SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 1-9466
Lehman Brothers Holdings Inc.
(Exact Name of Registrant As Specified In Its Charter)
Delaware 13-3216325
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3 World Financial Center
New York, New York 10285
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (212) 526-7000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ______
As of June 30, 1999, 119,862,748 shares of the Registrant's Common Stock, par
value $.10 per share, were outstanding.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED MAY 31, 1999
INDEX
Part I. FINANCIAL INFORMATION Page
Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Income -
Three and Six Months Ended
May 31, 1999 and 1998 ................................ 3
Consolidated Statement of Financial Condition -
May 31, 1999 and November 30, 1998 ................... 5
Consolidated Statement of Cash Flows -
Six Months Ended
May 31, 1999 and 1998................................. 7
Notes to Consolidated Financial Statements............ 9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............ 16
Part II. OTHER INFORMATION
Item 1. Legal Proceedings ..................................... 38
Item 6. Exhibits and Reports on Form 8-K ................. 40
Signatures............................................................. 41
EXHIBIT INDEX ................................................... 42
Exhibits
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions)
Three months ended
-----------------------------
May 31 May 31
1999 1998
------------ ------------
Revenues
Principal transactions $ 663 $ 588
Investment banking 467 495
Commissions 168 124
Interest and dividends 3,627 4,307
Other 7 40
------------ ------------
Total revenues 4,932 5,554
Interest expense 3,477 4,081
------------ ------------
Net revenues 1,455 1,473
------------ ------------
Non-interest expenses
Compensation and benefits 738 747
Technology and communications 81 79
Brokerage and clearance 61 63
Business development 30 29
Occupancy 28 28
Professional fees 28 25
Other 23 26
------------ ------------
Total non-interest expenses 989 997
------------ ------------
Income before taxes and dividends on trust
preferred ecurities 466 476
Provision for income taxes 126 152
Dividends on trust preferred securities 10
------------ ------------
Net income $ 330 $ 324
============ ============
Net income applicable to common stock $ 268 $ 268
============ ============
Earnings per common share
Basic $2.19 $2.22
============ ============
Diluted $2.09 $2.12
============ ============
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions)
Six months ended
-----------------------------
May 31 May 31
1999 1998
------------- ---------------
Revenues
Principal transactions $ 1,189 $ 1,011
Investment banking 788 843
Commissions 314 241
Interest and dividends 7,208 7,981
Other 24 58
------------- ---------------
Total revenues 9,523 10,134
Interest expense 6,950 7,616
------------- ---------------
Net revenues 2,573 2,518
------------- ---------------
Non-interest expenses
Compensation and benefits 1,305 1,277
Technology and communications 163 160
Brokerage and clearance 119 120
Business development 58 53
Occupancy 56 58
Professional fees 50 49
Other 47 50
------------- ---------------
Total non-interest expenses 1,798 1,767
------------- ---------------
Income before taxes and dividends on trust
preferred securities 775 751
Provision for income taxes 222 240
Dividends on trust preferred securities 13
------------- ---------------
Net income $ 540 $ 511
============= ===============
Net income applicable to common stock $ 466 $ 448
============= ===============
Earnings per common share
Basic $3.82 $3.71
============= ===============
Diluted $3.66 $3.57
============= ===============
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
May 31 November 30
1999 1998
------------------ ------------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 4,005 $ 3,055
Cash and securities segregated and on deposit for regulatory and other
purposes 915 1,183
Securities and other financial instruments owned:
Governments and agencies 30,671 23,000
Mortgages and mortgage-backed 21,348 23,458
Corporate equities 12,418 8,217
Corporate debt and other 10,998 11,160
Derivatives and other contractual agreements 8,955 9,883
Certificates of deposit and other money market instruments 2,484 1,282
------------------ ------------------
86,874 77,000
------------------ ------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 62,721 42,381
Securities borrowed 22,315 16,341
Receivables:
Broker, dealers and clearing organizations 2,981 2,298
Customers 8,463 7,758
Others 1,429 1,909
Property, equipment and leasehold improvements (net of accumulated
depreciation and amortization of $846 in 1999 and $810 in 1998)
493 505
Other assets 1,214 1,297
Excess of cost over fair value of net assets acquired (net of accumulated
amortization of $125 in 1999 and $120 in 1998) 133 163
------------------ ------------------
Total Assets $191,543 $153,890
================== ==================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION (Continued)
(Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
May 31 November 30
1999 1998
-------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Commercial paper and short-term debt $ 7,166 $ 6,657
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 21,496 14,963
Corporate equities 10,407 3,828
Derivatives and other contractual agreements 7,636 8,064
Corporate debt and other 1,655 1,948
-------------- ----------------
41,194 28,803
-------------- ----------------
Collateralized short-term financings:
Securities sold under agreements to repurchase 90,699 67,730
Securities loaned 5,384 3,165
Payables:
Broker, dealers and clearing organizations 1,514 1,322
Customers 6,679 9,203
Accrued liabilities and other payables 3,992 4,256
Long-term debt:
Senior notes 25,185 23,873
Subordinated indebtedness 3,277 3,468
-------------- ----------------
Total liabilities 185,090 148,477
-------------- ----------------
Commitments and contingencies
Trust preferred securities subject to mandatory redemption 710
STOCKHOLDERS' EQUITY
Preferred stock 808 908
Common stock, $0.10 par value; 300,000,000 shares authorized;
Shares issued: 122,180,136 in 1999 and 121,801,123 in 1998;
Shares outstanding: 119,700,830 in 1999 and 113,657,877 in 1998 12 12
Additional paid-in capital 3,431 3,534
Accumulated other comprehensive income (net of tax) 13 15
Retained earnings 1,550 1,105
Other stockholders' equity, net 56 269
Common stock in treasury, at cost: 2,479,306 shares in 1999 and 8,143,246 in 1998 (127) (430)
----------------
--------------
Total stockholders' equity 5,743 5,413
============== ================
Total liabilities and stockholders' equity $191,543 $153,890
============== ================
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
May 31 May 31
1999 1998
----------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITES
<S> <C> <C>
Net income $ 540 $ 511
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization 48 44
Provisions for losses and other reserves 18 22
Compensation payable in common stock 98 78
Other adjustments 4 (48)
Net change in:
Cash and securities segregated 268 (146)
Securities and other financial instruments owned (9,874) (12,903)
Securities borrowed (5,974) (6,556)
Receivables from brokers, dealers and clearing organizations (683) (13)
Receivables from customers (705) 1,297
Securities and other financial instruments sold but not yet
purchased 12,391 7,284
Securities loaned 2,219 (219)
Payables to brokers, dealers and clearing organizations 192 1,131
Payables to customers (2,524) 642
Accrued liabilities and other payables (282) 269
Other operating assets and liabilities, net 325 (171)
----------------- ----------------
Net cash used in operating activities $(3,939) $(8,778)
----------------- ----------------
</TABLE>
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS (Continued)
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Six months ended
-------------------------------------
May 31 May 31
1999 1998
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITES
<S> <C> <C>
Proceeds from issuance of senior notes $ 5,295 $ 7,566
Principal payments of senior notes (3,686) (1,534)
Proceeds from issuance of subordinated indebtedness 600
Principal payments of subordinated indebtedness (179)
Net proceeds from commercial paper and short-term debt 509 3,330
Resale agreements net of repurchase agreements 2,629 2,387
Payments for treasury stock purchases (146) (187)
Dividends paid (96) (78)
Issuances of common stock 9 21
(Redemption) Issuance of preferred stock (100) 250
Issuances of trust preferred securities, net of issuance costs 690
---------------- ----------------
Net cash provided by financing activities 4,925 12,355
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (36) (37)
---------------- ----------------
Net cash used in investing activities (36) (37)
---------------- ----------------
Net change in cash and cash equivalents 950 3,540
---------------- ----------------
Cash and cash equivalents, beginning of period 3,055 1,685
================ ================
Cash and cash equivalents, end of period $ 4,005 $ 5,225
================ ================
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $6,984 and $7,063 for the six months ended May 31, 1999
and 1998, respectively. Income taxes (received)/paid totaled ($132) and $207 for
the six months ended May 31, 1999 and 1998, respectively.
See notes to consolidated financial statements.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The consolidated financial statements include the accounts of Lehman Brothers
Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or
"Lehman Brothers"). Lehman Brothers is one of the leading global investment
banks serving institutional, corporate, government and high-net- worth
individual clients and customers. The Company's worldwide headquarters in New
York and regional headquarters in London and Tokyo are complemented by offices
in additional locations in North America, Europe, the Middle East, Latin America
and the Asia Pacific Region. The Company is engaged primarily in providing
financial services. The principal U.S. subsidiary of Holdings is Lehman Brothers
Inc. ("LBI"), a registered broker-dealer. All material intercompany accounts and
transactions have been eliminated in consolidation. The Company's financial
statements have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q
and reflect all normal recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods presented. Pursuant to such rules and regulations, certain footnote
disclosures which are normally required under generally accepted accounting
principles have been omitted. It is recommended that these consolidated
financial statements be read in conjunction with the audited consolidated
financial statements included in the Company's Annual Report on Form 10-K for
the twelve months ended November 30, 1998 (the "Form 10-K"). The Consolidated
Statement of Financial Condition at November 30, 1998 was derived from the
audited financial statements.
