury stock purchased (77) (130) (1)
Shares issued to RSU Trust 125
- ----------------------------------------------------------------------------------------
Ending balance (98) (146) (16)
- ----------------------------------------------------------------------------------------
Total Stockholders' Equity $ 4,523 $ 3,874 $ 3,698
========================================================================================
</TABLE>
(1) Net of income taxes of $8 in 1997, $(11) in 1996, and $(2) in 1995.
See Notes to Consolidated Financial Statements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
66
<PAGE> 6
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------------
(in millions) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net Income $647 $416 $242
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 86 91 105
Severance charge 84
Restructuring charge 80
Provisions for losses and other reserves 52 42 38
Deferred tax provision (benefit) (60) 72 (195)
Other adjustments (50) 184 169
Net change in:
Cash and securities segregated and on deposit (461) 257 475
Securities and other financial instruments owned (15,409) (8,432) (5,548)
Securities purchased under agreements to resell (11,266) 3,894 1,256
Securities borrowed 6,505 (4,361) (5,673)
Receivables from brokers, dealers and clearing organizations 685 (1,318) 3,374
Receivables from customers (3,292) (2,336) (683)
Securities and other financial instruments sold but
not yet purchased 3,716 4,550 4,784
Securities sold under agreements to repurchase 7,085 (2,916) 616
Securities loaned 1,550 4,330 339
Payables to brokers, dealers and clearing organizations 1,151 (99) (1,494)
Payables to customers 4,120 1,821 2,368
Accrued liabilities and other payables 782 217 165
Other operating assets and liabilities, net (286) 107 1,436
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities ($4,445) ($3,397) $1,854
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
67
<PAGE> 7
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------------
(in millions) 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Financing Activities
Proceeds from issuance of senior notes $ 7,242 $ 4,455 $ 5,033
Principal payments of senior notes (2,548) (2,411) (3,725)
Proceeds from issuance of subordinated indebtedness 407 1,330 258
Principal payments of subordinated indebtedness (550) (246) (214)
Net proceeds from (payments for) commercial paper
and short-term debt (384) 1,981 (3,180)
Payment for repurchase of preferred stock (200)
Payments for treasury stock purchases (77) (130) (1)
Dividends paid (58) (55) (64)
Issuance of common stock 23 6 1
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 4,055 4,730 (1,892)
- ----------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchase of property, equipment and leasehold improvements (74) (58) (52)
- ----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (74) (58) (52)
- ----------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents (464) 1,275 (90)
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, beginning of period 2,149 874 964
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 1,685 $ 2,149 $ 874
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
Supplemental Disclosure of Cash Flow Information (in millions)
Interest paid totaled $12,900 in 1997, $10,852 in 1996 and $10,372 in 1995.
Income taxes paid totaled $371 in 1997, $79 in 1996 and $149 in 1995.
See Notes to Consolidated Financial Statements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
68
<PAGE> 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
================================================================================
note 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
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 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 consolidated financial statements are prepared in conformity with generally
accepted accounting principles which require management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Management believes that the estimates utilized in preparing
its financial statements are reasonable and prudent. Actual results could differ
from these estimates.
The Company uses the trade date basis of accounting.
Certain prior period amounts reflect reclassifications to conform to the current
period's presentation.
Translation of Foreign Currencies > Assets and liabilities of foreign
subsidiaries having non-U.S. dollar functional currencies are translated at
exchange rates at the statement of financial condition date. Revenues and
expenses are translated at average exchange rates during the period. The gains
or losses resulting from translating foreign currency financial statements into
U.S. dollars, net of hedging gains or losses and related tax effects, are
included in a separate component of stockholders' equity, the Foreign currency
translation adjustment. Gains or losses resulting from foreign currency
transactions are included in the Consolidated Statement of Income.
Securities and Other Financial Instruments > Securities and other financial
instruments owned and securities and other financial instruments sold but not
yet purchased are valued at market or fair value, as appropriate, with
unrealized gains and losses reflected in Principal transactions in the
Consolidated Statement of Income. Market value is generally based on listed
market prices. If listed market prices are not available, fair value is
determined based on other relevant factors, including broker or dealer price
quotations and valuation pricing models which take into account time value and
volatility factors underlying the financial instruments.
Derivative Financial Instruments > Derivatives, typically defined as instruments
whose value is "derived" from an underlying instrument, index or rate, include
futures, forwards, swaps and options and other similar instruments. A derivative
contract generally represents future commitments to exchange interest or other
payment streams based on the contract or notional amount or to purchase or sell
financial instruments at specified terms and future dates. 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
LEHMAN BROTHERS 1997 ANNUAL REPORT
69
<PAGE> 9
risks resulting from its trading activities in cash instruments (collectively,
"Trading-Related Derivative Activities"). The Company's accounting methodology
for derivatives depends on both the type and purpose of the derivative financial
instrument.
Derivative transactions entered into for Trading-Related Derivative Activities
are recorded at market or fair value with realized and unrealized gains and
losses reflected 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, liquidity risk and ongoing costs. Further valuation adjustments may be
recorded, as deemed appropriate for new or complex products or for significant
positions. These adjustments are integral components of the mark-to-market
process.
The market or fair value associated with derivatives utilized for trading
purposes is recorded in the Consolidated Statement of Financial Condition on a
net by counterparty basis where a legal right of set-off exists and is netted
across products and against cash collateral when such provisions are stated in
the master netting agreement. The market or fair value of swap agreements, caps
and floors, and forward contracts in an unrealized gain position, as well as
options owned and warrants held, are reported in the Consolidated Statement of
Financial Condition as assets in Derivatives and other contractual agreements.
Similarly, swap agreements, caps and floors, and forward contracts in an
unrealized loss position, as well as options written and warrants issued, are
reported in the Consolidated Statement of Financial Condition as liabilities in
Derivatives and other contractual agreements. Margin on futures contracts is
included in receivables and payables, as applicable.
In addition to Trading-Related Derivative Activities, the Company enters into
various derivative financial instruments for non-trading purposes as an end
user to modify the interest rate exposure of certain assets and liabilities. In
this regard, the Company utilizes interest rate and currency swaps, caps,
collars and floors to manage the interest rate exposure associated with its
long-term debt obligations and secured financing activities, including
securities purchased under agreements to resell, securities borrowed,
securities sold under agreements to repurchase and securities loaned.
The Company also utilizes cross-currency swaps to hedge its exposure to foreign
currency risk as a result of its non-U.S. dollar debt obligations, after
consideration of non-U.S. dollar assets which are funded with long-term debt
obligations in the same currency.
In addition to modifying the interest rate and foreign currency exposure of
existing assets and liabilities, the Company utilizes derivative financial
instruments as an end user to modify the interest rate characteristics of
certain anticipated transactions related to its secured financing activities,
where there is a high degree of certainty that the Company will enter into such
contracts. These derivative financial instruments are designated against
existing secured financing transactions based upon their applicable maturity.
The remaining term of the derivative financial instruments is designated against
anticipated secured financing transactions which will replace the existing
secured financing transactions upon maturity. The Company monitors the level of
secured financing transactions to ensure that there is a high degree of
certainty that it will enter into the anticipated secured financing transactions
at a level in excess of the designated derivative product transactions.
Derivatives that have been designated as non-trading related positions and are
effective in modifying the interest rate characteristics of existing assets and
liabilities or anticipated transactions are accounted for on an accrual basis.
Under the accrual basis, interest is accrued into income or expense over the
life of the contract, resulting in the net interest impact of the derivative
and the underlying hedged item being recognized in income throughout the hedge
period.
The Company monitors the effectiveness of its end user hedging activities by
periodically comparing the change in the value of the hedge instrument to the
underlying item being hedged and reassessing the likelihood of the occurrence of
anticipated
LEHMAN BROTHERS 1997 ANNUAL REPORT
70
<PAGE> 10
transactions. In the event that the Company determines that a hedge is no longer
effective, such as upon extinguishment of the underlying asset or liability or a
change in circumstances whereby there is not a high degree of certainty that the
anticipated transaction will occur, the derivative transaction is no longer
accounted for as a hedge. Instead, the Company immediately recognizes the market
or fair value of the derivative financial instrument through earnings. Changes
in the fair value of the derivative contract would then be accounted for as a
derivative used for trading purposes as discussed above. In the event that a
derivative designated as a hedge is terminated early, any realized gain or loss
on the termination would be deferred and amortized to interest income or
interest expense over the original period of the hedge.
Repurchase and Resale Agreements > Securities purchased under agreements to
resell and securities sold under agreements to repurchase, which are treated as
financing transactions for financial reporting purposes, are collateralized
primarily by government and government agency securities and are carried net by
counterparty, when permitted, at the amounts at which the securities will be
subsequently resold or repurchased plus accrued interest. It is the policy of
the Company to take possession of securities purchased under agreements to
resell. The Company monitors the market value of the underlying positions on a
daily basis as compared to the related receivable or payable balances, including
accrued interest. The Company requires counterparties to deposit additional
collateral or return collateral pledged as necessary, to ensure that the market
value of the underlying collateral remains sufficient. Securities and other
financial instruments owned that are sold under repurchase agreements are
carried at market value with changes in market value reflected in the
Consolidated Statement of Income.
Securities purchased under agreements to resell and securities sold under
agreements to repurchase for which the resale/repurchase date corresponds to
the maturity date of the underlying securities are accounted for as purchases
and sales, respectively. At November 30, 1997, such resale and repurchase
agreements that had not yet matured aggregated $3.0 billion and $279 million,
respectively.
Securities Borrowed and Loaned > Securities borrowed and securities loaned are
carried at the amount of cash collateral advanced or received plus accrued
interest. It is the Company's policy to value the securities borrowed and loaned
on a daily basis and to obtain additional cash as necessary to ensure such
transactions are adequately collateralized.
Income Taxes > The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for
Income Taxes." The Company recognizes the current and deferred tax consequences
of all transactions that have been recognized in the financial statements using
the provisions of the enacted tax laws. In this regard, deferred tax assets are
recognized for temporary differences that will result in deductible amounts in
future years and for tax loss carryforwards, if in the opinion of management, it
is more likely than not that the deferred tax asset will be realized. SFAS 109
requires companies to set up a valuation allowance for that component of net
deferred tax assets which does not meet the "more likely than not" criterion for
realization.
Property, Equipment and Leasehold Improvements > Property, equipment and
leasehold improvements are recorded at historical cost, net of accumulated
depreciation and amortization. Depreciation is recognized on a straight-line
basis over the estimated useful lives of the related assets. Leasehold
improvements are amortized over the lesser of their economic useful lives or the
terms of the underlying leases.
Goodwill > Excess of cost over fair value of net assets acquired (goodwill) is
amortized using the straight-line method over a period of 35 years and is
evaluated periodically for impairment. Goodwill is also reduced upon the
recognition of certain acquired net operating loss carryforward benefits.
Statement of Cash Flows > The Company defines cash equivalents as highly liquid
investments with original maturities of three months or less, other than those
held for sale in the ordinary course of business.
LEHMAN BROTHERS 1997 ANNUAL REPORT
71
<PAGE> 11
Earnings Per Common Share > Earnings per common share was computed by dividing
net income applicable to common stock by the weighted average number of shares
of common stock and common stock equivalents outstanding.
================================================================================
note 2 SHORT-TERM FINANCINGS
- --------------------------------------------------------------------------------
The Company obtains short-term financing on both a secured and unsecured basis.
The secured financing is obtained through the use of repurchase agreements and
securities loaned agreements, which are primarily collateralized by government,
agency and equity securities. The unsecured financing is generally obtained
through short-term debt and the issuance of commercial paper.
The Company's commercial paper and short-term debt financing is comprised of the
following:
<TABLE>
<CAPTION>
NOVEMBER 30
------------------
(in millions) 1997 1996
================================================================================
<S> <C> <C>
Commercial paper $3,866 $3,074
Short-term debt
Master notes 1,752 2,190
Bank loans 1,414 2,278
Payables to banks 786 660
- --------------------------------------------------------------------------------
Total $7,818 $8,202
- --------------------------------------------------------------------------------
</TABLE>
The Company's weighted average interest rates were as follows:
<TABLE>
<CAPTION>
NOVEMBER 30
------------------
1997 1996
================================================================================
<S> <C> <C>
Commercial paper(1) 5.9% 5.1%
Short-term debt(2) 4.7% 5.2%
Securities sold under agreements to repurchase 5.0% 5.1%
- --------------------------------------------------------------------------------
</TABLE>
(1) Including weighted average interest rates of 6.O% and 2.2% as of November
30, 1997 and 5.7% and 1.2% as of November 30, 1996 related to U.S. dollar and
non-U.S. dollar obligations, respectively.
(2) Including weighted average interest rates of 5.7% and 3.4% as of November
30, 1997 and 5.6% and 4.1% as of November 30,1996 related to U.S. dollar and
non-U.S. dollar obligations, respectively.
Holdings maintains a Revolving Credit Agreement (the "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 be extended to 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.
In addition, the Company maintains 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 six
months on a secured basis. Any loans outstanding on the commitment termination
date may be extended to the first anniversary of the commitment termination date
at the option of LBIE. The loans provided by the bank group are available in
several currencies, including U.S. dollar, British pound ster-
LEHMAN BROTHERS 1997 ANNUAL REPORT
72
<PAGE> 12
ling, Deutsche mark, ECU, French franc and Italian lira, as requested. The
Facility 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 either the Credit Agreement or the
Facility at November 30, 1997. The Company may use the Credit Agreement and
the Facility for general corporate purposes from time to time. The Company
maintained compliance with the applicable covenants for both the Credit
Agreement and the Facility at all times.
================================================================================
note 3 LONG-TERM DEBT
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
U.S. DOLLAR NON-U.S. DOLLAR
---------------------- --------------------- NOVEMBER 30
FIXED FLOATING FIXED FLOATING -----------------------
(in millions) RATE RATE RATE RATE 1997 1996
========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Senior Notes
Maturing in Fiscal 1997 $ 2,254
Maturing in Fiscal 1998 $ 1,738 $ 606 $ 100 $ 266 $ 2,710 2,532
Maturing in Fiscal 1999 1,526 532 964 185 3,207 2,418
Maturing in Fiscal 2000 2,178 1,159 171 121 3,629 1,932
Maturing in Fiscal 2001 594 218 43 170 1,025 603
Maturing in Fiscal 2002 1,137 1,026 50 785 2,998 924
December 1,2002 and thereafter 2,122 590 707 61 3,480 1,908
- ------------------------------------------------------------------------------------------------------------------------
Senior Notes 9,295 4,131 2,035 1,588 17,049 12,571
- ------------------------------------------------------------------------------------------------------------------------
Subordinated Indebtedness
Maturing in Fiscal 1997 550
Maturing in Fiscal 1998 350 9 359 360
Maturing in Fiscal 1999 334 334 334
Maturing in Fiscal 2000 192 192 192
Maturing in Fiscal 2001 200 200 200
Maturing in Fiscal 2002 250 41 291 250
December 1,2002 and thereafter 1,631 187 18 1,836 1,465
- ------------------------------------------------------------------------------------------------------------------------
Subordinated Indebtedness 2,957 237 18 3,212 3,351
- ------------------------------------------------------------------------------------------------------------------------
Long-Term Debt $12,252 $4,368 $2,053 $1,588 $20,261 $15,922
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Of the Company's long-term debt outstanding as of November 30, 1997, $842
million is repayable prior to maturity at the option of the holder, at par
value. These obligations are reflected in the above table as maturing at their
put dates, which range from fiscal 1998 to fiscal 2003, rather than at their
contractual maturities, which range from fiscal 2000 to fiscal 2026. In
addition, $1,031 million of the Company's long-term debt is redeemable prior to
maturity at the option of the Company under various terms and conditions. These
obligations are reflected in the above table at their contractual maturity
dates.
The Company's interest in 3 World Financial Center is financed with U.S. dollar
fixed rate senior notes totaling $236 million as of November 30, 1997. Of this
amount, $80 million was redeemed prior to maturity in December 1997 and is
reflected in the above table as maturing in fiscal 1998. These notes are
unconditionally guaranteed by American Express with a portion of these notes
being collateralized by certain mortgage obligations.
As of November 30, 1997, the Company had $7.3 billion available for the issuance
of debt securities under various shelf registrations and debt programs, which
includes $1.1 billion of issuance availability under the Company's Euro
medium-term note program.
LEHMAN BROTHERS 1997 ANNUAL REPORT
73
<PAGE> 13
As of November 30, 1997, the Company's U.S. dollar and non-U.S. dollar debt
portfolios included approximately $461 million and $269 million, respectively,
of debt for which the interest rates and/or redemption values or maturity have
been linked to the performance of various indices including industry baskets of
stocks or commodities. Generally, such rates are issued as floating rate notes
or the interest rates on such index notes are effectively converted to floating
rates based primarily on LIBOR through the use of interest rate and currency
swaps.
End User Derivative Activities > The Company utilizes a variety of derivative
products including interest rate and currency swaps as an end user to modify the
interest rate characteristics of its long-term debt portfolio. The Company
actively manages the interest rate exposure on its long-term debt portfolio to
more closely match the terms of its debt portfolio to the assets being funded
and to minimize interest rate risk. In addition, the Company utilizes
cross-currency swaps to hedge its exposure to foreign currency risk as a result
of its non-U.S. dollar debt obligations, after consideration of non-U.S. dollar
assets which are funded with long-term debt obligations in the same currency. In
certain instances, two or more derivative contracts may be utilized by the
Company to manage the interest rate nature and/or currency exposure of an
individual long-term debt issuance. In these cases, the notional value of the
derivative contracts may exceed the carrying value of the related long-term debt
issuance.
At November 30, 1997 and 1996, the notional values of the Company's interest
rate and currency swaps related to its long-term debt obligations were
approximately $17.3 billion and $15.1 billion, respectively. In terms of
notional amounts outstanding, these derivative products mature as follows:
<TABLE>
<CAPTION>
NOVEMBER 30
----------------------
(in millions) U.S. DOLLAR NON-U.S. DOLLAR CR0SS CURRENCY 1997 1996
==================================================================================================================
<S> <C> <C> <C> <C> <C>
Maturing in Fiscal 1997 $ 3,363
Maturing in Fiscal 1998 $ 2,253 $ 6 $ 333 $ 2,592 2,454
Maturing in Fiscal 1999 2,119 152 977 3,248 2,651
Maturing in Fiscal 2000 3,136 57 234 3,427 2,008
Maturing in Fiscal 2001 722 31 182 935 535
Maturing in Fiscal 2002 1,823 482 184 2,489 1,152
December 1, 2002 and thereafter 3,837 584 202 4,623 2,937
- ------------------------------------------------------------------------------------------------------------------
Total $13,890 $1,312 $2,112 $17,314 $15,100
- ------------------------------------------------------------------------------------------------------------------
Weighted average rate(1)
Receive rate 7.23% 6.10% 4.55% 6.82% 6.61%
Pay rate 6.52% 5.17% 6.27% 6.39% 6.11%
</TABLE>
(1) Weighted average interest rates were calculated utilizing non-U.S. dollar
interest rates, where applicable.
On an overall basis, the Company's long-term debt related end user derivative
activities resulted in reduced interest expense of approximately $68 million,
$81 million and $74 million in 1997, 1996 and 1995, respectively. In addition,
the Company's end user derivative activities resulted in the following changes
to the Company's mix of fixed and floating rate debt and effective weighted
average rates of interest:
LEHMAN BROTHERS 1997 ANNUAL REPORT
74
<PAGE> 14
<TABLE>
<CAPTION>
NOVEMBER 30, 1997
----------------------------------------------------------
LONG-TERM DEBT WEIGHTED AVERAGE(1)
------------------------ ------------------------------
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
(in millions) ACTIVITIES ACTIVITIES RATE ACTIVITIES
================================================================================
<S> <C> <C> <C> <C>
USD Obligations
Fixed rate $12,252 $ 308 7.54% 10.56%
Floating rate 4,368 18,334 6.18% 6.48%
- --------------------------------------------------------------------------------
16,620 18,642 7.18% 6.55%
- --------------------------------------------------------------------------------
Non-USD Obligations 3,641 1,619 4.97% 4.94%
- --------------------------------------------------------------------------------
Total $20,261 $20,261 6.78% 6.42%
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
NOVEMBER 30, 1996
----------------------------------------------------------
LONG-TERM DEBT WEIGHTED AVERAGE(1)
------------------------ ------------------------------
BEFORE AFTER CONTRACTUAL EFFECTIVE RATE
END USER END USER INTEREST AFTER END USER
(in millions) ACTIVITIES ACTIVITIES RATE ACTIVITIES
================================================================================
<S> <C> <C> <C> <C>
USD Obligations
Fixed rate $10,100 $ 529 7.84% 8.95%
Floating rate 2,779 14,633 6.02% 6.39%
- --------------------------------------------------------------------------------
12,879 15,162 7.45% 6.48%
- --------------------------------------------------------------------------------
Non-USD Obligations 3,043 760 4.23% 3.36%
- --------------------------------------------------------------------------------
Total $15,922 $15,922 6.83% 6.33%
- --------------------------------------------------------------------------------
</TABLE>
(1) Weighted average interest rates were calculated using non-U.S. dollar
interest rates, where applicable.
================================================================================
note 4 PREFERRED STOCK
- --------------------------------------------------------------------------------
Cumulative Convertible Voting, Series A and Series B > The Cumulative
Convertible Voting Preferred Stock, Series A and Series B (together the
"Convertible Voting Preferred") have a liquidation preference of $39.10 per
share. The Series A was issued in 1987. The Series B was issued in exchange for
the Series A, on July 11, 1997. As of November 30, 1997, 33,050 shares of the
Series A and 12,966,950 shares of the Series B were outstanding.
The holders of the Convertible Voting Preferred are entitled to receive
preferred dividends at an annual rate of 5%, on the liquidation preference,
payable quarterly before any dividends are paid to the holders of Common Stock.
The Company has the right to redeem up to 10,400,000 shares of the Convertible
Voting Preferred up to and including June 15, 1998. On June 16, 1998, the
Company will have the right to redeem up to 13,000,000 shares subject to
adjustment and restrictions on redemption when dividends are in arrears. Such
redemption will be at a price per preferred share equal to $39.10.
Each share of the Convertible Voting Preferred is convertible, at any time prior
to the date of redemption, into 0.3178313 of a share of Common Stock. The Series
A is convertible provided that at least 250,000 shares (or such lesser number of
such
LEHMAN BROTHERS 1997 ANNUAL REPORT
75
<PAGE> 15
shares then outstanding) are converted each time. Each share of the Series B is
convertible without limitations. In each case, the conversion rate at November
30, 1997 was $123.02.
As of November 30, 1997, Nippon Life held 9,163,683 shares of the Series B. The
remaining 3,836,317 shares of the Convertible Voting Preferred were held by
various institutional investors. During December 1997, Nippon Life exercised its
right to exchange the 9,163,683 shares of the Series B for American Express
Company ("American Express") common shares. As a result, American Express owns
9,163,683 shares of the Series B. The exercise had no impact on the Company's
capital.
Redeemable Voting > In 1994, Holdings issued the Redeemable Preferred Stock to
American Express and Nippon Life for $1,000. The holders of the Redeemable
Preferred Stock will be entitled to receive annual dividends through May 31,
2002 equal to 50% of the amount, if any, by which the Company's net income for
the preceding year exceeds $400 million, up to a maximum of $50 million,
prorated in the case of the last dividend period, which runs from December 1,
2001 to May 31, 2002. For the years ended November 30, 1997 and 1996, the
Company's net income of $647 million and $416 million, respectively, resulted in
the recognition of dividends in the amount of $50 million and $8 million,
respectively, on the Redeemable Voting Preferred Stock.
Holdings may not redeem shares of the Redeemable Preferred Stock prior to the
final dividend payment date. However, in the event of a change of control of the
Company, holders of the Redeemable Preferred Stock will have the right to
require Holdings to redeem all of this stock for an aggregate redemption price
equal to $200 million if such change of control occurs prior to November 30,
1998, declining $50 million per year in each of the four years thereafter. If a
change of control is not approved by a majority of the Company's Board of
Directors, the funds for redemption must be raised by an offering of the
Company's equity securities which are not redeemable. These shares are not
convertible into Common Stock.
================================================================================
note 5 COMMON STOCK
- --------------------------------------------------------------------------------
Changes in shares of Holdings' common stock (the "Common Stock") outstanding are
as follows:
<TABLE>
<CAPTION>
NOVEMBER 30
-----------------------------------------------
1997 1996 1995
==============================================================================================================
<S> <C> <C> <C>
Shares outstanding, beginning of period 100,449,144 104,565,875 104,537,690
Exercise of stock options and other share issuances 1,719,799 1,108,973 76,142
Treasury stock purchases (1,556,869) (5,225,704) (47,957)
Issuance of shares to the RSU Trust 16,000,000
- --------------------------------------------------------------------------------------------------------------
Shares outstanding, end of period 116,612,074 100,449,144 104,565,875
- --------------------------------------------------------------------------------------------------------------
</TABLE>
The Company has reserved for issuance approximately 4.1 million shares of Common
Stock for conversion of the Convertible Voting Preferred.
During the years ended November 30, 1997 and 1996, the Company repurchased or
acquired shares of its Common Stock in the open market and through an odd-lot
buy back program at an aggregate cost of approximately $77 million and $130
million, respectively. These shares are being reserved for future issuances
under employee stock-based compensation plans.