The nature of the Company's business is such that the results of any interim
period may vary significantly from quarter to quarter and may not be indicative
of the results to be expected for the fiscal year. Certain prior period amounts
reflect reclassifications to conform to the current period's presentation.
2. Long-Term Debt:
During the six months ended May 31, 1999, the Company issued $5,295 million of
long-term debt (all of which were senior notes). Of the total issuances during
the period, $2,760 million were U.S. dollar fixed rate, $1,306 million were U.S.
dollar-floating rate, $1,207 million were foreign currency denominated fixed
rate, and $22 million were foreign currency denominated floating rate. These
issuances were primarily utilized to refinance maturities of long-term debt in
1999 and to increase total capital (stockholders' equity, long-term debt and
trust preferred securities).
The Company's floating rate new issuances contain contractual interest rates
based primarily on London Interbank Offered Rates ("LIBOR"). All of the
Company's fixed rate new issuances were effectively converted to floating rate
obligations through the use of interest rate swaps. Of the foreign currency
denominated new issuances totaling $1,229 million, $615 million were effectively
swapped to U.S. dollars, with the remainder match funding foreign currency
denominated capital needs.
The Company had $3,865 million of long-term debt mature during the six months
ended May 31, 1999.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
3. Capital Requirements:
The Company operates globally through a network of subsidiaries, with several
being subject to regulatory requirements. In the United States, LBI, as a
registered broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule,
which requires LBI to maintain net capital of not less than the greater of 2% of
aggregate debit items arising from customer transactions, as defined, or 4% of
funds required to be segregated for customers' regulated commodity accounts, as
defined. At May 31, 1999, LBI's regulatory net capital, as defined, of $1,247
million exceeded the minimum requirement by $1,149 million.
Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered
broker-dealer and subsidiary of Holdings, is subject to the capital requirements
of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial
resources, as defined, must exceed the total financial resources requirement of
the SFA. At May 31, 1999, LBIE's financial resources of approximately $1.8
billion exceeded the minimum requirement by approximately $546 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 May 31, 1999,
had net capital of approximately $322 million which was approximately $47
million in excess of the specified levels required. Certain other non-U.S.
subsidiaries are subject to various securities, commodities and banking
regulations and capital adequacy requirements promulgated by the regulatory and
exchange authorities of the countries in which they operate. At May 31, 1999,
these other subsidiaries were in compliance with their applicable local capital
adequacy requirements. In addition, the Company's "AAA" rated derivatives
subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman
Brothers Derivative Products Inc. ("LBDP"), have established certain capital and
operating restrictions which are reviewed by various rating agencies. At May 31,
1999, LBFP and LBDP each had capital which exceeded the requirement of the most
stringent rating agency by approximately $137 million and $30 million,
respectively.
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.
4. Derivative Financial Instruments:
In the normal course of business, the Company enters into derivative
transactions to satisfy the needs of its clients and to manage the Company's own
exposure to market and credit risk resulting from its trading activities
(collectively, "Trading-Related Derivative Activities").
Derivative transactions entered into for Trading-Related Derivative Activities
are recorded at market or fair value with realized and unrealized gains and
losses recognized currently in Principal transactions in the Consolidated
Statement of Income. Market or fair value for trading-related instruments is
generally determined by either quoted market prices (for exchange-traded futures
and options) or pricing models (for over-the-counter swaps, forwards and
options).
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
Pricing models utilize a series of market inputs to determine the present value
of future cash flows, with adjustments, as required for credit risk and
liquidity risk. Further valuation adjustments may be recorded, as deemed
appropriate for new or complex products or for positions with significant
concentrations. These adjustments are integral components of the mark-to-market
process. Credit-related valuation adjustments incorporate business and economic
conditions, historical experience, concentrations, estimates of expected losses
and the character, quality and performance of credit sensitive financial
instruments.
Unrealized gains and losses on derivative contracts are recorded on a net basis
in the Consolidated Statement of Financial Condition for those transactions with
counterparties executed under a legally enforceable master netting agreement and
are netted across products when such provisions are stated in the master netting
agreement. Listed in the following table is the fair value and average fair
value of the Company's Trading-Related Derivative Activities. Average fair
values of these instruments were calculated based upon month-end statement of
financial condition values, which the Company believes do not vary significantly
from the average fair value calculated on a more frequent basis. Variances
between average fair values and period-end values are due to changes in the
volume of activities in these instruments and changes in the valuation of these
instruments due to variations in market and credit conditions.
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Six Months Ended
May 31, 1999 May 31, 1999
--------------------------------- -- ---------------------------------
(in millions) Assets Liabilities Assets Liabilities
- -------------------------------------------------------- -------------- -- --------------- -- -------------- --- --------------
Interest rate and currency swaps and options
<S> <C> <C> <C> <C>
(including caps, collars and floors) $3,655 $2,719 $4,510 $2,974
Foreign exchange forward contracts and
options 1,143 1,420 1,401 1,237
Options on other fixed income securities,
mortgage-backed securities forward contracts and
options 453 412 317 293
Equity contracts (including equity swaps,
warrants and options) 3,698 3,084 2,494 3,188
Commodity contracts (including swaps,
forwards and options) 6 1 33 12
-------------- -- --------------- -- -------------- --- --------------
Total $8,955 $7,636 $8,755 $7,704
-------------- -- --------------- -- -------------- --- --------------
</TABLE>
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Twelve Months Ended
November 30, 1998 November 30, 1998
---------------------------------- -- --------------------------------
(in millions) Assets Liabilities Assets Liabilities
- -------------------------------------------------------- -------------- -- ---------------- -- -------------- -- --------------
Interest rate and currency swaps and options
<S> <C> <C> <C> <C>
(including caps, collars and floors) $5,877 $3,240 $5,550 $3,361
Foreign exchange forward contracts and options
1,583 1,367 1,724 1,558
Options on other fixed income securities,
mortgage-backed securities forward contracts and
options 224 214 288 264
Equity contracts (including equity swaps, warrants
and options) 2,128 3,167 2,218 2,946
Commodity contracts (including swaps, forwards
and options) 71 76 147 146
-------------- -- ---------------- -- -------------- -- --------------
Total $9,883 $8,064 $9,927 $8,275
-------------- -- ---------------- -- -------------- -- --------------
</TABLE>
* Amounts represent carrying value (exclusive of non-cash collateral) and do
not include receivables or payables related to exchange-traded futures
contracts.
Assets included in the table above and on the previous page 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 May 31, 1999 represents the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral. Included within the $8,955 million fair value of assets at May 31,
1999 was $8,065 million related to swaps and other OTC contracts and $890
million related to exchange-traded option and warrant contracts. Included within
the $9,883 million fair value of assets at November 30, 1998 was $9,211 million
related to swaps and other OTC contracts and $672 million related to
exchange-traded option and warrant contracts.
With respect to OTC contracts, including swaps, the Company views its net credit
exposure to be $5,245 million at May 31, 1999, representing the fair value of
the Company's OTC contracts in an unrealized gain position, after consideration
of collateral. Presented below is an analysis of the Company's net credit
exposure at May 31, 1999 for OTC contracts based upon actual ratings made by
external rating agencies or by equivalent ratings established and utilized by
the Company's Credit Risk Management Department.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
Counterparty S&P/Moody's Net Credit
Risk Rating Equivalent Exposure
- ----------- ---------- --------
1 AAA/Aaa 11%
2 AA-/Aa3 or higher 32%
3 A-/A3 or higher 33%
4 BBB-/Baa3 or higher 20%
5 BB-/Ba3 or higher 2%
6 B+/B1 or lower 2%
The Company is also subject to credit risk related to its exchange-traded
derivative contracts. Exchange-traded contracts, including futures and certain
options, are transacted directly on the exchange. To protect against the
potential for a default, all exchange clearinghouses impose net capital
requirements for their membership. Additionally, the exchange clearinghouse
requires counterparties to futures contracts to post margin upon the origination
of the contract and for any changes in the market value of the contract on a
daily basis (certain foreign exchanges provide for settlement within three
days). Therefore, the potential for losses from exchange-traded products is
limited.
For a further discussion of the Company's derivative related activities, refer
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Off-Balance Sheet Financial Instruments and Derivatives" and Notes
1 and 12 to the Consolidated Financial Statements, included in the Form 10-K.
5. Other Commitments and Contingencies:
In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $4.1 billion at
May 31, 1999 and $3.7 billion at November 30, 1998. 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.
The Company, through its high yield sales, trading and underwriting activities,
makes commitments to extend credit principally to below investment grade
borrowers and then sells a significant portion of these commitments through
syndication. These commitments, net of syndications and participations, totaled
$1.7 billion and $2.0 billion at May 31, 1999 and November 30, 1998,
respectively, and 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. Total commitments are not indicative of actual risk or funding
requirements as the commitments may not be drawn or fully utilized and the
Company will continue to syndicate and/or sell these commitments.
The Company also had lending commitments to high-grade borrowers of $1.1 billion
and $675 million at May 31, 1999 and November 30, 1998, respectively. These
commitments also are
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
typically secured against the borrower's assets, have fixed maturity dates, and
are generally contingent upon certain representations, warranties and
contractual conditions of the borrower. The company generally sells a
significant portion of these commitments through syndication
At May 31, 1999 and November 30, 1998, the Company had commitments to invest up
to $526 million and $379 million, respectively, directly and through
partnerships, which in turn will make merchant banking and venture capital
related investments. These commitments will be funded as required through the
end of the respective investment periods, principally expiring in 2004.