The Company established a trust (the "RSU Trust") in order to provide common
stock voting rights to employees who hold outstanding restricted stock units
("RSU"), in furtherance of the Company's stated goal when RSU awards were
initiated in
LEHMAN BROTHERS 1997 ANNUAL REPORT
76
<PAGE> 16
June 1994, to encourage employees to think and act like owners. The RSU Trust
was initially funded with a total of 16 million shares consisting of 5 million
treasury shares for RSU awards under the Employee Incentive Plan and 11 million
new issue shares of Common Stock for RSU awards under the 1994 Management
Ownership Plan. The establishment of the RSU Trust did not impact the total
number of shares used in the computation of earnings per common share because
the RSUs have historically been viewed as common stock equivalents for purposes
of these computations. Accordingly, there was no effect on total equity, net
income and earnings per share of the Company.
================================================================================
note 6 INCENTIVE PLANS
- --------------------------------------------------------------------------------
Employee Stock Purchase Plan > The Employee Stock Purchase Plan (the "ESPP")
allows employees to purchase Common Stock at a 15% discount from market value,
with a maximum of $25,000 in annual aggregate purchases by any one individual.
The number of shares of Common Stock authorized for purchase by eligible
employees is 6 million. As of November 30, 1997 and 1996, 1.6 million shares and
1.2 million shares, respectively, of Common Stock had been purchased by eligible
employees through the ESPP. The Company controls the dilutive impact of the ESPP
through open market purchases.
1994 Incentive Plans > The 1994 Management Replacement Plan (the "Replacement
Plan") provided awards similar to the American Express common shares granted to
Company employees which were canceled as of the date of the spin-off from
American Express. Through November 30, 1997, a total of 2.0 million awards had
been granted under the Replacement Plan, including both stock options and
restricted stock; 0.6 million were outstanding at November 30, 1997. No future
awards will be granted under this plan.
The Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (the "1994
Plan") provides for the issuance of RSUs, performance stock units ("PSUs"),
stock options and other equity awards for a period of up to ten years to
eligible employees. A total of 16.6 million shares of Common Stock may be
granted under the 1994 Plan. At November 30, 1997, RSU and stock option awards
with respect to 15.6 million shares of Common Stock have been made under the
1994 Plan of which 14.0 million are outstanding and 1.6 million have been
converted to freely transferable Common Stock. The Company will utilize the
remaining authorization of 1.0 million shares to satisfy dividend reinvestment
requirements for outstanding awards and to fund the annual RSU awards for the
Company's non-employee directors.
1996 Management Ownership Plan > During 1996, the Company's stockholders
approved the 1996 Management Ownership Plan (the "1996 Plan") under which awards
similar to those of the 1994 Plan may be granted and under which up to 10
million shares of Common Stock may be subject to awards. At November 30, 1997,
RSU and stock option awards with respect to 4.4 million shares of Common Stock
have been made under the 1996 Plan, of which 4.3 million are outstanding and 0.1
million have been converted to freely transferable Common Stock.
Employee Incentive Plan > The Employee Incentive Plan ("EIP") has provisions
similar to the 1994 Plan and the 1996 Plan and authorization for up to 30
million shares of Common Stock which may be subject to awards. The Company
controls the dilutive impact of these awards through open market purchases. At
November 30, 1997, awards with respect to 19.1 million shares of Common Stock
have been made under the EIP of which 19.0 million are outstanding and 0.1
million have been converted to freely transferable Common Stock. Approximately
16.0 million of the outstanding awards consist of RSUs which have vesting and
transfer restrictions extending through the year 2004.
LEHMAN BROTHERS 1997 ANNUAL REPORT
77
<PAGE> 17
The following is a summary of RSUs outstanding under Holdings' stock-based
incentive plans:
<TABLE>
<CAPTION>
========================================================================================================================
RESTRICTED STOCK UNITS
- ------------------------------------------------------------------------------------------------------------------------
1994 1996
PLAN PLAN EIP TOTAL
========================================================================================================================
<S> <C> <C> <C> <C>
Balance, November 30, 1994 4,605,105 4,605,105
- ------------------------------------------------------------------------------------------------------------------------
Granted 8,021,784 2,039,220 10,061,004
Canceled (586,092) (586,092)
- ------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1995 12,040,797 2,039,220 14,080,017
- ------------------------------------------------------------------------------------------------------------------------
Granted 419,614 7,130,720 7,550,334
Canceled (801,614) (405,575) (1,207,189)
Exchanged for stock without restrictions (474,222) (474,222)
- ------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1996 11,184,575 8,764,365 19,948,940
- ------------------------------------------------------------------------------------------------------------------------
Granted 1,814,685 1,332,250 8,810,609 11,957,544
Canceled (846,191) (1,530,562) (2,376,753)
Exchanged for stock without restrictions (254,894) (139,371) (55,825) (450,090)
- ------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1997 11,898,175 1,192,879 15,988,587 29,079,641
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
Eligible employees receive RSUs as a portion of their total compensation in lieu
of cash. There is no further cost to employees associated with the RSU awards.
The Company records compensation expense for RSUs based on the market value of
its Common Stock and the applicable vesting provisions. RSU awards made to
employees have various vesting provisions and generally convert to unrestricted
freely transferable Common Stock five years from the grant date. Holdings pays a
dividend equivalent on each RSU outstanding based on dividends paid on its
Common Stock.
Of the RSUs outstanding at November 30, 1997, approximately 13.8 million RSUs
were vested, approximately 1.4 million RSUs will vest during fiscal 1998, and
the remaining RSUs will vest subsequent to November 30, 1998.
Total compensation cost recognized during 1997 and 1996 for the Company's
stock-based awards was approximately $162 million and $136 million,
respectively.
In addition to the RSUs included in the above table, as of December 31,1997, the
Company has awarded PSUs under the 1996 Plan and under the EIP to certain senior
officers. The number of PSUs which may be earned is dependent upon the
achievement of certain performance levels within predetermined performance
periods. At the end of a performance period, any PSUs earned will convert
one-for-one to RSUs which then vest in three, four or five years. As of December
31,1997, approximately 1.7 million PSUs have been earned to date, subject to
vesting and transfer restrictions. The compensation cost for the RSUs payable in
satisfaction of PSUs is accrued over the combined performance and vesting
periods.
LEHMAN BROTHERS 1997 ANNUAL REPORT
78
<PAGE> 18
================================================================================
STOCK OPTIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
1994 REPLACEMENT 1996 EXERCISE EXPIRATION
PLAN PLAN PLAN EIP TOTAL PRICE DATES
=========================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, November 30, 1994 1,960,720 1,789,769 3,750,489 $ 18.00 2/95-5/04
- -------------------------------------------------------------------------------------------------------------------------
Granted 1,125,000 1,400,000 2,525,000 $ 20.875 10/00
Exercised (68,996) (68,996) $ 18.00
Canceled (7,040) (291,588) (298,628) $ 18.00
- -------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1995 3,078,680 1,429,185 1,400,000 5,907,865 $ 18.68 5/96-5/04
- -------------------------------------------------------------------------------------------------------------------------
Granted 825,000 2,650,000 3,475,000 $ 24.16 3/01-5/01
Exercised (93,333) (251,909) (345,242) $ 18.00
Canceled (116,667) (22,247) (850,000) (988,914) $ 22.83
- -------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1996 2,868,680 1,155,029 825,000 3,200,000 8,048,709 $ 20.58 2/97-5/04
- -------------------------------------------------------------------------------------------------------------------------
Granted 2,250,000 2,250,000 $ 30.52 1/02-3/02
Exercised (743,040) (521,192) (1,264,232) $ 18.85
Canceled (4,943) (150,000) (154,943) $ 23.81
- -------------------------------------------------------------------------------------------------------------------------
Balance, November 30, 1997 2,125,640 628,894 3,075,000 3,050,000 8,879,534 $ 23.64 1/98-5/04
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
At November 30, 1997 and 1996, approximately 8.9 million and 2.6 million stock
options, respectively, were exercisable at weighted-average prices of $23.64 and
$18.00, respectively. The weighted average remaining contractual life of the
stock options outstanding at November 30, 1997 is 3.3 years. The exercise price
for all stock options awarded has been equal to 100% of the market price of
Common Stock on the day of grant. As a result of Holdings' stock price exceeding
specific target prices, all stock options outstanding as of November 30, 1997
are exercisable.
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"). SFAS No. 123
establishes financial accounting and reporting standards for stock-based
employee compensation plans. The financial accounting standards of SFAS No. 123
permit companies to either continue accounting for stock-based compensation
under existing rules or adopt SFAS No. 123 and begin reflecting the fair value
of stock options and other forms of stock-based compensation in the results of
operations as additional expense. The disclosure requirements of SFAS No. 123
require companies which elect not to record the fair value in the Consolidated
Statement of Income to provide pro forma disclosures of net income and earnings
per share in the notes to the consolidated financial statements as if the fair
value of stock-based compensation had been recorded.
The Company will continue to follow Accounting Principles Board No. 25 and its
related interpretations in accounting for its stock-based compensation plans.
Accordingly, no compensation cost has been recognized in the Consolidated
Statement of Income for its stock option awards and employee stock purchase
plan.
The Company utilized the Black-Scholes option-pricing model to quantify the pro
forma effects on net income and earnings per common share of the fair value of
the stock options granted during 1997 and 1996. Based on the results of the
model, the fair value of the stock options granted was $7.14 and $5.41 for 1997
and 1996, respectively. The weighted average assumptions which were used for
1997 and 1996 included risk-free interest rates of 6.14% and 5.35%,
respectively, an expected life of 3 years for both years and expected volatility
of 29% for both years. In addition, annual dividends of $0.24 (increasing 10%
per year beginning in 1998) and $0.20 were assumed for the 1997 and 1996
options, respectively.
LEHMAN BROTHERS 1997 ANNUAL REPORT
79
<PAGE> 19
The Company's 1997 and 1996 pro forma net income would have been $629 million
and $413 million, respectively, compared to actual net income of $647 million
and $416 million, respectively. Pro forma earnings per common share for 1997 and
1996 would have been $4.57 and $3.22, respectively compared to actual earnings
per common share of $4.72 and $3.24, respectively. The pro forma amounts reflect
the effects of the 1997 and 1996 stock option grants and the 15% purchase
discount from market value offered to the Company's employees who participate in
the ESPP. The pro forma effect in 1997 increased compared to 1996 due to all
stock options becoming exercisable in 1997.
================================================================================
note 7 EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
The weighted average number of shares of common stock and common stock
equivalents included in the calculations of earnings per common share is as
follows:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
------------------------------------------------
1997 1996 1995
================================================================================
<S> <C> <C> <C>
Common stock 105,193,272 101,548,947 104,535,218
Common stock issuable 13,812,029 13,779,315 8,420,122
Other share equivalents 2,059,628 1,045,323 459,344
- --------------------------------------------------------------------------------
Total 121,064,929 116,373,585 113,414,684
- --------------------------------------------------------------------------------
</TABLE>
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 No. 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 income 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 SFAS No. 128, basic EPS would have been $0.37, $0.26 and $0.06
higher than the amounts reported for 1997, 1996 and 1995, respectively. Diluted
EPS would have been the same as the reported amounts.
================================================================================
note 8 CAPITAL REQUIREMENTS
- --------------------------------------------------------------------------------
The Company operates globally through a network of subsidiaries with several
subject to regulatory requirements. In the United States, LBI, as a registered
broker-dealer, is subject to the Securities and Exchange Commission ("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 November 30, 1997, LBI's
regulatory net capital, as defined, of $1,484 million exceeded the minimum
requirement by $1,359 million.
In addition to amounts presented in the accompanying Consolidated Statement of
Financial Condition as cash and securities segregated and on deposit for
regulatory and other purposes, securities with a market value of approximately
$1,290 million and $345 million at November 30, 1997 and 1996, respectively,
primarily collateralizing securities purchased under agreements to resell, have
been segregated in a special reserve bank account for the exclusive benefit of
customers pursuant to the Reserve Formula requirements of SEC Rule 15c3-3.
LEHMAN BROTHERS 1997 ANNUAL REPORT
80
<PAGE> 20
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 November 30, 1997, LBIE's financial resources of approximately $2.3
billion exceeded the minimum requirement by approximately $500 million. 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 November 30,
1997, had net capital of approximately $400 million which was approximately $100
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 November 30,
1997, these other subsidiaries were in compliance with their applicable local
capital adequacy requirements. The Company's "AAA" rated derivatives subsidiary,
Lehman Brothers Financial Products Inc. ("LBFP"), has established certain
capital and operating restrictions which are reviewed by various rating
agencies. At November 30, 1997, LBFP had capital which exceeded the requirement
of the most stringent rating agency by approximately $100 million.
The regulatory rules referred to above, and certain covenants contained in
various debt agreements may restrict Holdings' ability to withdraw capital from
its regulated subsidiaries, which in turn could limit its ability to pay
dividends to shareholders. At November 30, 1997, approximately $2.9 billion of
net assets of subsidiaries were restricted as to the payment of dividends to
Holdings.