In addition to these specific commitments, the Company had various other
commitments of approximately $330 million and $335 million at May 31, 1999 and
November 30, 1998, respectively.
In the normal course of its business, the Company has been named a defendant in
a number of lawsuits and other legal proceedings. After considering all relevant
facts, available insurance coverage and the advice of outside counsel, in the
opinion of the Company such litigation will not, in the aggregate, have a
material adverse effect on the Company's consolidated financial position or
results of operations.
As a leading global investment bank, risk is an inherent part of all of the
Company's businesses and activities. The extent to which the Company properly
and effectively identifies, assesses, monitors and manages each of the various
types of risks involved in its trading (including derivatives), brokerage, and
investment banking activities is critical to the success and profitability of
the Company. The principal types of risks involved in the Company's activities
are market risk, credit or counterparty risk and transaction risk. Management
has developed a control infrastructure throughout the Company to monitor and
manage these risks on a global basis. For further discussion of these matters,
refer to Note 14 to the Consolidated Financial Statements, in the Form 10-K.
6. Incentive Plans:
In the second quarter of 1999, the Company transferred 2.4 million shares of its
common stock held in treasury into the RSU Trust. The RSU Trust is included in
the Consolidated Statement of Financial Condition as a component of other
stockholders' equity. The transfer had no impact on the total stockholders'
equity of the Company as the decrease in treasury stock was also offset by a
corresponding decrease in additional paid-in capital and other stockholders'
equity.
In May 1999, the Company granted to senior officers options to acquire 5.175
million shares of its common stock that expire in five years. No compensation
expense has been recognized for these stock options as they were granted with an
exercise price at the market price of the common stock on the date of the grant.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
7. Trust Preferred Securities Subject to Mandatory Redemption:
In April 1999, the Company's wholly owned trust, Lehman Brothers Holdings
Capital Trust II ("Trust II") issued 15,400,000 7.875% Preferred Securities,
Series J (the "Series J Preferred"). Trust II's sole assets are $385 million of
the Company's 7.875% Subordinated Deferrable Interest Debentures due 2048 (the
"Trust II Subordinated Debentures"). Holders of the Series J Preferred will
receive a cash distribution at an annual rate of 7.875%. The Company guarantees
payment of such distribution to the holders of Series J Preferred to the extent
the Company makes principal and interest payments on the Trust II Subordinated
Debentures. The Trust II Subordinated Debentures are redeemable by the Company
in whole or in part on or after June 30, 2004 or upon the occurrence of certain
changes in law. Trust II will redeem the Series J Preferred when the Trust II
Subordinated Debentures are paid at maturity on June 30, 2048. In addition,
Trust II must redeem Series J Preferred having an aggregate liquidation
preference equal to the aggregate principal amount of Trust II Subordinated
Debentures redeemed prior to maturity. The redemption price on the securities is
$25 per share, together with accrued and unpaid dividends.
8. Earnings Per Common Share:
Earnings per share was calculated as follows (in millions, except for per share
data):
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
May 31 May 31
-------------------------------- --------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
Numerator:
<S> <C> <C> <C> <C>
Net income $330 $324 $540 $511
Preferred stock dividends (62) (56) (74) (63)
-------------- -------------- -------------- --------------
Numerator for basic earnings per share -
income available to common stockholders $268 $268 $466 $448
Convertible preferred stock dividends 4 10
-------------- -------------- -------------- --------------
Numerator for diluted earnings per share-income
available to common stock holders (adjusted for
assumed conversion of preferred stock) $272 $268 $476 $448
============== ============== ============== ==============
Denominator:
Denominator for basic earnings per share -
weighted-average shares 122.2 120.6 122.1 120.6
Effect of dilutive securities:
Employee stock options 3.1 3.4 2.7 3.0
Restricted stock units 2.2 2.3 1.9 2.0
Preferred shares assumed converted
into common 2.9 3.3
-------------- -------------- -------------- --------------
Dilutive potential common shares 8.2 5.7 7.9 5.0
============== ============== ============== ==============
Denominator for diluted earnings per share
- adjusted weighted-average shares 130.4 126.3 130.0 125.6
============== ============== ============== ==============
Basic earnings per share $2.19 $2.22 $3.82 $3.71
==============
============== ============== ==============
Diluted earnings per share $2.09 $2.12 $3.66 $3.57
============== ============== ============== ==============
</TABLE>
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Business Environment
The principal business activities of Lehman Brothers Holdings Inc. ("Holdings")
and subsidiaries (collectively, the "Company" or "Lehman Brothers") are
investment banking and securities trading and sales, which by their nature are
subject to volatility, primarily due to changes in interest and foreign exchange
rates and security valuations, global economic and political trends and industry
competition. Revenues and earnings may vary significantly from quarter to
quarter and from year to year. 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
revenue base, stringent cost controls, global presence, and risk management
practices.
Increasing evidence that the U.S. economic growth remained very strong led to a
sharp rise in U.S. bond yields in early 1999. Gross domestic product growth of
6% in the fourth quarter of 1998 was followed by growth of 4.1% in the first
quarter of 1999. While wage and price inflation remained low, a larger-than
expected rise in core inflation in May and the shift in bias by the Federal
Reserve to tighten interest rates, led to a further sell-off in the U.S. bond
market and a general widening in credit spreads. As a result, U.S. ten-year bond
yields rose by approximately one percentage point to 5.6% over the six months
ended May 1999. Nevertheless, interest rates still remained in a relatively low
historical range.
Initially, the U.S. equity markets responded positively to stronger-than
expected growth: by late April the S&P 500 had risen 15% to around 1350.
Assessing that the global financial crisis had subsided considerably and that
global growth was on a firmer footing, performance broadened with smaller
capitalization and cyclical industry stocks outperforming the overall market
beginning in April. Reflecting good local and global growth, earnings for the
first calendar quarter were significantly ahead of expectations. However, a
further rise in U.S. bond yields in May and the heightened concerns that the
Federal Reserve would soon raise interest rates led to a decline through May,
with the S&P ending the month at around 1300.
Unlike conditions in the U.S., European growth weakened sharply in late 1998 as
consumer demand failed to offset the effects of a growing trade inbalance. In
the euro-area, official interest rates were cut in December and the European
Central Bank's key repo rate was cut by a further 50 basis points in early
April. For several months, European bond yields remained within a narrow trading
range, but by May, the rise in U.S. Treasury yields, combined with signs of
stronger European growth, led to a rise in yields.
From its creation at the beginning of January, the euro fell in a straight line
by a little over 10% against the U.S. dollar to $/euro 1.04 by the end of May.
Previous expectations of a positive start to the EMU experiment were
disappointed. The main reasons for the decline appear to have been the very
different cyclical positions of the U.S. and European economies, as well as
fears that Europe was not dealing adequately with its structural and fiscal
problems.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
European equity markets followed the rise in the U.S. through the end of March,
with increases of 10% to 20% in local currency terms. However, unlike the U.S.,
most markets held on to these gains in April and May, although they did not
advance further. Supportive factors were the further cut in interest rates in
April, signs of a long-awaited recovery in growth and the weakness of the euro.
Far Eastern markets significantly outperformed the U.S. and European markets
over the period, supported by progress on recapitalizing the Japanese banks and
increasing signs of economic recovery across the rest of the region.
On June 30, 1999, the Federal Reserve, as expected, raised the Federal funds
rate by 25 basis points to 5.0% and announced a change in its bias to a neutral
stance. These actions served to calm the U.S. markets and produced rallies in
both the U.S. debt and equity markets.
Corporate Finance Advisory activities continued at near record levels during the
first half of 1999. Industrywide, the volume of announced transactions soared to
roughly $1.5 trillion. The first six months of 1999 also reflected a steady
advance of merger and acquisition activity involving European companies and
cross-border mergers and acquisitions. Merger and acquisition activities
continued to reflect the trends of consolidation, deregulation and globalization
across industry sectors and across borders.
Note: Except for the historical information contained herein, this
Management's Discussion and Analysis of Financial Condition and Results
of Operations contains forward-looking statements that are based on
current expectations, estimates and projections about the industries in
which the Company operates. These statements are not guarantees of
future performance and involve certain risks, uncertainties and
assumptions which are difficult to predict. The Company undertakes no
obligation to update publicly any forward-looking statements, whether
as a result of new information, future events or otherwise.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Results of Operations
For the Three Months Ended May 31, 1999 and 1998
The Company reported net income of $330 million for the second quarter ended May
31, 1999, representing an increase of 2% from net income of $324 million for the
second quarter ended May 31, 1998. Earnings per common share (diluted) decreased
to $2.09 for the second quarter of 1999 from $2.12 for the second quarter of
1998. Included in the 1999 and 1998 earnings per share computation was the
recognition of $50 million in dividends on the Company's Redeemable Voting
Preferred Stock. American Express Company and Nippon Life Insurance Company are
entitled to receive an annual non-cumulative preferred dividend equal to 50
percent of the amount by which the company's net income for the full fiscal year
exceeds $400 million, up to a maximum of $50 million per year, through 2002.