================================================================================
note 9 EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
The Company provides various pension plans for the majority of its employees
worldwide. In addition, the Company provides certain other postretirement
benefits, primarily health care and life insurance to eligible employees. The
following summarizes these plans:
Pension Plans > The Company sponsors several noncontributory defined benefit
pension plans which cover substantially all employees. The cost of pension
benefits for eligible employees, measured by length of service, compensation and
other factors, is currently being funded through trusts established under the
plans. Funding of retirement costs for the applicable plans complies with the
minimum funding requirements specified by the Employee Retirement Income
Security Act of 1974, as amended, and other statutory requirements.
Net (income) expense related to pension benefits for 1997, 1996 and 1995
consisted of the following components:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------
(in millions) 1997 1996 1995
================================================================================
<S> <C> <C> <C>
Service cost--benefits earned during the period $ 22 $ 18 $ 13
Interest cost on projected benefit obligation 36 34 31
Actual return on plan assets (91) (101) (77)
Net amortization and deferral 27 47 36
- --------------------------------------------------------------------------------
Net (income) expense $ (6) $ (2) $ 3
- --------------------------------------------------------------------------------
</TABLE>
Plan assets within the trusts consist principally of equities and bonds. The
actual return on plan assets for 1997, 1996 and 1995 reflects the favorable
market environments in those years. In addition, Company contributions increased
assets under investment in 1997, 1996 and 1995.
LEHMAN BROTHERS 1997 ANNUAL REPORT
81
<PAGE> 21
The following table sets forth the funded status of the Company's defined
benefit plans:
<TABLE>
<CAPTION>
NOVEMBER 30
------------------
(in millions) 1997 1996
================================================================================
<S> <C> <C>
Actuarial present value of benefit obligations
Vested benefit obligation $(526) $(452)
- --------------------------------------------------------------------------------
Accumulated benefit obligation $(530) $(456)
- --------------------------------------------------------------------------------
Projected benefit obligation $(560) $(480)
Plan assets at fair value 747 667
- --------------------------------------------------------------------------------
Plan assets in excess of projected benefit obligation 187 187
Unrecognized net loss 39 20
- --------------------------------------------------------------------------------
Prepaid pension asset recognized in the
Consolidated Statement of Financial Condition $226 $207
- --------------------------------------------------------------------------------
</TABLE>
The weighted average assumed discount rate used in determining the actuarial
present value of the projected benefit obligation for the Company's plans was
7.2% and 7.5% in 1997 and 1996, respectively. The weighted average rate of
increase in future compensation levels used was 5.1% and 5.0% for 1997 and 1996,
respectively. The weighted average expected long-term rate of return on assets
was 9.3% in 1997, 9.5% in 1996 and 9.75% in 1995.
Postretirement Benefits > The Company sponsors several defined benefit health
care plans that provide health care, life insurance and other postretirement
benefits to substantially all eligible retired employees. The health care plans
include participant contributions, deductibles, co-insurance provisions and
service-related eligibility requirements. The Company funds the cost of these
benefits as they are incurred.
Net periodic postretirement benefits cost for 1997, 1996 and 1995 consisted of
the following components:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------
(in millions) 1997 1996 1995
================================================================================
<S> <C> <C> <C>
Service cost $ 1 $ 1 $ 1
Interest cost 3 3 4
Amortization of unrecognized net reduction in
prior service cost and unrecognized gain (2) (1) (1)
- --------------------------------------------------------------------------------
Net periodic postretirement benefits cost $ 2 $ 3 $ 4
- --------------------------------------------------------------------------------
</TABLE>
The following table sets forth the amount recognized in the Consolidated
Statement of Financial Condition for the Company's postretirement benefit plans
(other than pension plans):
<TABLE>
<CAPTION>
NOVEMBER 30
------------------
(in millions) 1997 1996
================================================================================
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees $36 $36
Fully eligible active plan participants 3 3
Other active plan participants 10 10
- --------------------------------------------------------------------------------
49 49
- --------------------------------------------------------------------------------
Unrecognized net gain 22 21
Unrecognized net reduction in prior service cost 7 8
- --------------------------------------------------------------------------------
Accrued postretirement liability recognized in the
Consolidated Statement of Financial Condition $78 $78
- --------------------------------------------------------------------------------
</TABLE>
LEHMAN BROTHERS 1997 ANNUAL REPORT
82
<PAGE> 22
The discount rate used in determining the accumulated postretirement benefit
obligation was 7.0% and 7.5% in 1997 and 1996, respectively.
The annual assumed health care cost trend rate is 8.5% for the year ended
November 30, 1998 and is assumed to decrease at the rate of 0.5% per year to
5.5% in the year ended November 30, 2004 and remain at that level thereafter. An
increase in the assumed health care cost trend rate by one percentage point in
each period would increase the accumulated postretirement benefit obligation as
of November 30, 1997 by approximately $5 million.
================================================================================
note 10 INCOME TAXES
- --------------------------------------------------------------------------------
The Company files a consolidated U.S. federal income tax return reflecting the
income of Holdings and its subsidiaries. The provision for income taxes consists
of the following:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------
(in millions) 1997 1996 1995
================================================================================
<S> <C> <C> <C>
Current
Federal $110 $(20) $170
State 58 36 80
Foreign 182 133 72
- --------------------------------------------------------------------------------
350 149 322
- --------------------------------------------------------------------------------
Deferred
Federal (6) 61 (144)
State (4) 11 (51)
Foreign (50)
- --------------------------------------------------------------------------------
$290 $221 $127
- --------------------------------------------------------------------------------
</TABLE>
Income before taxes included $121 million, $335 million and $173 million that is
subject to income taxes of foreign jurisdictions for 1997, 1996 and 1995,
respectively
The income tax provision (benefit) differs from that computed by using the
statutory federal income tax rate for the reasons shown below:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED NOVEMBER 30
-------------------------------
(in millions) 1997 1996 1995
================================================================================
<S> <C> <C> <C>
Federal income taxes at statutory rate $328 $223 $129
State and local taxes 35 31 18
Tax-exempt income (60) (24) (31)
Amortization of goodwill 3 3 2
Foreign operations (3) (26) (1)
Other, net (13) 14 10
- --------------------------------------------------------------------------------
$290 $221 $127
- --------------------------------------------------------------------------------
</TABLE>
Deferred income taxes are provided for the differences between the tax bases of
assets and liabilities and their reported amounts in the consolidated financial
statements. These temporary differences will result in future income or
deductions for income tax purposes and are measured using the enacted tax rates
that will be in effect when such items are expected to reverse. The Company
provides deferred income taxes on undistributed earnings of foreign
subsidiaries.
LEHMAN BROTHERS 1997 ANNUAL REPORT
83
<PAGE> 23
At November 30, 1997 and 1996 the deferred tax assets and liabilities consisted
of the following:
<TABLE>
<CAPTION>
NOVEMBER 30
-------------------
(in millions) 1997 1996
==============================================================================================
<S> <C> <C>
Deferred tax assets
Reserves not currently deductible $185 $245
Deferred compensation 325 258
Tax return NOLs 15 66
Other 10 26
- ----------------------------------------------------------------------------------------------
535 595
Less: Valuation allowance 43 83
- ----------------------------------------------------------------------------------------------
Total deferred tax assets net of valuation allowance $492 $512
- ----------------------------------------------------------------------------------------------
Deferred tax liabilities
Undistributed earnings of foreign subsidiaries (net of credits) $ 7 $ 23
Excess tax over financial depreciation 112 102
Unrealized trading and investment activity 8 88
Pension and retirement costs 46 41
Other 4 4
- ----------------------------------------------------------------------------------------------
Total deferred tax liabilities $177 $258
- ----------------------------------------------------------------------------------------------
Net deferred tax asset $315 $254
- ----------------------------------------------------------------------------------------------
</TABLE>
The net deferred tax assets are included in Other assets in the accompanying
Consolidated Statement of Financial Condition. At November 30, 1997, the
valuation allowance recorded against deferred tax assets was $43 million
compared to $83 million at November 30, 1996, of which approximately $27 million
and $51 million, respectively, will reduce goodwill if future circumstances
permit recognition. The Company's Consolidated Statement of Income includes a
$10 million benefit from the reversal of a portion of this valuation allowance;
the remaining decrease in the valuation allowance is associated with a
corresponding decrease in the Company's net deferred tax asset.
For tax return purposes, the Company has approximately $44 million of NOL
carryforwards, substantially all of which are attributable to the 1988
acquisition of EF Hutton Group, Inc. (now known as LB I Group Inc.).
Substantially all of the NOLs are scheduled to expire in the years 1999 through
2009.
================================================================================
note 11 DERIVATIVE FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
Derivatives are financial instruments whose value is based upon an underlying
asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g.,
LIBOR). Over-the-counter ("OTC") derivative products are privately negotiated
contractual agreements that can be tailored to meet individual client needs and
include forwards, swaps and certain options including caps, collars and floors.
Exchange-traded derivative products are standardized contracts transacted
through regulated exchanges and include futures and certain option contracts
listed on an exchange.
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
risk resulting from its trading activities in cash instruments (collectively,
"Trading-Related Derivative Activities"). As an end user, the Company primarily
enters into interest rate swap and option contracts to adjust the interest rate
nature of its funding sources from fixed to floating rates and vice versa, and
to change the index upon which floating interest rates are based (e.g., Prime to
LIBOR) (collectively, "End User Derivative Activities").
LEHMAN BROTHERS 1997 ANNUAL REPORT
84
<PAGE> 24
There is an extensive volume of derivative products available in the marketplace
which can vary from a simple forward foreign exchange contract to a complex
derivative instrument with multiple risk characteristics involving the
aggregation of the risk characteristics of a number of derivative product types
including swap products, options and forwards. Listed below are examples of
various derivative product types along with a brief discussion of the
performance mechanics of certain specific derivative instruments.
Swap Products > Interest rate swap products include interest rate and currency
swaps, leveraged swaps, swap options and other interest rate option products
including caps, collars and floors. An interest rate swap is a negotiated OTC
contract in which two parties agree to exchange periodic interest payments for a
defined period, calculated based upon a predetermined notional amount. Interest
payments are usually exchanged on a net basis throughout the duration of the
swap contract. A currency swap is an OTC agreement to exchange a fixed amount of
one currency for a specified amount of a second currency at the outset and
completion of the swap term. Leveraged swaps involve the multiplication of the
interest rate factor upon which the interest payment streams are based (i.e.,
Party A pays 3 times the six month LIBOR). Caps are contractual commitments that
require the writer to pay the purchaser the amount by which an interest
reference rate exceeds a defined contractual rate, if any, at specified times
during the contract. Conversely, a floor is a contractual commitment that
requires the writer to pay the amount by which a defined contractual rate
exceeds an interest reference rate at specified times over the life of the
contract, if any.
Equity swaps are contractual agreements whereby one party agrees to receive the
appreciation (or depreciation) value over a strike price on an equity investment
in return for paying another rate, which is usually based upon equity index
movements or interest rates. Commodity swaps are contractual commitments to
exchange the fixed price of a commodity for a floating price (which is usually
the prevailing spot price) throughout the swap term.
Options > Option contracts provide the option purchaser (holder) with the right
but not the obligation to buy or sell a financial instrument, commodity or
currency at a predetermined exercise price (strike price) during a defined
period (American Option) or at a specified date (European Option). The option
purchaser pays a premium to the option seller (writer) for the right to exercise
the option. The option seller is obligated to buy (call) or sell (put) the item
underlying the contract at a set price, if the option purchaser chooses to
exercise. Option contracts also exist for various indices and are similar to
options on a security or other instrument except that, rather than settling
physical with delivery of the underlying instrument, they are cash settled. As a
purchaser of an option contract, the Company is subject to credit risk, since
the counterparty is obligated to make payments under the terms of the option
contract, if the Company exercises the option. As the writer of an option
contract, the Company is not subject to credit risk but is subject to market
risk, since the Company is obligated to make payments under the terms of the
option contract if exercised.
Option contracts may be exchange-traded or OTC. Exchange-traded options are the
obligations of the exchange and generally have standardized terms and
performance mechanics. In contrast, all of the terms of an OTC option including
the method of settlement, term, strike price, premium and security are
determined by negotiation of the parties.
Futures and Forwards > Futures contracts are exchange-traded contractual
commitments to either receive (purchase) or deliver (sell) a standard amount or
value of a financial instrument or commodity at a specified future date and
price. Maintaining a futures contract requires the Company to deposit with the
exchange an amount of cash or other specified asset as security for its
obligation. Additionally, futures exchanges generally require the daily cash
settlement of unrealized gains/losses on open contracts with the futures
exchange. Therefore, futures contracts provide a reduced funding alternative to
purchasing the underlying cash position in the marketplace. Futures contracts
may be settled by physical delivery of the underlying asset or cash settlement
(for index futures) on the settlement date or by entering into an offsetting
futures contract with the futures exchange prior to the settlement date.