Net revenues decreased slightly to $1,455 million for the second quarter of 1999
from $1,473 million for the second quarter of 1998. Revenues were well balanced
across all of the Company's major businesses in the current quarter versus the
prior year's quarter, when net revenue included the impact of several sizable
high yield origination transactions. Consistent with the Company's strategy to
grow higher margin businesses and diversify its revenue base, a greater
proportion of revenues were generated in the combined businesses of equities,
which experienced a record quarter, and investment banking.
Compensation and benefits expense as a percentage of net revenues was 50.7% for
both the second quarter of 1999 and 1998, reflecting the seventeenth successive
quarter of consistent compensation levels relative to net revenues. Nonpersonnel
expenses were $251 million in the second quarter of fiscal 1999, essentially
unchanged from the $250 million in the second quarter of fiscal 1998. The pretax
operating margin of 32% remained relatively unchanged compared to the second
quarter of 1998.
In the following table of net revenues, the Company has been segregated into
four major business units: equity, corporate finance advisory, fixed income and
merchant banking. Net revenues from the Company's market-making and trading
activities in equity and fixed income products are recognized as either
principal transactions or net interest revenues depending upon the method of
financing and/or hedging related to specific inventory positions. The Company
evaluates its trading strategies on an overall profitability basis which
includes both principal transactions revenues and net interest. Therefore,
changes in net interest should not be viewed in isolation but should be viewed
in conjunction with revenues from principal transactions. 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.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Three Months Ended May 31, 1999
<TABLE>
<CAPTION>
Principal
Transactions and
Net Interest Investment
Commissions Banking Other Total
- -------------------------------------- ------------------- ------------------ ------------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Equity $327 $155 $122 $ 1 $ 605
Corporate Finance Advisory (4) 132 128
Fixed Income 494 9 171 3 677
Merchant Banking (5) 42 37
Other 1 4 3 8
- -------------------------------------- ------------------- ------------------ ------------------ ------------ -----------
$813 $168 $467 $ 7 $1,455
- -------------------------------------- ------------------- ------------------ ------------------ ------------ -----------
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended May 31, 1998
Principal
Transactions and
Net Interest Investment
Commissions Banking Other Total
- -------------------------------------- ------------------- ------------------ ------------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Equity $169 $111 $122 $ 2 $ 404
Corporate Finance Advisory 104 104
Fixed Income 647 9 220 3 879
Merchant Banking (3) 49 46
Other 1 4 35 40
- -------------------------------------- ------------------- ------------------ ------------------ ----------- -----------
$814 $124 $495 $40 $1,473
- -------------------------------------- ------------------- ------------------ ------------------ ----------- -----------
</TABLE>
Equity. Equity net revenues reflect equity underwriting, customer flow
activities (both institutional and high-net-worth retail), secondary trading and
derivative and financing activities related to equity products. The Company's
equity net revenues increased 50% to a record high of $605 million for the
second quarter of 1999 from $404 million for the second quarter of 1998. Higher
revenues in the U.S. and Europe resulted from increased customer flow activities
in cash and derivative products as well as a strong performance in equity
arbitrage.
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 consists of advising clients on
mergers and acquisitions, divestitures, leveraged buyouts, financial
restructurings, and a variety of cross-border transactions. Net revenues from
corporate finance advisory activities were $128 million for the second quarter
of 1999, an increase of 23% versus the $104 million recognized in the second
quarter of 1998. This increase reflected the company's increase in global market
share from approximately 9% at the end of the second quarter of 1998 to
approximately 13% at the end of the second quarter of 1999 as well as continued
strength in the overall U.S. and European merger and acquisition market
environment.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Fixed Income. The Company's fixed income net revenues reflect debt underwriting,
customer flow activities (both institutional and high-net-worth retail),
secondary trading and financing activities related to fixed income products.
Fixed income products include dollar- and non-dollar government securities,
mortgage- and asset-backed securities, money market products, dollar- and
non-dollar corporate debt securities, emerging market securities, municipal
securities, financing (global access to debt financing sources including
repurchase and reverse repurchase agreements), foreign exchange, and fixed
income derivative products. Fixed income net revenues decreased 23% to $677
million for the second quarter of 1999 from the record $879 million recognized
in the second quarter of 1998. The decrease in the second quarter results from
the prior year's quarter was due to the absence of several sizable leveraged
finance transactions that were present in the prior year's quarter, and the
effect of an overall decline in the high yield orgination market, partially
offset by increased institutional customer flow activity across most fixed
income products and higher origination in the high-grade corporate bond sector.
Merchant Banking. The Company is the general partner for eleven active merchant
banking and venture capital partnerships and also invests directly in other
merchant banking and venture capital transactions. Current merchant banking
investments include both publicly traded and privately held companies. Merchant
banking net revenues represent net realized and unrealized gains and losses from
the revaluation of these investments. 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 related to
the financing of the Company's investment in the partnerships. Merchant banking
net revenues were $37 million for the second quarter of 1999, down from $46
million in the second quarter of 1998.
Non-Interest Expenses. Non-interest expenses were $989 million for the second
quarter of 1999 and $997 million for the second quarter of 1998. Compensation
and benefits expense as a percentage of net revenues remained unchanged from the
prior year quarter at 50.7%. Nonpersonnel expenses were $251 million in the
second quarter of 1999 compared to $250 million in the second quarter of 1998,
reflecting the Company's continued emphasis on maintaining strict cost controls.
Income Taxes. The Company's income tax provision was $126 million for the second
quarter of 1999 compared to $152 million for the second quarter of 1998. The
effective tax rate was 27% for the second quarter of 1999 and 32% for the second
quarter of 1998. The lower effective tax rate is the result of a more favorable
mix of earnings (foreign vs. domestic), which reduced the state and local
provision, and an increase in tax benefits attributable to income and
transactions subject to preferential tax treatment. The Company estimates its
1999 effective tax rate to be approximately 28% compared to 30% in 1998. In
accordance with generally accepted accounting principles, the Company adjusted
its effective tax rate in the second quarter to 27% from 31% in the first
quarter to reflect its revised full year estimate.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Results of Operations
For the Six Months Ended May 31, 1999 and 1998
The Company reported net income of $540 million for the six months ended May 31,
1999, representing an increase of 6% from net income of $511 million for the six
months ended May 31, 1998. Earnings per common share (diluted) increased to
$3.66 for the six months of 1999 from $3.57 for the six months of 1998. Included
in the 1999 and 1998 earnings per share computation was the recognition of $50
million in dividends on the Company's Redeemable Voting Preferred Stock.
American Express Company and Nippon Life Insurance Company are entitled to
receive an annual non-cumulative preferred dividend equal to 50 percent of the
amount by which the company's net income for the full fiscal year exceeds $400
million, up to a maximum of $50 million per year, through 2002.
Net revenues increased to a record $2,573 million for the six months of 1999
from $2,518 million for the six months of 1998. The increase in net revenues was
driven by an overall increase in customer flow activities across a broad array
of fixed income and equity products. Consistent with the Company's strategy to
achieve a better balance between its businesses and to grow its higher margin
businesses, a greater proportion of the Company's net revenues were generated in
equities and investment banking over the current period.
Compensation and benefits expense as a percentage of net revenues was 50.7% for
both the first half of 1999 and 1998. Nonpersonnel expenses were $493 million in
the six months of fiscal 1999, essentially unchanged from the $490 million in
expenses for the six months of fiscal 1998. Increased net revenues and unchanged
expense levels led to an increase in the Company's pretax operating margin to
30.1% for the six months of fiscal 1999 from 29.8% in the six months of fiscal
1998.
In the following table of net revenues, the Company has been segregated into
four major business units: equity, corporate finance advisory, fixed income and
merchant banking. Net revenues from the Company's market-making and trading
activities in equity and fixed income products are recognized as either
principal transactions or net interest revenues depending upon the method of
financing and/or hedging related to specific inventory positions. The Company
evaluates its trading strategies on an overall profitability basis which
includes both principal transactions revenues and net interest. Therefore,
changes in net interest should not be viewed in isolation but should be viewed
in conjunction with revenues from principal transactions. 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.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Six Months Ended May 31, 1999
<TABLE>
<CAPTION>
Principal
Transactions and
Net Interest Investment
Commissions Banking Other Total
- -------------------------------------- ------------------- ------------------ ------------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Equity $ 443 $289 $181 $ 6 $ 919
Corporate Finance Advisory (8) 232 224
Fixed Income 1,021 17 322 7 1,367
Merchant Banking (10) 53 43
Other 1 8 11 20
- -------------------------------------- ------------------- ------------------ ------------------ ------------ -----------
$1,447 $314 $788 $24 $2,573
- -------------------------------------- ------------------- ------------------ ------------------ ------------ -----------
</TABLE>
Six Months Ended May 31, 1998
<TABLE>
<CAPTION>
Principal
Transactions and
Net Interest Investment
Commissions Banking Other Total
- -------------------------------------- ------------------- ------------------ ------------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Equity $ 287 $216 $182 $ 4 $ 689
Corporate Finance Advisory (2) 199 197
Fixed Income 1,096 17 376 6 1,495
Merchant Banking (6) 85 79
Other 1 8 1 48 58
- -------------------------------------- ------------------- ------------------ ------------------ ----------- -----------
$1,376 $241 $843 $58 $2,518
- -------------------------------------- ------------------- ------------------ ------------------ ----------- -----------
</TABLE>
Equity. Equity net revenues reflect equity underwriting, customer flow
activities (both institutional and high-net-worth retail), secondary trading and
derivative and financing activities related to equity products. The Company's
equity net revenues increased 33% to $919 million for the six months of 1999
from $689 million for the six months of 1998. Higher revenues in the U.S. and
Europe resulted from increased customer flow activity in cash and derivative
products and improved performance in equity arbitrage.