LEHMAN BROTHERS 1997 ANNUAL REPORT
85
<PAGE> 25
Forwards are OTC contractual commitments to purchase or sell a specified amount
of a financial instrument, foreign currency or commodity at a future date at a
predetermined price. TBAs are forward contracts which give the purchaser/seller
an obligation to obtain/deliver mortgage securities in the future. Therefore,
TBAs subject the holder to both interest rate risk and principal prepayment
risk.
Trading-Related Derivative Activities > Derivatives are subject to various risks
similar to other financial instruments including market, credit and operational
risk. In addition, the Company may also be exposed to legal risks related to its
derivative activities including the possibility that a transaction may be
unenforceable under applicable law. The risks of derivatives should not be
viewed in isolation, but rather should be considered on an aggregate basis along
with the Company's other trading-related activities. The Company manages the
risks associated with derivatives on an aggregate basis along with the risks
associated with its proprietary trading and market-making activities in cash
instruments as part of its firmwide risk management policies.
Derivatives are generally based upon notional values. Notional values are not
recorded on-balance sheet, but rather are utilized solely as a basis for
determining future cash flows to be exchanged. Therefore, notional amounts
provide a measure of the Company's involvement with such instruments, but are
not indicative of actual or potential risk.
The following table reflects the notional/contract value of the Company's
Trading-Related Derivative Activities:
<TABLE>
<CAPTION>
==========================================================================================
TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS
- ------------------------------------------------------------------------------------------
1997
NOTIONAL/CONTRACT VALUE WEIGHTED
------------------------- AVERAGE
NOVEMBER 30 NOVEMBER 30 MATURITY
(in millions) 1997 1996 (IN YEARS)
==========================================================================================
<S> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $ 961,762 $ 686,932 4.53
Foreign exchange forward and future
contracts and options 478,899 378,314 .40
Other fixed income securities contracts
(including futures contracts and options),
mortgage-backed securities forward
contracts and options 364,009 374,048 .91
Equity contracts (including equity swaps,
futures, warrants and options) 40,522 30,582 .94
Commodity contracts (including swaps,
futures, forwards and options) 10,292 46,946 .78
- ------------------------------------------------------------------------------------------
Total $1,855,484 $1,516,822 2.65
- ------------------------------------------------------------------------------------------
</TABLE>
Of the total notional value at November 30, 1997 and 1996, approximately $1,615
billion and $1,186 billion are over-the-counter and $240 billion and $331
billion are exchange-traded, respectively. The total weighted average maturity
at November 30, 1997, for over-the-counter and exchange-traded contracts was
2.93 years and 0.77 years, respectively. Approximately $952 billion of the
notional/contract value of the Company's Trading-Related Derivative Activities
mature within the year ended November 30, 1998, of which approximately 34% have
maturities of less than one month.
The Company records its Trading-Related Derivative Activities on a
mark-to-market basis with realized and unrealized gains and losses recognized
currently in Principal transactions in the Consolidated Statement of Income.
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 and against cash collateral when such provisions are
stated in the master netting agreement. While the Company may utilize deriv-
LEHMAN BROTHERS 1997 ANNUAL REPORT
86
<PAGE> 26
ative products in all its businesses, the Company views its derivative product
revenues as the revenues earned from the Company's fixed income and equity
derivative products businesses and foreign exchange and commodity derivatives.
Principal transactions and net interest revenues related to the Company's fixed
income derivative products business were $362 million for 1997, $541 million for
1996 and $409 million for 1995. Principal transactions and net interest (loss)
revenues related to the Company's equity derivative products business were $(41)
million for 1997, $116 million for 1996 and $65 million for 1995. The losses in
equity derivatives were attributable to the volatility in the Asian markets
during the latter portion of fiscal 1997. Principal transactions and net
interest revenues related to foreign exchange and commodity derivatives were $92
million for 1997, $147 million for 1996 and $72 million for 1995.
Listed in the following table is the fair value of the Company's Trading-Related
Derivative Activities as of November 30, 1997 and 1996 as well as the average
fair value of these instruments. Average fair values of these instruments were
calculated based upon month-end statement of financial condition values, which
the Company believes does 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.
<TABLE>
<CAPTION>
==================================================================================================
FAIR VALUE OF TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS
AVERAGE FAIR VALUE*
FAIR VALUE* TWELVE MONTHS ENDED
NOVEMBER 30, 1997 NOVEMBER 30, 1997
-------------------- --------------------
(in millions) ASSETS LIABILITIES ASSETS LIABILITIES
==================================================================================================
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $4,704 $3,303 $4,306 $3,224
Foreign exchange forward contracts and options 1,840 1,885 1,236 1,532
Options on other fixed income securities,
mortgage-backed securities forward contracts
and options 310 297 275 246
Equity contracts (including equity swaps, warrants
and options) 1,304 1,696 2,134 1,681
Commodity contracts (including swaps, forwards
and options) 195 186 304 465
- --------------------------------------------------------------------------------------------------
Total $8,353 $7,367 $8,255 $7,148
- --------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE FAIR VALUE*
FAIR VALUE* TWELVE MONTHS ENDED
NOVEMBER 30, 1996 NOVEMBER 30, 1996
-------------------- --------------------
(in millions) 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) and do not include
receivables or payables related to exchange-traded futures contracts.
LEHMAN BROTHERS 1997 ANNUAL REPORT
87
<PAGE> 27
Assets included in the preceding 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/liabilities related to
derivative contracts at November 30, 1997 represents the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral. Included within the $8,353 million fair value of assets at November
30,1997 was $8,016 million related to swaps and OTC contracts and $337 million
related to exchange-traded option and warrant contracts. Included within the
$6,909 million fair value of assets at November 30, 1996 was $6,537 million
related to swaps and OTC contracts and $372 million related to exchange-traded
option and warrant contracts.
The primary difference in risks related to OTC and exchange-traded contracts is
credit risk. OTC contracts contain credit risk for unrealized gains from various
counterparties for the duration of the contract, net of collateral.
With respect to OTC contracts, including swaps, the Company views its net credit
exposure to be $5,252 million at November 30, 1997, representing the fair value
of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral of $2,764 million.
Counterparties to the Company's OTC derivative products are primarily financial
intermediaries (U.S. and foreign banks), securities firms, corporations,
governments and their agencies, finance companies, insurance companies,
investment companies and pension funds. Collateral held related to OTC contracts
generally includes cash and U.S. government and federal agency securities.
Presented below is an analysis of the Company's net credit exposure at November
30, 1997 for OTC contracts based upon internal designations of counterparty
credit quality.
<TABLE>
<CAPTION>
COUNTERPARTY S&P/MOODY'S NET CREDIT
RISK RATING EQUIVALENT EXPOSURE
================================================================================
<S> <C> <C>
1 AAA/Aaa 18%
2 AA-/Aa3 or higher 19%
3 A-/A3 or higher 40%
4 BBB-/Baa3 or higher 12%
5 BB-/Ba3 or higher 7%
6 B+/B1 or lower 4%
- --------------------------------------------------------------------------------
</TABLE>
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 provide for settlement within three
days). Therefore, the potential for losses from exchange-traded products is
limited.
End User Derivative Activities > The Company utilizes a variety of derivative
products as an end user to modify the interest rate characteristics of its
long-term debt portfolio. The Company actively manages the interest rate
exposure on its long-term debt portfolio to more closely match the terms of its
debt portfolio to the assets being funded and to minimize interest rate risk. At
November 30, 1997 and 1996, the notional value of the Company's end user
activities related to its long-term debt obligations was approximately $17.3
billion and $15.1 billion, respectively. (For a further discussion of the
Company's long-term debt related end user derivative activities see Note 3.)
LEHMAN BROTHERS 1997 ANNUAL REPORT
88
<PAGE> 28
The Company also utilizes derivative products as an end user to modify its
interest rate exposure associated with its secured financing activities,
including securities purchased under agreements to resell, securities borrowed,
securities sold under agreements to repurchase and securities loaned. At
November 30, 1997 and 1996, the Company had $129 billion and $115 billion,
respectively, of such secured financing activities. As with the Company's
long-term debt, its secured financing activities expose the Company to interest
rate risk. The Company, as an end user, manages the interest rate risk related
to these activities by utilizing derivative financial instruments, including
interest rate swaps and purchased options. The Company designates certain
specific derivative transactions against specific assets and liabilities with
matching maturities. In addition, the Company manages the interest rate risk of
anticipated secured financing transactions with derivative products. These
derivative products are designated against the existing secured financing
transactions for their applicable maturity. The remaining term of these
transactions is designated against the anticipated secured financing
transactions which will replace the existing secured financing transactions at
their maturity. The Company monitors the level of secured financing transactions
to ensure that there is a high degree of certainty that the Company will enter
into the anticipated secured financing transactions at a level in excess of the
designated derivative product transactions. At November 30, 1997 and 1996, the
Company, as an end user, utilized derivative financial instruments with an
aggregate notional amount of $38.7 billion and $47.6 billion, respectively, to
modify the interest rate characteristics of its secured financing activities.
The total notional value of these agreements had a weighted average maturity of
0.5 years as of November 30, 1997 and 1996.
The Company terminated certain swaps designated as hedges of the Company's
secured financing activities. At November 30, 1997, a loss of approximately $12
million from these terminated contracts was deferred and will be amortized to
interest expense over the original period of the hedge. On an overall basis, the
Company's secured financing end user derivative activities (decreased) increased
net interest income by approximately $(10) million, $16 million and $39 million
for 1997, 1996 and 1995, respectively.
================================================================================
note 12 FAIR VALUE OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
SFAS No. 107 "Disclosures about Fair Value of Financial Instruments" requires
the Company to report the fair value of financial instruments, as defined.
Assets and liabilities that are carried at fair value include all of the
Company's trading assets and liabilities including derivative financial
instruments used for trading purposes as described in Note 1, which are recorded
as securities and other financial instruments owned and securities and other
financial instruments sold but not yet purchased.
Assets and liabilities, which are recorded at contractual amounts that
approximate market or fair value, include cash and cash equivalents, cash and
securities segregated and on deposit for regulatory and other purposes,
receivables, certain other assets, commercial paper and short-term debt and
payables. The market value of such items is not materially sensitive to shifts
in market interest rates because of the limited term to maturity of these
instruments and their variable interest rates.
Financial instruments which are recorded at amounts that do not necessarily
approximate market or fair value include long-term debt, certain secured
financing activities and the related financial instruments utilized by the
Company as an end user to manage the interest rate risk of these exposures. The
Company's long-term debt is recorded at contractual or historical amounts. The
following table provides a summary of the fair value of the Company's long-term
debt and related end user derivative activities. The fair value of the Company's
long-term debt was estimated using either quoted market prices or discounted
cash flow analyses based on the Company's current borrowing rates for similar
types of borrowing arrangements.
LEHMAN BROTHERS 1997 ANNUAL REPORT
89
<PAGE> 29
The unrecognized net gain (loss) related to the Company's end user derivative
activities reflects the estimated amounts the Company would receive (pay) if the
derivative financial instruments were terminated based on market rates at
November 30, 1997 and 1996, respectively.
<TABLE>
<CAPTION>
NOVEMBER 30
------------------------
(in millions) 1997 1998
================================================================================
<S> <C> <C>
Carrying value of long-term debt $20,261 $15,922
Fair value of long-term debt 20,688 16,415
- --------------------------------------------------------------------------------
Unrecognized net gain (loss) on long-term debt $ (427) $ (493)
- --------------------------------------------------------------------------------
Unrecognized net gain (loss) on long-term debt
end user activities $ 188 $ 153
- --------------------------------------------------------------------------------
</TABLE>
The Company carries its secured financing activities, including securities
purchased under agreements to resell, securities borrowed, securities sold under
agreements to repurchase and securities loaned, at their original contract
amount plus accrued interest, which for the majority of such financing
activities is an approximation of fair value. At November 30, 1997 and 1996, the
Company had $129 billion and $115 billion, respectively, of such secured
financing activities. As with the Company's long-term debt, its secured
financing activities expose the Company to interest rate risk.
At November 30, 1997 and 1996, the Company, as an end user, utilized derivative
financial instruments with an aggregate notional amount of $38.7 billion and
$47.6 billion, respectively, to modify the interest rate characteristics of its
secured financing activities. The unrecognized net losses related to these
derivative financial instruments were $6 million and $10 million at November 30,
1997 and 1996, respectively.
================================================================================
note 13 OTHER COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
As of November 30, 1997 and 1996, the Company was contingently liable for $4.2
billion and $3.0 billion, respectively, of letters of credit, primarily used to
provide collateral for securities and commodities borrowed and to satisfy margin
deposits at option and commodity exchanges and other guarantees.
As of November 30, 1997 and 1996, in connection with its financing activities,
the Company had outstanding commitments under certain lending arrangements of
approximately $2.4 billion and $2.1 billion, respectively. 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.
As of November 30, 1997 and 1996, the Company had pledged or otherwise
transferred securities, primarily fixed income, having a market value of
approximately $49.9 billion and $37.2 billion, respectively, as collateral for
securities borrowed or otherwise received having a market value of approximately
$49.3 billion and $36.9 billion, respectively.