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 consists of advising clients on
mergers and acquisitions, divestitures, leveraged buyouts, financial
restructurings, and a variety of cross-border transactions. Net revenues from
corporate finance advisory activities increased 14% to $224 million for the six
months of 1999, versus the $197 million recognized in the six months of 1998.
This increase reflected the company's increase in global market share from
approximately 9% at the end of the first half of 1998 to approximately 13% at
the end of the first half of 1999 as well as continued strength in the overall
U.S. and European merger and acquisition market environment.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Fixed Income. The Company's fixed income net revenues reflect debt underwriting,
customer flow activities (both institutional and high-net-worth retail),
secondary trading and financing activities related to fixed income products.
Fixed income products include dollar- and non-dollar government securities,
mortgage and asset-backed securities, money market products, dollar- and
non-dollar corporate debt securities, emerging market securities, municipal
securities, financing (global access to debt financing sources including
repurchase and reverse repurchase agreements), foreign exchange, and fixed
income derivative products. Fixed income net revenues decreased 9% to $1,367
million for the six months of 1999 from $1,495 million for the six months of
1998. The decrease in the first half results from the prior year's first half
reflected the absence of several sizable leveraged finance transactions that
were present in the prior year's second quarter, as well as a substantial
decline in the overall high yield origination market, partially offset by strong
institutional customer flow activity across most fixed income products and
higher origination in the high-grade corporate bond sector.
Merchant Banking. The Company is the general partner for eleven active merchant
banking partnerships and also invests directly in other merchant banking and
venture capital transactions. Current merchant banking and venture capital
investments include both publicly traded and privately held companies. Merchant
banking net revenues represent net realized and unrealized gains and losses from
the revaluation of these investments. 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 related to
the financing of the Company's investment in the partnerships. Merchant banking
net revenues were $43 million for the six months of 1999, down from $79 million
in the six months of 1998.
Non-Interest Expenses. Non-interest expenses were $1,798 million for the six
months of 1999 and $1,767 million for the six months of 1998. Compensation and
benefits expense as a percentage of net revenues remained unchanged from the
prior year period at 50.7%. Nonpersonnel expenses were $493 million in the first
six months of 1999 compared to $490 million for the comparable 1998 period,
reflecting the Company's continued emphasis on maintaining strict cost controls.
Nonpersonnel expenses as a percentage of net revenues decreased in the period to
19.2 % from 19.5% a year ago.
Income Taxes. The Company's income tax provision was $222 million for the six
months of 1999 compared to $240 million for the six months of 1998. The
effective tax rate was 28.6% for the six months of 1999 and 32% for the six
months of 1998. The lower effective tax rate is the result of a more favorable
mix of earnings (foreign vs. domestic), which reduced the state and local
provision, and an increase in tax benefits attributable to income and
transactions subject to preferential tax treatment.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Funding, Capital Resources and Liquidity
Funding and Capital Policies. The Company's Finance Committee is responsible for
establishing and managing the funding and liquidity policies of the Company.
These policies include recommendations for capital and balance sheet size as
well as the allocation of capital and balance sheet to product areas. Members of
the Company's treasury department and business unit financing groups work with
the Finance Committee to ensure coordination of global funding efforts and
implementation of the funding and liquidity policies. Regional asset and
liability committees in the Company's principal funding centers are responsible
for implementing funding strategies for their respective regions.
The primary goal of the Company's funding policies is to provide sufficient
liquidity and availability of funding sources to meet the needs of the Company's
businesses. The key elements of these policies are to:
(1) Maintain a total capital structure that supports the business activities
in which the Company is engaged.
(2) Finance the Company's assets, primarily on a secured basis. Together with
Total Capital, secured funding provides a stable funding base and enables
the Company to minimize its reliance on short-term unsecured debt.
(3) Maintain funding availability in excess of actual utilization and
diversify funding through a global investor base which increases liquidity
and reduces concentration risk.
(4) Maintain sufficient financial resources to enable the Company to meet its
obligations in periods of financial stress, defined as any event that
severely constrains the Company's access to unsecured funding sources.
Total Capital. Total Capital was $34.9 billion at May 31, 1999 compared to $32.8
billion at November 30, 1998. The increase in Total Capital resulted from
increases in long-term debt of $1.1 billion, the issuance of $710 million of
Trust Preferred Securities and the retention of earnings offset by the
repurchase of 2.56 million shares of convertible Series B Preferred Stock.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
May 31 November 30
(in millions) 1999 1998
- --------------------------------------------------------------------------------
Long-term Debt
Senior Notes $25,185 $23,873
Subordinated Indebtedness 3,277 3,468
-------- -------
28,462 27,341
Trust Preferred Securities 710
Stockholders' Equity
Preferred Equity 808 908
Common Equity 4,935 4,505
----- -------
5,743 5,413
- --------------------------------------------------------------------------------
Total Capital $34,915 $32,754
- --------------------------------------------------------------------------------
During the first six months of 1999, the Company issued $5.3 billion in
long-term debt, which was $1.4 billion in excess of its maturing debt. Long-term
debt increased to $28.5 billion at May 31, 1999 from $27.3 billion at November
30, 1998, with a weighted-average maturity of 3.7 years at May 31, 1999 and 3.5
years at November 30, 1998.
In the first and second quarter of 1999, trusts wholly owned by the Company
issued $710 million of preferred securities which are subject to mandatory
redemption. Additional information about the first and second quarter issuances
can be found in the Company's February 28, 1999 Form 10-Q and in Note 7,
respectively.
In January 1999, the Company announced it was extending its previously announced
7.5 million share buyback program by an additional 2.0 million shares. The
Company expects to complete its repurchase program and buyback 3.7 million
shares during the second half of the year.
On April 26, 1999, the Company entered into an Agreement and Plan of Merger with
Delaware Savings Bank, FSB (the "Bank"), pursuant to which the Bank would become
a wholly owned subsidiary of the Company. The purchase price was approximately
$2 million. The acquisition was consummated on June 30, 1999. In connection
therewith, the Company injected an additional $50 million of capital into the
Bank and changed the Bank's name to Lehman Brothers Bank, FSB.
Secured Funding. The Company strives to maximize the portion of the Company's
balance sheet that is funded on a secured basis. Secured Funding includes
securities and other financial instruments sold but not yet purchased, as well
as collateralized short-term financings, defined as securities sold under
agreements to repurchase ("repos") and securities loaned. Because of their
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
secured nature, OECD government repos and other investment grade types of
collateralized borrowings are less credit-sensitive and have historically been a
stable financing source irrespective of market conditions. At May 31, 1999 and
November 30, 1998, $130 billion and $92 billion, respectively, of the Company's
total balance sheet of $192 billion and $154 billion at May 31, 1999 and
November 30, 1998, respectively, were financed on a secured basis.
By maximizing its use of secured funding, the Company minimizes its reliance on
unsecured funding. As of May 31, 1999 and November 30, 1998, commercial paper
and short-term debt outstanding were $7.2 billion and $6.7 billion,
respectively. Of these amounts, commercial paper outstanding as of May 31, 1999
and November 30, 1998, was $4.4 billion and $3.6 billion, respectively.
Back-Up Credit Facilities. 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
for up to an additional year 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.
The Company also maintains a $1 billion Committed Securities Repurchase Facility
(the "Facility") for LBIE, the Company's major operating entity in Europe, which
matures on July 27, 1999. Management expects that the facility will be renewed.
The Facility provides secured multi-currency financing for a broader range of
collateral types than LBIE's previous committed secured credit facility. Under
the terms of the Facility, the bank group will agree to provide funding for up
to one year on a secured basis. Any loans outstanding on the commitment
termination date may be extended for up to an additional year at the option of
LBIE. The Facility contains covenants which require, among other things, that
LBIE maintain specified levels of tangible net worth.
There are no borrowings outstanding under either the Credit Agreement or the
Facility. The Company may use the Credit Agreement and the Facility for general
corporate purposes from time to time. The Company has maintained compliance with
the applicable covenants for both the Credit Agreement and the Facility at all
times.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Balance Sheet. The Company's total assets increased to $191.5 billion at May 31,
1999 from $179.3 billion at February 28, 1999 and $153.9 billion at November 30,
1998. The Company's adjusted total assets, defined as total assets less the
lower of securities purchased under agreements to resell or securities sold
under agreements to repurchase were $128.8 billion at May 31, 1999 compared to
$121.9 billion at February 28, 1999 and $111.5 billion at November 30, 1998. The
Company believes adjusted total assets is a more effective measure of balance
sheet usage when comparing companies in the securities industry. The increases
in adjusted total assets reflect increases in liquid government and agency
inventory levels associated with increased customer flow activities. The
remaining increase in total assets was driven by an increase in secured customer
financing activities.
The Company's balance sheet consists primarily of cash and cash equivalents,
securities and other financial instruments owned, and collateralized short-term
financing agreements. The liquid nature of these assets provides the Company
with flexibility in financing and managing its business. The majority of these
assets are funded on a secured basis through collateralized short-term financing
agreements with the remaining assets being funded through short-term unsecured
financing and Total Capital, defined as long-term debt, trust preferred
securities and stockholders' equity.