Securities and other financial instruments sold but not yet purchased represent
obligations of the Company to purchase the securities at prevailing market
prices. Therefore, the future satisfaction of such obligations may be for an
amount greater
LEHMAN BROTHERS 1997 ANNUAL REPORT
90
<PAGE> 30
or less than the amount recorded. The ultimate gain or loss is dependent upon
the price at which the underlying financial instrument is purchased to settle
its obligation under the sale commitment.
In the normal course of business, the Company is exposed to off-balance sheet
credit and market risk as a result of executing, financing and settling various
customer security and commodity transactions. Off-balance sheet risk arises from
the potential that customers or counterparties fail to satisfy their obligations
and that the collateral obtained is insufficient. In such instances, the Company
may be required to purchase or sell financial instruments at unfavorable market
prices. The Company seeks to control these risks by obtaining margin balances
and other collateral in accordance with regulatory and internal guidelines.
The Company, through its high yield sales and trading activities, makes
commitments to extend credit in loan syndication transactions principally to
below investment grade borrowers and participates a significant portion of these
commitments. These commitments, which totaled $1.4 billion at November 30, 1997,
are typically secured against the borrower's assets and have fixed maturity
dates. The draw down of these facilities is generally contingent upon certain
representations, warranties and contractual conditions of the borrower. The
total commitments may not be indicative of actual funding requirements as they
may expire without being drawn upon and the Company may participate additional
amounts in the normal course of its business.
The Company has commitments to invest up to $498 million in partnerships, which
in turn will make direct merchant banking related investments. These commitments
will be funded as required through the end of the respective partnerships'
investment periods, principally expiring in 2004.
The Company is also a sponsor of a fund to provide interim acquisition
facilities. In connection therewith, the Company may provide up to $150 million
to be used by the fund to provide short-term acquisition financing. Any draw
downs under the facility are expected to be repaid within a short-term period.
Subsidiaries of the Company, as general partner, are contingently liable for the
obligations of certain public and private limited partnerships organized as
pooled investment funds or engaged primarily in real estate activities. In the
opinion of the Company, contingent liabilities, if any, for the obligations of
such partnerships will not in the aggregate have a material adverse effect on
the Company's consolidated financial position or results of operations.
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.
Concentrations of Credit Risk > As one of the leading global investment banks,
the Company is actively involved in securities underwriting, brokerage,
distribution and trading. These and other related services are provided on a
worldwide basis to a large and diversified group of clients and customers,
including multinational corporations, governments, emerging growth companies,
financial institutions and individual investors.
LEHMAN BROTHERS 1997 ANNUAL REPORT
91
<PAGE> 31
A substantial portion of the Company's securities and commodities transactions
is collateralized and is executed with, and on behalf of, commercial banks and
other institutional investors, including other brokers and dealers. The
Company's exposure to credit risk associated with the non-performance of these
customers and counterparties in fulfilling their contractua1 obligations
pursuant to securities transactions can be directly impacted by volatile or
illiquid trading markets, which may impair the ability of customers and
counterparties to satisfy their obligations to the Company.
Securities and other financial instruments owned by the Company include U.S.
government and agency securities, and securities issued by non-U.S. governments
(principally Germany and Japan) which, in the aggregate, represented 22% of the
Company's total assets at November 30, 1997. In addition, primarily all of the
collateral held by the Company for resale agreements or securities borrowed,
which together represented 38% of total assets at November 30, 1997, consisted
of securities issued by the U.S. government, federal agencies or non-U.S.
governments. In addition to these specific exposures, the Company's most
significant concentration is financial institutions, which include other brokers
and dealers, commercial banks and institutional clients. This concentration
arises in the normal course of the Company's business.
Lease Commitments > The Company leases office space and equipment throughout the
world and is a party to a ground lease with the Battery Park City Authority
covering its headquarters at 3 World Financial Center which extends through
2069. Total rent expense for 1997, 1996 and 1995 was $42 million, $48 million
and $67 million, respectively. Certain leases on office space contain escalation
clauses providing for additional rentals based upon maintenance, utility and tax
increases.
Minimum future rental commitments under noncancellable operating leases (net of
subleases of $182 million) are as follows:
<TABLE>
<CAPTION>
(in millions)
================================================================================
<S> <C>
Fiscal 1998 $ 36
Fiscal 1999 33
Fiscal 2000 31
Fiscal 2001 32
Fiscal 2002 32
December 1, 2002 and thereafter 463
- --------------------------------------------------------------------------------
$627
- --------------------------------------------------------------------------------
</TABLE>
================================================================================
note 14 INTERNATIONAL OPERATIONS
- --------------------------------------------------------------------------------
Although the Company's business activities are highly integrated and constitute
a single industry segment for the purposes of SFAS No. 14, "Financial Reporting
for Segments of a Business Enterprise," they can be broadly categorized into the
three major geographic areas in which it conducts operations: the Americas,
Europe and Asia Pacific.
The Company manages its businesses with the goal of maximizing worldwide
profitability by product line. Activities such as the global distribution of
underwritings and the twenty-four hour risk management of trading positions
render geographic profitability to be highly subjective, since it is the result
of numerous estimates and assumptions.
The amounts presented below provide a broad indication of each region's
contribution to the consolidated results. The method of allocation is as
follows: Gross and Net Revenues, if syndicate 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 domes-
LEHMAN BROTHERS 1997 ANNUAL REPORT
92
<PAGE> 32
tic 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. The expenses
associated with these revenues have also been reclassified. Income (Loss) Before
Taxes includes expenses associated with generating the revenues reflected in
each region. Identifiable Assets represent essentially those recorded in the
legal entities in which the Company does business within the respective region.
<TABLE>
<CAPTION>
GROSS NET INCOME (LOSS) IDENTIFIABLE
(in millions) REVENUES REVENUES BEFORE TAXES ASSETS
==================================================================================================
<S> <C> <C> <C> <C>
Twelve months ended November 30, 1997
International operations:
Europe $ 1,190 $ 812 $ 179 $ 37,571
Asia Pacific 330 282 (36) 7,875
- --------------------------------------------------------------------------------------------------
Total international 1,520 1,094 143 45,446
Americas(3) 15,363 2,779 794 106,259
- --------------------------------------------------------------------------------------------------
Total $16,883 $3,873 $ 937 $151,705
- --------------------------------------------------------------------------------------------------
Twelve months ended November 30, 1996
International operations:
Europe $ 1,373 $ 972 $ 346 $ 25,553
Asia Pacific 559 413 100 6,829
- --------------------------------------------------------------------------------------------------
Total international 1,932 1,385 446 32,382
Americas(3) 12,328 2,059 191(2) 96,214
- --------------------------------------------------------------------------------------------------
Total $14,260 $3,444 $ 637 $128,596
- --------------------------------------------------------------------------------------------------
Twelve months ended November 30, 1995
International operations:
Europe $ 1,067 $ 750 $ 127 $ 27,844
Asia Pacific 475 455 173 5,513
- --------------------------------------------------------------------------------------------------
Total international 1,542 1,205 300 33,357
Americas(3) 11,934(1) l,866(1) 69 81,946
- --------------------------------------------------------------------------------------------------
Total $13,476 $3,071 $ 369 $115,303
- --------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes $129 million resulting from the Company's sale of its stake in
Omnitel.
(2) Includes $84 million severance charge.
(3) Includes non-U.S. revenues of $67 million, $42 million and $93 million in
1997, 1996 and 1995, respectively.
================================================================================
note 15 OTHER CHARGES
- --------------------------------------------------------------------------------
1996 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 severance charge
reflected the culmination of a worldwide business unit economic performance
review that 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 aimed at delayering management. The severance charge has led to
personnel cost savings of approximately $90 million annually. The charge also
resulted in a permanent decrease in nonpersonnel expenses of approximately $20
million annually. The Company intends to reinvest substantially all these
LEHMAN BROTHERS 1997 ANNUAL REPORT
93
<PAGE> 33
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 $59 million during fiscal 1997. The remaining
residual payments will be paid as deferred payment arrangements are completed.
1995 Restructuring Charge > During the fourth quarter of 1995, the Company
recorded a charge of $97 million pretax ($58 million aftertax) for
occupancy-related real estate and severance expenses. The occupancy-related real
estate component of the charge, $80 million pretax ($48 million aftertax),
resulted from a complete global review of the Company's real estate requirements
at current headcount levels and the elimination of excess real estate, primarily
in its New York, London and Tokyo locations. The charge included the cost to
write-down the carrying value of leasehold improvements as well as the
difference between expected operating costs and projected sublease recoveries.
In addition, the restructuring charge included a $17 million pretax ($10 million
aftertax) component related to severance payments made during the fourth
quarter. The severance component of the charge related to payments made to
terminated personnel arising from a fourth quarter formalized business unit
productivity review.
================================================================================
note 16 QUARTERLY INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
The following information represents the Company's unaudited quarterly results
of operations for 1997 and 1996. Certain amounts reflect reclassifications to
conform to the current period's presentation. These quarterly results reflect
all normal recurring adjustments which are, in the opinion of management,
necessary for a fair presentation of the results. Revenues and earnings of the
Company can vary significantly from quarter to quarter due to the nature of the
Company's business activities.
<TABLE>
<CAPTION>
1997 1996
---------------------------------------- ----------------------------------------
(in millions, except per share amounts) NOV. 30 AUG. 31 MAY 31 FEB. 28 NOV. 30 AUG. 31 MAY 31 FEB. 29
===============================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues $4,609 $4,469 $3,806 $3,999 $3,813 $3,585 $3,476 $3,386
Interest expense 3,586 3,398 2,952 3,074 2,745 2,863 2,643 2,565
- -------------------------------------------------------------------------------------------------------------------------------
Net revenues 1,023 1,071 854 925 1,068 722 833 821
Non-interest expenses:
Compensation
and benefits 519 543 433 469 542 366 422 416
Other expenses 239 247 249 237 247 240 242 246
Severance 84
- -------------------------------------------------------------------------------------------------------------------------------
Total non-interest
expenses 758 790 682 706 873 606 664 662
- -------------------------------------------------------------------------------------------------------------------------------
Income before taxes 265 281 172 219 195 116 169 159
Provision for
income taxes 80 84 51 75 68 39 61 55
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 185 $ 197 $ 121 $ 144 $ 127 $ 77 $ 108 $ 104
- -------------------------------------------------------------------------------------------------------------------------------
Net income
applicable to
common stock $ 160 $ 160 $ 114 $ 138 $ 113 $ 71 $ 102 $ 93
- -------------------------------------------------------------------------------------------------------------------------------
Average common and
common equivalent
shares outstanding 123.0 122.4 120.4 118.5 116.9 117.2 114.8 116.9
- -------------------------------------------------------------------------------------------------------------------------------
Earnings per
common share $ 1.30 $ 1.30 $ 0.95 $ 1.16 $ 0.96 $ 0.60 $ 0.89 $ 0.79
Dividends per
common share $ 0.06 $ 0.06 $ 0.06 $ 0.06 $ 0.05 $ 0.05 $ 0.05 $ 0.05
Book value per
common share (at period end) $33.39 $31.86 $30.67 $29.76 $28.84 $27.74 $27.29 $26.41
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
LEHMAN BROTHERS 1997 ANNUAL REPORT
94
<PAGE> 1
EXHIBIT 13.3
SELECTED FINANCIAL DATA
The following table summarizes certain consolidated financial information based
upon the Company's historical results included in the audited consolidated
financial statements. During 1993, the Company completed the sales of three
businesses: The Boston Company on May 21; LBI's domestic retail brokerage
business (except for such business conducted under the Lehman Brothers' name)
and substantially all of its asset management business (collectively,
"Shearson") on July 31; and Shearson Lehman Hutton Mortgage Corporation
("SLHMC") on August 31. In the Company's historical consolidated financial
statements, the operating results of The Boston Company are accounted for as a
discontinued operation while the operating results of Shearson and SLHMC are
included in the Company's results from continuing operations through their
respective sale dates.
In addition, the Company's 1994 results presented below are for the eleven month
period ended November 30, due to the Company's decision to change its year-end
from December 31. For these reasons, the Company's 1994 results are not fully
comparable with the prior year period.