Financial Leverage. 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 and trust preferred securities. The Company believes that
the adjusted leverage ratio is a more effective measure of financial risk when
comparing companies in the securities industry. The Company's adjusted leverage
ratios based on adjusted total assets were 20.0x and 20.6x at May 31, 1999 and
November 30, 1998, respectively. The Company's average adjusted leverage ratio
was 20.6x and 25.6x for the quarters ended May 31, 1999 and November 30, 1998,
respectively. 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. [GRAPHIC OMITTED]
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
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. On July 7, 1999, Moody's placed the long-term
ratings of Holdings and LBI on review for possible upgrade. As of May 31, 1999
the short- and long-term senior debt ratings of Holdings and 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
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Other
High Yield Securities and Lending Activities. The Company underwrites, trades,
invests and makes markets in high yield corporate debt securities. The Company
also syndicates, trades and invests in loans to below investment grade-rated
companies. For purposes of this discussion, high yield debt instruments are
defined as securities or loans to companies rated BB+ or lower, or equivalent
ratings by recognized credit rating agencies, as well as non-rated securities or
loans which, in the opinion of management, are non-investment grade.
Non-investment grade securities generally involve greater risks than investment
grade securities due to the issuer's creditworthiness and the liquidity of the
market for such securities. In addition, these issuers have higher levels of
indebtedness, resulting in an increased sensitivity to adverse economic
conditions. The Company recognizes these risks and aims to reduce market and
credit risk through the diversification of its products and counterparties. High
yield debt instruments are carried at market value, and unrealized gains or
losses for these securities are reflected in the Company's Consolidated
Statement of Income. The Company's portfolio of such instruments at May 31,
1999, February 28, 1999 and November 30, 1998 included long positions with an
aggregate market value of approximately $2.9 billion, $2.7 billion and $2.3
billion, respectively, and short positions with an aggregate market value of
approximately $189 million, $119 million and $217 million, respectively. The
Company may, from time to time, mitigate its net exposure to any single issuer
through the use of derivatives and other financial instruments.
Additional information about the Company's High Yield Securities and Lending
Activities, including related commitments, can be found in Note 5 to the
Consolidated Financial Statements (Other Commitments and Contingencies).
Merchant Banking. At May 31, 1999, the Company's investment in merchant banking
and venture capital partnerships totaled $201 million and direct merchant
banking and venture capital investments totaled $209 million. The Company's
merchant banking and venture capital activities include investments in eleven
partnerships, for which the Company acts as general partner, as well as direct
investments. The Company's policy is to carry its investments, including its
partnership interests, at fair value based upon the Company's assessment of the
underlying investments. Additional information about the Company's merchant
banking activities, including related commitments, can be found in Note 5 to the
Consolidated Financial Statements (Other Commitments and Contingencies).
Excess of Cost over Fair Value of Net Assets acquired ("Goodwill"). During the
quarter, the Company reduced Goodwill as a result of recognizing the tax
benefits associated with net operating losses acquired in prior year
acquisitions.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Risk Management
As a leading global investment banking company, risk is an inherent part of the
Company's businesses. Global markets, by their nature, are prone to uncertainty
and subject participants to a variety of risks. The Company has developed
policies and procedures to identify, measure and monitor each of the risks
involved in its trading, brokerage and investment banking activities on a global
basis. The principal risks of Lehman Brothers are market, credit, liquidity,
legal and operational risks. Risk Management is considered to be of paramount
importance. The Company devotes significant resources across all of its
worldwide trading operations to the measurement, management and analysis of
risk, including investments in personnel and technology.
The Company seeks to reduce risk through the diversification of its businesses,
counterparties and activities in geographic regions. The Company accomplishes
this objective by allocating the usage of capital to each of its businesses,
establishing trading limits for individual products and traders and setting
credit limits for individual counterparties, including regional concentrations.
The Company seeks to achieve adequate returns from each of its businesses
commensurate with the risks that they assume.
Overall risk management policy is established by a Risk Management Committee
(the "Committee") comprised of the Chief Executive Officer, the Global Risk
Manager, the Chief Financial and Administrative Officer, the Head of Equities,
the Head of Fixed Income, the Head of Global Sales and Research and the Co-Heads
of Investment Banking. The Committee brings together senior management with the
sole intent of discussing risk related issues and provides an effective forum
for managing risk at the highest levels within the Company. The Committee meets
on a monthly basis, or more frequently if required, to discuss, among other
matters, significant market exposures, concentrations of positions (e.g.,
counterparty, market risk), potential new transactions or positions and risk
limit exceptions.
The Global Risk Management Group (the "Group") supports the Committee, is
independent of the trading areas and reports directly to the Chief Executive
Officer. The Group combines two departments, credit risk management and market
risk management, into one unit. This facilitates the analysis of counterparty
credit and market risk exposures and leverages personnel and information
technology resources in a cost-efficient manner. The Group maintains staff in
each of the Company's regional trading centers and has daily contact with
trading staff at all levels within the Company. These discussions include a
review of trading positions and risk exposures.
Credit Risk. Credit risk represents the possibility that a counterparty will be
unable to honor its contractual obligations to the Company. Credit risk
management is therefore an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department")
has global responsibility for implementing the Company's overall credit risk
management framework.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
The CRM Department manages the credit exposure related to trading activities by
giving initial credit approval for counterparties, establishing credit limits by
counterparty, country and industry group and by requiring collateral in
appropriate circumstances. In addition, the CRM Department strives to ensure
that master netting agreements are obtained whenever possible. The CRM
Department also considers the duration of transactions in making its credit
decisions, along with the potential credit exposure for complex derivative
transactions. The CRM Department is responsible for the continuous monitoring
and review of counterparty credit exposure and creditworthiness and
recommending, where appropriate, credit risk-related valuation adjustments.
Credit risk and related valuation adjustments are reviewed periodically to
ensure that they remain appropriate in light of market events or the
counterparty's financial condition.
Valuation adjustments for credit risk incorporate business and economic
conditions, historical experience, concentrations, estimates of expected losses
and the character, quality and performance of credit sensitive financial
instruments.
Market Risk. Market risk represents the potential change in value of a portfolio
of financial instruments due to changes in market rates, prices, and
volatilities. Market risk management also is an essential component of the
Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for implementing the
Company's overall market risk management framework. It is responsible for the
preparation and dissemination of risk reports, developing and implementing the
firmwide Risk Management Guidelines and evaluating adherence to these
guidelines. These guidelines provide a framework for risk management
decision-making. To that end, the MRM Department identifies and quantifies risk
exposures, develops limits, and reports and monitors these risks with respect to
the approved limits. The identification of material market risks inherent in
positions includes, but is not limited to, interest rate, equity, and foreign
exchange risk exposures. In addition to these risks, the MRM Department also
evaluates liquidity risks, credit and sovereign concentrations.
The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.
Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client driven market-making transactions, the size of the Company's
proprietary and arbitrage positions, and the volatility of financial instruments
traded. The Company seeks to mitigate, whenever possible, excess market risk
exposures through the use of futures and option contracts and offsetting cash
market instruments.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
The Company participates globally in interest rate, equity, and foreign exchange
markets. The Company's Fixed Income division has a broadly diversified market
presence in U.S. and foreign government bond trading, emerging market
securities, corporate debt (investment and non-investment grade), money market
instruments, mortgages and mortgage-backed securities, asset-backed securities,
municipal bonds, and interest rate derivatives. The Company's Equities division
facilitates domestic and foreign trading in equity instruments, indices, and
related derivatives. The Company's foreign exchange businesses are involved in
trading currencies on a spot and forward basis as well as through derivative
products and contracts.
The Company incurs short-term interest rate risk when facilitating the orderly
flow of customer transactions through the maintenance of government and
high-grade corporate bond inventories. Market-making in high yield instruments
exposes the Company to additional risk due to potential variations in credit
spreads. Trading in international markets exposes the Company to spread risk
between the term structure of interest rates in differing countries.
Mortgage-related securities are subject to prepayment risk and changes in the
level of interest rates. Trading in derivatives and structured products exposes
the Company to changes in the level and volatility of interest rates. The
Company actively manages interest rate risk through the use of interest rate
futures, options, swaps, forwards, and offsetting cash market instruments.
Inventory holdings, concentrations, and agings are monitored closely and used by
management to selectively hedge or liquidate undesirable exposures.
The Company is a significant intermediary in the global equity markets, 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 market valuation. Equity market risk is actively
managed through the use of index futures, exchange-traded and OTC options, swaps
and cash instruments. Equity risk exposures are aggregated and reported to
management on a regular basis.
The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar as well as a variety of developed and emerging
market currencies. The Company hedges its risk exposures primarily through the
use of currency forwards, swaps, futures, and options.
Value at Risk. For purposes of Securities and Exchange Commission ("SEC") risk
disclosure requirements, the Company has performed an entity-wide value at risk
calculation of virtually all of the Company's trading activities. The value at
risk calculation measures the potential loss in expected revenues with a 95%
confidence level. The methodology incorporates actual trading revenues over a
standardized 250-day historical period. A confidence level of 95% implies, on
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
average, that daily trading revenues or losses will exceed daily expected
trading revenues by an amount greater than value at risk one out of every 20
trading days.
Average value at risk computed in this manner was $28.3 million and $18.6
million for the periods ended May 31, 1999 and November 30, 1998, respectively.
Average value at risk increased in 1999 compared to 1998 because of the extreme
market volatility during the August-October 1998 period. Excluding the effects
of this volatility, average value at risk for the second quarter ended May 31,
1999 was $17 million.
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.
As discussed throughout Management's Discussion and Analysis, the Company seeks
to reduce risk through the diversification of its businesses and a focus on
customer flow activities. This diversification and focus, combined with the
Company's risk management controls and processes, helps mitigate the net revenue
volatility inherent in the Company's trading activities. Although historical
performance is not necessarily indicative of future performance, the Company
believes its focus on business diversification and customer flow activities
should continue to help mitigate the volatility of future net trading revenues.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Year 2000 Readiness Disclosure
The year 2000 issue originates from computer programs and imbedded chips using
two digits rather than four to define the calendar year. Computer programs that
have date-sensitive software may recognize a date using "00"as the year 1900
rather than the year 2000.
If not addressed and completed on a timely basis, failure of the Company's
computer systems to process year 2000 related data correctly could have a
material adverse effect on the Company's operations and financial condition.
Failures of this kind could, for example, lead to incomplete or inaccurate
accounting, settlement failures, trade processing or recording errors in
securities, currencies, commodities or other assets. It could also lead to
uncertainty regarding risk, exposures and liquidity. If not addressed, the
potential risks to the Company include financial loss, legal liability,
interruption of business and regulatory actions.
The Company established a team in 1996 to modify or replace and then test the
appropriate software and equipment to ensure that year 2000 issues were
addressed. The Company presently believes that, with modifications to existing
software and conversions to new software, the year 2000 issue will be resolved
for all the Company's own systems worldwide.
In its approach to the year 2000 problem, Lehman Brothers has been guided by a
three-step methodology. The steps are:
o Inventory and Assessment
o Remediation
o Testing
Inventory and assessment consisted of initial technical and functional analysis
across the Company's applications. Initial analysis identified systems and
applications. Each application was then reviewed and classified as highly
critical, critical or non-critical. This process is complete.
Remediation is divided into three phases. Applications specified as year 2000
non-compliant have been analyzed to determine business impact and those that
have been deemed critical were targeted for remediation. Selected Lehman
Brothers mainframe applications were sent to an outside vendor for remediation,
while the remaining applications have been repaired internally. Remediation of
critical applications was completed by the end of the second quarter of 1999.
All remediated applications are tested for non-year 2000 functionality to
confirm they still run correctly prior to year 2000 testing. At the time of
remediation, applications are logged into a change management system to further
ensure any additional changes are monitored and re-tested for year 2000
compliance.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Testing for year 2000 compliance has also been organized into three phases.
Phase one involves testing individual applications or groups of applications on
mainframe or on distributed platforms. Consultants were engaged to assist with
the testing of distributed applications classified as highly critical. Phase two
involves real-time testing across platforms (integration testing). Phase three
involves testing applications between firms (external testing).
Each of these phases has been pursued in a worldwide effort coordinated in New
York, London and Tokyo where project teams and segregated lab environments have
been established.
External testing itself is being performed in three steps. "Point-to-point"
testing confirms that application interfaces between the Company and individual
services and utilities function correctly. Point-to-point testing began in
February 1998. "Beta" testing for a product follows Point-to-point testing and
is a dress rehearsal for industrywide testing. Beta testing is only performed in
the U.S. Many of the markets are not providing Industrywide testing, but they
are providing some amount of end-to-end testing, where data is passed to more
than one exchange or utility. Industrywide testing follows beta testing as the
final external testing step.
In 1998, the Company participated in two Beta tests in the U.S., for the SIA and
for the Futures Industry Association (FIA). The Company has also participated in
the SIA Money Market Beta Test, the Mortgage-Backed Securities Clearing
Corporation Test, the Participant Trust Company Mortgage Test and the Government
Securities Clearing Corporation Test, the SIA Market Data Beta Test. Overseas
tests in which the Company has participated include the Central Gilts Office
(CGO) and CREST in the United Kingdom and the Singapore International Monetary
Exchange (SIMEX) test in Singapore.
In March and April of 1999, the Company participated in the SIA Industrywide
Test, as well as the Stock Loan Test and SIA Market Data Test in May. The
Company has participated in a variety of point-to-point oversees tests in Hong
Kong and Tokyo. We are currently participating in Industrywide testing in Japan
with a June 27 completion. The Company has participated in testing in Germany,
Italy, U.K., Sweden, and France. The Company is also participating in a
cooperative test with Euroclear. The Company is also participating in Custody
2000 testing of cash and securities settlement systems with banks in Italy and
Poland. Additional European tests are scheduled to October, 1999. All tests to
date have been successful.
The Company has taken a leading role in the industry's efforts to deal with the
year 2000 issue by actively participating and in some cases, leading,
industrywide testing efforts. Lehman Brothers chaired the Participants'
Industrywide Testing Subcommittee of the Securities Industry Association (SIA)
which, with partners such as exchanges, depositories, market data vendors and
buy-side firms, set up, refined and coordinated industrywide testing in the
United States. Industrywide testing is the forum in which firms within the
financial industry test the applications that transfer data between them. These
tests started in March 1999 and are expected to be completed in July, 1999.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
In addition to its leadership in U.S. testing efforts, through membership in the
Executive Committee of Global 2000, a group of international financial firms,
the Company is participating in the coordination of global year 2000 readiness
in the financial community. The Company is also pursuing separate point-to-
point testing with firms not participating in industrywide testing. Lehman
Brothers also serves as a member of the Custody 2000 Working Group whose goal is
to assist the financial community in the assessment of year 2000 readiness of
custodians in a variety of global markets. The Custody 2000 Working Group will
also conduct proxy testing of selected sub-custodians in a number of markets
globally.
Year 2000 also affects building and infrastructure systems. The Company is
engaged in a global effort to address facilities issues. Critical areas include
facilities components such as building management systems, elevators, heating
systems, security and fire alarm systems, electrical and other building
services. Facilities staff has surveyed and continues to test equipment and
components and, with the Third Party Vendor team, is working to ensure that
vendors and suppliers are year 2000 ready.
However, even if these changes are successful, the Company remains at risk from
year 2000 failures caused by third parties. Externally, the Company is an active
participant in the SIA Third Party Vendor Committee. Internally, the Company is
evaluating efforts of key counterparties, banks, exchanges, agencies, utilities
and suppliers, among others, to assess and remediate their year 2000 issues. As
part of this effort, the Third Party Vendor team has inventoried and has sent
surveys to vendors whose software and hardware products the Company uses and
whose services the Company employs to determine their year 2000 readiness. The
team is also testing critical software and hardware products to ensure year 2000
readiness. To date the Company has received information from 99% of its vendors,
including overseas vendors whose year 2000 awareness seems to be less advanced
than in the United States.
Examples of problems that could result from the failure by third parties with
whom the Company interacts to remediate year 2000 bugs include: (i) in the case
of exchanges and clearing agents, funding disruptions, failure to trade in
certain markets and settlement failures; (ii) in the case of counterparties and
clients, accounting and financial difficulties to those parties that may expose
the Company to increased credit risk and lost business; (iii) in the case of
vendors, service failures such as power, telecommunications, elevator operations
and loss of security access control; (iv) in the case of banks and other
lenders, the potential for liquidity stress due to disruptions to funding flows;
and, (v) in the case of data providers, inaccurate or out of date information
that would impair the Company's ability to perform critical functions such as
pricing securities and currencies.
Additionally, general uncertainty regarding the success of remediation may cause
many market participants to reduce their market activities temporarily as they
address and assess their year 2000 efforts in 1999. This could result in a
general reduction in market activities and revenue opportunities in late 1999
and early 2000. Management cannot predict the magnitude of any such reduction or
its impact on the Company 's financial results. However, the Company's Risk
Management Department continues to evaluate third party and credit risks posed
by year 2000.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Recognizing the uncertainty of external dependencies, the Company is also
preparing a contingency plan that identifies potential problems, actions to
minimize the likelihood of them occurring and action plans to be invoked should
they occur. The plan includes backup processes that do not rely on computer
systems, where appropriate. The base contingency plan was finalized at the end
of April 1999. The Company's business units continue to review and fine tune the
contingency plan and to respond to new information about year 2000 risks as such
information becomes available.
However, as stated above, there can be no guarantee or assurance that the
systems of other companies on which the Company's systems rely will be
remediated in a timely manner. This or a failure to remediate by another company
or a remediation that is incompatible with the Company's systems could have a
material adverse effect on the Company.
The Company has established an internal auditing plan to ensure ongoing
compliance of tested applications.
The Company's total year 2000 project cost is based on presently available
information. The total remaining cost of the year 2000 project is estimated at
approximately $22 million, which will be funded through operating cash flow and
expensed as incurred over the next one year. The Company has incurred and
expensed approximately $16 million in 1997, $31 million in 1998, and $19 million
through May 31, 1999, related to the year 2000 project.
The costs of year 2000 testing, modifications and/or replacements and the date
on which the Company plans to complete the project are based on management's
best estimates. These estimates were derived using numerous assumptions of
future events including the continued availability of certain resources, third
party modification plans and other factors.