<TABLE>
<CAPTION>
HISTORICAL FINANCIAL DATA
--------------------------------------------------------------
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
TWELVE MONTHS ENDED NOVEMBER 30 NOVEMBER 30 DECEMBER 31
-------------------------------- ------------- -------------
(in millions, except Per share and Other data) 1997 1996 1995 1994 1993
======================================================================================================================
<S> <C> <C> <C> <C> <C>
Consolidated statement of income
Revenues:
Principal transactions $ 1,418 $ 1,579 $ 1,393 $ 1,345 $ 2,055
Investment banking 1,318 981 801 572 972
Commissions 423 362 450 445 1,316
Interest and dividends 13,635 11,298 10,788 6,761 5,840
Other 89 40 44 67 491
- ----------------------------------------------------------------------------------------------------------------------
Total revenues 16,883 14,260 13,476 9,190 10,674
Interest expense 13,010 10,816 10,405 6,452 5,368
- ----------------------------------------------------------------------------------------------------------------------
Net revenues 3,873 3,444 3,071 2,738 5,306
- ----------------------------------------------------------------------------------------------------------------------
Non-interest expenses:
Compensation and benefits 1,964 1,747 1,544 1,413 2,989
Other expenses 972 976 1,061 1,084 1,603
Loss on sale of Shearson 535
Severance and other charges 84 97 48 152
- ----------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 2,936 2,807 2,702 2,545 5,279
- ----------------------------------------------------------------------------------------------------------------------
Income from continuing operations
before taxes and cumulative effect
of changes in accounting principles 937 637 369 193 27
Provision for income taxes 290 221 127 67 318
- ----------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations
before cumulative effect of changes in
accounting principles 647 416 242 126 (291)
Income from discontinued operations 189
Cumulative effect of changes in
accounting principles, net of taxes (13)
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 647 $ 416 $ 242 $ 113 $ (102)
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common stock $ 572 $ 378 $ 200 $ 75 $ (150)
- ----------------------------------------------------------------------------------------------------------------------
Consolidated statement of financial
condition (at period end)
Total assets $ 151,705 $ 128,596 $ 115,303 $ 109,947 $ 80,474
Total assets excluding matched book(a) 108,099 96,256 79,069 72,457 54,428
Long-term debt(b) 20,261 15,922 12,765 11,321 9,899
Total stockholders' equity 4,523 3,874 3,698 3,395 2,052
Total capital(c) 24,784 19,796 16,463 14,716 11,951
- ----------------------------------------------------------------------------------------------------------------------
Per share data(d)
Income (loss) from continuing operations
before cumulative effect of change
in accounting principle $ 4.72 $ 3.24 $ 1.76 $ 0.81 $ (3.20)
Discontinued operations 1.79
Cumulative effect of change in
accounting principle (0.12)
Net income (loss) $ 4.72 $ 3.24 $ 1.76 $ 0.69 $ (1.41)
Dividends declared per common share 0.24 0.20 0.20 0.175
Book value per common share (at period end) 33.39 28.84 25.67 24.35
- ----------------------------------------------------------------------------------------------------------------------
Other data (at period end)
Ratio of total assets to total stockholders' equity 33.5x 33.2x 31.2x 32.4x 39.2x
Ratio of total assets excluding matched book to
total stockholders' equity (a) 23.9x 24.8x 21.4x 21.3x 26.5x
Return on common equity (annualized) 15.6% 12.1% 7.1% 4.0%
Employees 8,340 7,556 7,771 8,512 9,300
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
LEHMAN BROTHERS 1997 ANNUAL REPORT
95
<PAGE> 2
As noted previously, the Company's historical consolidated financial statements
are not fully comparable, due to the sales of three significant businesses in
1993 and the eleven month reporting period presented for 1994. To facilitate an
understanding of the Company's results, included below is a table reflecting the
results of the ongoing businesses of the Company (the "Lehman Businesses") for
the twelve months ended November 30, 1997, 1996 and 1995, the eleven months
ended November 30, 1994 and the year ended December 31, 1993.
<TABLE>
<CAPTION>
LEHMAN BUSINESSES
----------------------------------------------------------------
ELEVEN MONTHS TWELVE MONTHS
ENDED ENDED
TWELVE MONTHS ENDED NOVEMBER 30 NOVEMBER 30 DECEMBER 31
------------------------------- ------------- -------------
(in millions, except Financial ratios) 1997 1996 1995 1994 1993
==================================================================================================================
<S> <C> <C> <C> <C> <C>
Consolidated statement of income
Revenues:
Principal transactions $ 1,418 $ 1,579 $ 1,393 $ 1,345 $ 1,732
Investment banking 1,318 981 801 572 802
Commissions 423 362 450 445 488
Interest and dividends 13,635 11,298 10,788 6,761 5,679
Other 89 40 44 67 79
- ------------------------------------------------------------------------------------------------------------------
Total revenues 16,883 14,260 13,476 9,190 8,780
Interest expense 13,010 10,816 10,405 6,452 5,225
- ------------------------------------------------------------------------------------------------------------------
Net revenues 3,873 3,444 3,071 2,738 3,555
- ------------------------------------------------------------------------------------------------------------------
Non-interest expenses:
Compensation and benefits 1,964 1,747 1,544 1,413 1,825
Other expenses 972 976 1,061 1,084 1,133
Severance and other charges 84 97 48 32
- ------------------------------------------------------------------------------------------------------------------
Total non-interest expenses 2,936 2,807 2,702 2,545 2,990
- ------------------------------------------------------------------------------------------------------------------
Income from continuing operations
before taxes and cumulative effect of
changes in accounting principles 937 637 369 193 565
Provision for income taxes 290 221 127 67 210
- ------------------------------------------------------------------------------------------------------------------
Income from continuing operations before
cumulative effect of changes in accounting
principles $ 647 $ 416 $ 242 $ 126 $ 355
- ------------------------------------------------------------------------------------------------------------------
Financial ratios (%):
Compensation and benefits/net revenues(e) 50.7 50.7 50.8 51.6 5l.4
Pretax operating margin 24.2 18.5 12.0 7.0 15.9
Effective tax rate(e) 31 35 35 34 37
Return on common equity (annualized) 15.6 12.1 7.1 4.0
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Matched book represents "securities purchased under agreements to resell"
("reverse repos") to the extent that such balance is less than "securities sold
under agreements to repurchase" ("repos") as of the statement of financial
condition date. Several nationally recognized rating agencies consider such
reverse repos to be a proxy for matched book assets when evaluating the
Company's capital strength and financial ratios. Such agencies consider matched
book assets to have a low risk profile and exclude such amounts in the
calculation of leverage (total assets divided by total stockholders' equity).
Although there are other assets with similar risk characteristics on the
Company's Consolidated Statement of Financial Condition, the exclusion of
reverse repos from total assets in this calculation reflects the fact that these
assets are matched against liabilities of a similar nature, and therefore
require minimal amounts of capital support. Accordingly, the Company believes
the ratio of total assets excluding matched book to total stockholders' equity
to be a more meaningful measure of the Company's leverage.
(b) Long-term debt includes senior notes and subordinated indebtedness.
(c) Total capital includes total stockholders' equity and long-term debt.
(d) Earnings per common share data for the year ended 1993 includes Common Stock
issued as of May 31, 1994.
(e) For the twelve months ended November 30,1995, excludes the effect of the
sale of Omnitel.
LEHMAN BROTHERS 1997 ANNUAL REPORT
96
<PAGE> 1
EXHIBIT 13.4
================================================================================
OTHER STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
ANNUAL MEETING
The annual meeting of stockholders of Lehman Brothers Holdings Inc. will be held
on Tuesday, March 31, 1998 at 10:30 a.m. at 3 World Financial Center, 26th
Floor, 200 Vesey Street, New York, NY 10285.
TRANSFER AGENT AND REGISTRAR
Questions regarding dividends, transfer requirements, lost certificates, changes
of address, direct deposit of dividends, the dividend reinvestment and optional
cash purchase program, or other inquiries from registered stockholders should be
directed to:
Bank of Boston
c/o Boston EquiServe, L.P.
Mailstop 45-02-64
P.O. Box 644
Boston, MA 02102-0644
Telephone: (800) 730-6001
DIVIDEND PAYMENTS
Dividends on common stock are generally payable, following declaration by the
Board of Directors, on the last business day of February, May, August and
November. The annual dividend rate for fiscal 1997 was $0.24 per common share.
The Company recently announced an annual common stock dividend policy of $0.30
per share. Direct deposit of dividends is available to registered stockholders
with U.S. bank accounts. For more information regarding this program, contact
the Company's Transfer Agent listed above.
DIVIDEND REINVESTMENT AND OPTIONAL CASH PURCHASE PROGRAM
This program allows registered stockholders of twenty-five or more shares to
automatically reinvest their dividends. The program also permits voluntary
optional cash purchases of common stock up to a maximum of $15,000 a quarter.
All stockholders of record are eligible to participate in the optional cash
purchase program. Lehman Brothers absorbs all bank service charges and stock
purchase fees under the terms of the program. Additional information and
enrollment forms can be obtained from the Company's Transfer Agent listed above.
FORM 10-K
Lehman Brothers will make available upon request copies of the Annual Report on
Form 10-K as filed with the Securities and Exchange Commission. Requests may be
directed to:
Jennifer Marre
Corporate Secretary
Lehman Brothers Holdings Inc.
3 World Financial Center, 24th Floor
New York, NY 10285
Telephone: (212) 526-1936
E-mail:
[email protected]
INVESTOR INQUIRIES
Investor inquiries may be directed to:
Shaun K. Butler
Investor Relations
Lehman Brothers Holdings Inc.:
3 World Financial Center, 10th Floor
New York, NY 10285
Telephone: (212) 526-8381
E-mail:
[email protected]
Additional copies of this Annual Report may be obtained through:
Corporate Communications
Lehman Brothers Holdings Inc.
3 World Financial Center, 10th Floor
New York, NY 10285
Telephone: (212) 526-1829
E-mail:
[email protected]
WORLD WIDE WEB
Financial statement filings, stockholder information, press releases and general
news about the Company also may be accessed via the World Wide Web at the
following address:
http://www.lehman.com
================================================================================
PRICE RANGE OF COMMON STOCK
- --------------------------------------------------------------------------------
The common stock of Lehman Brothers Holdings Inc. is listed on the New York and
Pacific Stock Exchanges under the trading symbol LEH. As of January 14, 1998,
there were 25,480 holders of record of the Company's common stock. On January
14, 1998, the last reported sales price of the Company's common stock was
$52.6875.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------------------
1997 1996
------------------------------------ -------------------------------------
NOV. 30 AUG. 31 MAY 31 FEB. 28 NOV. 30 AUG. 31 MAY 31 FEB. 29
==========================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High $56 1/8 $52 $41 $36 3/8 $29 3/8 $26 $27 $26
Low $43 1/8 $37 3/4 $29 $29 1/8 $20 7/8 $21 1/8 $22 1/8 $20 1/4
</TABLE>
LEHMAN BROTHERS 1997 ANNUAL REPORT
98
<PAGE> 1
EXHIBIT 21.1
Subsidiary List
Name Place of Incorporation
305 W. Due West Ave. Inc. Delaware
314 Commonwealth Ave. Inc. Delaware
72nd Street Premises, Inc. Delaware
Americal GP Corp. Delaware
American Entertainment Depositary Corp. Delaware
American Entertainment Depositary Corp. II Delaware
American Entertainment Partners II L.P. Delaware
American Entertainment Partners L.P. Delaware
American Storage Properties L.P. Delaware
ASAS Investment Company Delaware
Asesoria Empresarial ICC, S.A. de C.V. Mexico
Aurora Loan Services Inc. Delaware
Banque Lehman Brothers S.A. France
Boulevard Investors, Inc. Delaware
Boulevard Real Estate Corp. Delaware
Broad OK Corp. Delaware
Broadway Oklahoma Associates Delaware
Burlington Investors Inc. Delaware
CA Victory Assignor Corp. Delaware
CA Victory Inc. Delaware
Cable Income Services Inc. Delaware
Canyon Terrace Inc. Delaware
Canyon Terrace Ltd. Delaware
Casitas Associates, Inc. California
CG California Commercial Lending Inc. Delaware
CG Realty Funding Inc. Delaware
<PAGE> 2
Name Place of Incorporation
CG Zero Coupon Depositary Corp. Delaware
Client Account Protection Insurance Company Vermont
Cobex Realty Inc. Texas
Commerical Asset Liability Management Limited England
Consolidated Real Property Corp. Nevada
Creekside Inc. Delaware
Crescent Gardens Inc. Delaware
DA Group Holdings Inc. Delaware
DAG Lending Corp. Delaware
DAG Realty Brokerage Inc. New York
Diogenes Holdings Inc. Delaware
Diogenes Investments Ltd. Bermuda
Diogenes Management Company Inc. Delaware
E.H.P. Depositary Corp. Delaware
Fiduciaria Lehman Brothers SPA Societa`
di Intermediazione Mobiliare Italy
First Cap IV, Inc. Delaware
First Dallas Associates Inc. Delaware
Fundimmo Limited England
GA Wildwood I Inc. Georgia
<PAGE> 3
Name Place of Incorporation
GLG Partners Asset Management Limited Ireland
Grass Valley/Marguerite, Inc. California
Heritage Park II Inc. Delaware
Heritage Park Inc. Delaware
HillCreste Properties Inc. Delaware
Hollywood Partners Inc. Delaware
Indian Oaks Inc. Delaware
Industrial Holdings Corporation New York
Jackson Capitol Inc. Delaware
L Ram I, Inc. Delaware
L Ram II, Inc. Delaware
La Jolla GP Inc. Delaware
Laurel Capital Growth Investors Corporation Delaware
Laurel Centre Depositary Corp. Delaware
LB 1997-N1 Inc. Delaware
LB 400 I Inc. Delaware
LB 400 II Inc. Delaware
LB 400 III Inc. Delaware
<PAGE> 4
Name Place of Incorporation
LB 500 I Inc. Delaware
LB 500 II Inc. Delaware
LB 500 III Inc. Delaware
LB Austin Hotel I Inc. Delaware
LB Austin Hotel II Inc. Delaware
LB BBB I Inc. Delaware
LB BBB II Inc. Delaware
LB BBB III Inc. Delaware
LB Energy Inc. Delaware
LB Funding Corp. II Delaware
LB II 1997-N1 Inc. Delaware
LB Impala Associates Inc. Delaware
LB Midlands I Inc. Delaware
LB North Hills II Inc. Delaware
LB North Hills Inc. Delaware
LB Richmond I Inc. Delaware
LB Saddleback I Inc. Delaware
LB Saddleback Inc. Delaware
LB Wellington Tower Associates Inc. Delaware
LB West 45th Street Associates Inc. Delaware
LB Westbury I Inc. Delaware
LB Worldwide Services Co. Delaware
LBAC Holdings I Inc. Delaware
LBTS1, Inc. Delaware
LBTS2, Inc. Delaware
Lehman ALI Inc. Delaware
<PAGE> 5
Name Place of Incorporation
Lehman Brothers (Luxembourg) S.A. Luxembourg
Lehman Brothers (Taiwan) Ltd. Taiwan
Lehman Brothers (Thailand) Limited Thailand
Lehman Brothers Argentina S.A. Argentina
Lehman Brothers Asia Capital Company Hong Kong
Lehman Brothers Asset Trading Inc. Delaware
Lehman Brothers Bankhaus Aktiengesellschaft Germany
Lehman Brothers Canada Inc. New Brunswick
Lehman Brothers Capital GmbH Germany
Lehman Brothers Commercial Corporation Delaware
Lehman Brothers Commercial Corporation Asia Limited Hong Kong
Lehman Brothers Commodities Far East Inc. Delaware
Lehman Brothers do Brasil Ltda Brazil
Lehman Brothers EBS Limited United Kingdom
Lehman Brothers Finance S.A. Switzerland
Lehman Brothers Futures Asia Limited Hong Kong
Lehman Brothers Futures Asset Management Corp. Delaware
Lehman Brothers Gilts Ltd. United Kingdom
Lehman Brothers Global Asset Management Inc. Delaware
Lehman Brothers Global Finance Limited United Kingdom
Lehman Brothers Global Managers Inc. Delaware
Lehman Brothers Holdings Plc United Kingdom
Lehman Brothers Inc. Delaware
Lehman Brothers International (Europe) United Kingdom
Lehman Brothers International S.A. Spain
Lehman Brothers International S.P.A. Italy
Lehman Brothers Investments PTE Limited Singapore
Lehman Brothers Japan Inc. Delaware
Lehman Brothers Limited United Kingdom
Lehman Brothers Merchant Banking Advisors II Inc. Delaware
<PAGE> 6
Name Place of Incorporation
Lehman Brothers Merchant Banking Advisors Inc. Delaware
Lehman Brothers Merchant Banking Partners II Inc. Delaware
Lehman Brothers Nominees Limited United Kingdom
Lehman Brothers Offshore Partners II Ltd. Bermuda
Lehman Brothers Pera Cable Inc. Delaware
Lehman Brothers Pera Inc. Delaware
Lehman Brothers Power Inc. Delaware
Lehman Brothers Realty Corp. Delaware
Lehman Brothers Services SNC France
Lehman Brothers South Asia Limited Hong Kong
Lehman Brothers SpA Societa Di Intermediazione Mobiliare Italy
Lehman Brothers TB Inc. Delaware
Lehman Brothers Trading Services B.V. Netherlands
Lehman Brothers Treasury Co. B.V. Netherlands
Lehman Brothers Trust Company New York
Lehman Brothers Trustees S.A. Switzerland
Lehman Brothers U.K. Holdings (Delaware) Inc. Delaware
Lehman Brothers UK Holdings Ltd. England
Lehman Brothers Verwaltungs-und Beteiligungsgesellschaft mbH Germany
Lehman Brothers/FW Inc. Delaware
Lehman Brothers/MBGP Inc. Delaware
Lehman Brothers/MBLP Inc. Delaware
Lehman Brothers/Rosecliff Inc. Delaware
Lehman Electric Inc. Delaware
Lehman Housing Capital Inc. Delaware
Lehman Housing Lending Corp. Delaware
Lehman Investments Inc. Delaware
Lehman JFK MM Inc. Delaware
Lehman JFK Non-MM Inc. Delaware
<PAGE> 7
Name Place of Incorporation
Lehman Lending Corp. Delaware
Lehman Ltd. I Inc. Delaware
Lehman Management Company (Ireland) Limited Ireland
Lehman Structured Assets Inc. Delaware
Lehman Syndicated Loan Inc. Delaware
Lehman Tax Credit Advisor Inc. Delaware
Lehman/SDI Inc. Delaware
LHCI GP IX Inc. Delaware
LHCI GP VI Inc. Delaware
LHCI GP VII Inc. Delaware
LHCI GP VIII Inc. Delaware
LIBRO Holdings I Inc. Delaware
LIBRO Holdings II Inc. Delaware
Lowell Investors Inc. Delaware
Lowell Real Estate Corp. Delaware
Malibu Canyon Inc. Delaware
Manhattan Beach Commercial Properties III Depositary Inc. Delaware
Manhattan Beach Commercial Properties III Inc. Delaware
Medical Office Properties Depositary Inc. Delaware
Medical Office Properties Inc. Delaware
Messal Nominees Limited United Kingdom
Midwest Centers Depositary Inc. Delaware
Morgan Drive Property Co. Delaware
MTGCO Inc. Delaware
N.P. Investment XIX Co. Delaware
N.P. Investment XV Co. Delaware
<PAGE> 8
Name Place of Incorporation
N.P. Investment XVI Co. Delaware
N.P. Investment XVII Co. Delaware
N.P. Investment XVII Co. Florida
N.P. Investment XVIII Co. Delaware
N.P. Investment XX Co. Delaware
N.P. Investment XXI Co. Delaware
NGP Inc. Delaware
NJ Atlantic Inc. Delaware
NJ Somerset Inc. Delaware
Novacorp Realty/GP Inc. Canada
Pacific Village Inc. Delaware
PAMCO (No. 2) Limited United Kingdom
PAMCO (UK) Limited United Kingdom
PAMI Central Islip Inc. Delaware
PAMI Michigan Inc. Delaware
PAMI Newark Inc. Delaware
PAMI Nominee Corporation Delaware
PAMI Raymond Inc. Delaware
PDF86 Depositary Corp. Delaware
Platform Finance Limited United Kingdom
Platform Home Mortgage Securities No. 1 Plc United Kingdom
Platform Home Mortgage Securities No. 2 Plc United Kingdom
Platform Home Mortgage Securities No. 4 Limited United Kingdom
Platform Home Mortgage Securities No. 5 Limited England
Platform Investments England
Platform Mortgage United Kingdom
Playa Blanca Inc. Delaware
Prime Depositary Corp. Delaware
Principal Growth Realty Funding, Inc. Delaware
Principal Growth Realty Management Inc. Delaware
Prometheus GP Inc. Delaware
Prometheus II Inc. Delaware
Property Asset Management Inc. Delaware
<PAGE> 9
Name Place of Incorporation
Raintree GP Inc. Delaware
Regional Malls Depositary Corp. Delaware
Regional Malls Inc. Delaware
Research Partners Inc. Washington
Revival Holdings Limited Cayman Islands
Rock Hill Investors, Inc. Delaware
Senior Income Depositary, Inc. Delaware
Sharpstown Center Inc. New York
SM7 Apartment Investors Inc. Texas
South Cobb Land Inc. Georgia
Stamford Real Estate Corporation Delaware
Stamford Towers Depositary Corp. Delaware
Stamford Towers Inc. Delaware
Storage Inc. Delaware
Storm Funding Ltd. England
Sunrise Finance Co., Ltd. Japan
<PAGE> 10
Name Place of Incorporation
Tower Investors, Inc. Delaware
Tower Real Estate Corporation Delaware
Trans Orbital Sciences Inc. Delaware
Union Square Depositary Corp. Delaware
Walnut Grove GP Corp. Delaware
Warner Center Inc. Delaware
Warner Center/MGP Inc. Delaware
Warren Atlantic Inc. Delaware
Warren/GP Corp. Delaware
Wellington-Medford III Properties, Inc. Massachusetts
Winter Garden, Inc. Delaware
Working Interest Inc. Delaware
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this 1997 Annual Report on
Form 10-K of Lehman Brothers Holdings Inc. (the "Company") of our report dated
January 7, 1998, included in the 1997 Annual Report to Stockholders of Lehman
Brothers Holdings Inc.
Our audits also included the financial statement schedule of Lehman
Brothers Holdings Inc. listed in Item 14(a). This schedule is the responsibility
of the Company's management. Our responsibility is to express an opinion based
on our audits. In our opinion, the financial statement schedule referred to
above, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
We also consent to the incorporation by reference in the Registration
Statements and Post Effective Amendments on Form S-3 File Nos. 333-44771,
333-38227, 333-14791 and 33-53651 of the Company and in the related
Prospectuses, of our report dated January 7, 1998 with respect to the
consolidated financial statements and financial statement schedule of Lehman
Brothers Holdings Inc. included or incorporated by reference in this 1997 Annual
Report on Form 10-K for the year ended November 30, 1997.
ERNST & YOUNG LLP
New York, New York
February 27, 1998
<PAGE> 1
EXHIBIT 24.1
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Thomas A. Russo, Marc A. Silverman and Karen M.
Muller and each of them, his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign the Annual Report on Form 10-K of
Lehman Brothers Holdings Inc., for the fiscal year ended November 30, 1997 and
any and all amendments thereto, and to file the same, with all exhibits thereto,
and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Dated: As of February 27, 1998
<TABLE>
<CAPTION>
SIGNATURES TITLE
- ------------------------------------- ---------------------------------------------
<S> <C>
/s/ RICHARD S. FULD, JR. Chief Executive Officer and,
- ------------------------------------- Chairman of the Board of
Richard S. Fuld, Jr. Directors
(principal executive officer)
/s/ CHARLES B. HINTZ Chief Financial Officer
- ------------------------------------- (principal financial and accounting officer)
Charles B. Hintz
/s/ MICHAEL L. AINSLIE Director
- -------------------------------------
Michael L. Ainslie
/s/ JOHN F. AKERS Director
- -------------------------------------
John F. Akers
/s/ ROGER S. BERLIND Director
- -------------------------------------
Roger S. Berlind
/s/ THOMAS H. CRUIKSHANK Director
- -------------------------------------
Thomas H. Cruikshank
/s/ HENRY KAUFMAN Director
- -------------------------------------
Henry Kaufman
/s/ HIDEICHIRO KOBAYASHI Director
- -------------------------------------
Hideichiro Kobayashi
/s/ JOHN D. MACOMBER Director
- -------------------------------------
John D. Macomber
/s/ DINA MERRILL Director
- -------------------------------------
Dina Merrill
/s/ MASAHIRO YAMADA Director
- -------------------------------------
Masahiro Yamada
</TABLE>
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
This schedule contains summary financial information extracted from the
Company's Consolidated Statement of Financial Condition at November 30, 1997 and
the Consolidated Statement of Income for the twelve months ended November 30,
1997 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> NOV-30-1997
<PERIOD-START> DEC-01-1996
<PERIOD-END> NOV-30-1997
<CASH> 2,834
<RECEIVABLES> 12,838
<SECURITIES-RESALE> 43,606
<SECURITIES-BORROWED> 14,146
<INSTRUMENTS-OWNED> 76,862
<PP&E> 468
<TOTAL-ASSETS> 151,705
<SHORT-TERM> 7,818
<PAYABLES> 13,857
<REPOS-SOLD> 63,204
<SECURITIES-LOANED> 7,846
<INSTRUMENTS-SOLD> 30,080
<LONG-TERM> 20,261
0
508
<COMMON> 12
<OTHER-SE> 4,003
<TOTAL-LIABILITY-AND-EQUITY> 151,705
<TRADING-REVENUE> 1,418
<INTEREST-DIVIDENDS> 13,635
<COMMISSIONS> 423
<INVESTMENT-BANKING-REVENUES> 1,318
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 13,010
<COMPENSATION> 1,964
<INCOME-PRETAX> 937
<INCOME-PRE-EXTRAORDINARY> 647
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 647
<EPS-PRIMARY> $4.72
<EPS-DILUTED> $4.71
</TABLE>