New Accounting Standards
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131 "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 is effective
for the Company in Fiscal 1999 and establishes standards for related disclosures
about products and services, geographic areas and major customers. The Company
will adopt SFAS No. 131 in its 1999 Annual Report.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which requires all derivatives to be
recorded on the balance sheet at fair value. In June 1999, the FASB extended the
implementation date of SFAS No. 133 by one year. As a result, SFAS No. 133 will
now be effective for the Company on December 1, 2000 (Fiscal Year 2001). The
expected impact of adoption on the Company's results of operations has not yet
been determined, however it is not likely to be material since most of the
Company's derivatives are carried at fair value.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUSBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
Lehman Brothers is involved in a number of judicial, regulatory and
arbitration proceedings concerning matters arising in connection with the
conduct of its business. Such proceedings include actions brought against LBI
and others with respect to transactions in which LBI acted as an underwriter or
financial advisor, actions arising out of LBI's activities as a broker or dealer
in securities and commodities and actions brought on behalf of various classes
of claimants against many securities and commodities firms of which LBI is one.
Although there can be no assurance as to the ultimate outcome, Lehman
Brothers has denied, or believes it has meritorious defenses and will deny,
liability in all significant cases pending against it including the matters
described below, and intends to defend vigorously each such case. Although there
can be no assurance as to the ultimate outcome, based on information currently
available and established reserves, the Company believes that the eventual
outcome of the actions against it, including the matters described below, will
not, in the aggregate, have a material adverse effect on its business or
consolidated financial condition.
County of Orange et al. v. Bear Stearns & Co. et al. (Reported in Holdings'
Annual Report on Form 10-K)
On June 29, 1999, the district court entered final orders approving the
settlement reached between the County and the remaining broker-dealer
defendants. This settlement finally resolves all of the County's claims against
the Company.
Bamaodah v. E.F. Hutton & Company Inc. (Reported in Holdings' Annual Report on
Form 10-K)
The hearing scheduled for April, 1999 has been adjourned to October,
1999.
Actions Relating to National Association of Securities Dealers Automated
Quotations System ("NASDAQ") Market Maker Antitrust and Securities Litigation
(Reported in Holdings' Annual Report on Form 10-K)
Two appeals from the Final Judgment and Order of Dismissal were filed.
One was withdrawn. The other was dismissed by the Second Circuit Court of
Appeals on July 8, 1999.
<PAGE>
Easton & Co. v. Mutual Benefit Life Insurance Co., et al., Easton & Co. v.
Lehman Brothers Inc. (Reported In Holdings' Annual Report on Form 10-K)
On May 25, 1999, the Court signed an Order and Final Judgment approving
the settlements reached in these two consolidated class actions.
Corporacion Nacional del Cobre de Chile v. Lehman Brothers Inc., Lehman Brothers
Commercial Corp., Lehman Brothers Commodities Ltd. and Lehman Brothers Holdings
Inc.
On April 29, 1999, Corporacion Nacional del Cobre de Chile ("Codelco")
filed an Amended Statement of Claim against Holdings and certain of its
subsidiaries in a proceeding before the American Arbitration Association. In
connection with the metals trading conducted by Codelco's chief metals trader,
Juan Pablo Davila, the Amended Statement of Claim asserts the following claims
against Lehman Brothers: common law fraud, aiding and abetting fraud, breach of
fiduciary duty, aiding and abetting a breach of fiduciary duty, breach of
contract, and breach of duty of good faith and fair dealing. The Amended
Statement of Claim seeks damages in the amount of $48 million for Codelco's
alleged trading losses with Lehman Brothers, additional amounts to be determined
by the arbitrators for Codelco's losses with other brokers allegedly caused by
Lehman's misconduct, plus punitive damages and attorneys' fees.
<PAGE>
ITEM 6 Exhibits and Reports on Form 8-K
The following exhibits and reports on Form 8-K are filed as part of this
Quarterly Report, or where indicated, were heretofore filed and are hereby
incorporated by reference:
(a) Exhibits:
12.1 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
27 Financial Data Schedule
(b) Reports on Form 8-K:
1. Form 8-K dated April 20, 1999, Item 7.
2. Form 8-K dated June 22, 1999, Items 5 and 7.
3. Form 8-K dated July 7, 1999, Item 7.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEHMAN BROTHERS HOLDINGS INC.
(Registrant)
Date: July 15, 1999 By: /s/ John Cecil
-------------------------
Chief Financial and
Administrative Officer
(Principal Financial Officer)
<PAGE>
EXHIBIT INDEX
Exhibit No. Exhibit
Exhibit 12.1 Computation in Support of Ratio of Earnings to Fixed Charges
Exhibit 12.2 Computation in Support of Ratio of Earnings to Combined Fixed
Charges and Preferred Dividends
Exhibit 27 Financial Data Schedule
<PAGE>
Exhibit 12.1
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
COMPUTATION in SUPPORT of RATIO of EARNINGS to FIXED CHARGES
(Dollars in millions)
(Unaudited)
<TABLE>
<CAPTION>
For the For the For the For the For the For the
Eleven Twelve Twelve Twelve Twelve Six
Months Months Ended Months Ended Months Ended Months Ended Months Ended
Ended November 30 November 30 November 30 November 30 May 31
November 30 1995 1996 1997 1998 1999
1994
------------- ------------- ------------- -------------- ------------- --------------
Fixed Charges:
Interest expense:
<S> <C> <C> <C> <C> <C> <C>
Subordinated indebtedness $ 158 $ 206 $ 220 $ 240 $ 245 $ 148
Bank loans and other
borrowings* 6,294 10,199 10,596 12,770 15,536 6,803
Interest component of rentals
of office and equipment 42 44 34 32 32 16
Other adjustments** 4 28 16 9 15 34
============= ============= ============= ============== ============= ==============
TOTAL (A) $6,498 $10,477 $10,866 $13,051 $15,828 $7,001
============= ============= ============= ============== ============= ==============
Earnings:
Pretax income (loss) from
continuing operations $ 193 $ 369 $ 637 $ 937 $ 1,052 $ 775
Fixed charges 6,498 10,477 10,866 13,051 15,828 7,001
Other adjustments*** (4) (28) (14) (8) (15) (34)
============= ============= ============= ============== ============= ==============
TOTAL (B) $6,687 $10,818 $11,489 $13,980 $16,865 $7,742
============= ============= ============= ============== ============= ==============
(B/A) 1.03 1.03 1.06 1.07 1.07 1.11
</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>
Exhibit 12.2
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
COMPUTATION in SUPPORT of RATIO of EARNINGS to COMBINED
FIXED CHARGES and PREFERRED DIVIDENDS
(Dollars in millions)
(Unaudited)
<TABLE>
<CAPTION>
For the For the For the For the For the For the
Eleven Twelve Twelve Twelve Twelve Six
Months Months Ended Months Ended Months Ended Months Ended Months
Ended November 30 November 30 November 30 November 30 Ended
November 30 1995 1996 1997 1998 May 31
1994 1999
------------- -------------- ------------- ------------- ------------- ------------
Combined Fixed Charges and
Preferred Dividends:
Interest expense:
<S> <C> <C> <C> <C> <C> <C>
Subordinated indebtedness $ 158 $ 206 $ 220 $ 240 $ 245 $ 148
Bank loans and other
borrowings* 6,294 10,199 10,596 12,770 15,536 6,803
Interest component of rentals
of office and equipment 42 44 34 32 32 16
Other adjustments** 4 28 16 9 15 34
------------- -------------- ------------- ------------- ------------- ------------
Total fixed charges 6,498 10,477 10,866 13,051 15,828 7,001
Preferred dividends (tax
equivalent basis) 58 64 58 109 124 104
============= ============== ============= ============= ============= ============
TOTAL (A) $6,556 $10,541 $10,924 $13,160 $15,952 $7,105
============= ============== ============= ============= ============= ============
Earnings:
Pretax income (loss) from
continuing operations $ 193 $ 369 $ 637 $ 937 $ 1,052 $ 775
Fixed charges 6,498 10,477 10,866 13,051 15,828 7,001
Other adjustments*** (4) (28) (14) (8) (15) (34)
============= ============== ============= ============= ============= ============
TOTAL (B) $6,687 $10,818 $11,489 $13,980 $16,865 $7,742
============= ============== ============= ============= ============= ============
(B/A) 1.02 1.03 1.05 1.06 1.06 1.09
</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.
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
This schedule contains summary financial information extracted from the
Company's Consolidated Statement of Financial Condition at May 31, 1999
(Unaudited) and the Consolidated Statement of Income for the six months ended
May 31, 1999 (Unaudited) and is qualified in its entirety by reference to such
financial statements. Amounts are in millions, except for e.p.s. amounts.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> NOV-30-1999
<PERIOD-START> DEC-01-1998
<PERIOD-END> MAY-31-1999
<CASH> 4,920
<RECEIVABLES> 12,873
<SECURITIES-RESALE> 62,721
<SECURITIES-BORROWED> 22,315
<INSTRUMENTS-OWNED> 86,874
<PP&E> 493
<TOTAL-ASSETS> 191,543
<SHORT-TERM> 7,166
<PAYABLES> 12,185
<REPOS-SOLD> 90,699
<SECURITIES-LOANED> 5,384
<INSTRUMENTS-SOLD> 41,194
<LONG-TERM> 28,462
710
808
<COMMON> 12
<OTHER-SE> 4,923
<TOTAL-LIABILITY-AND-EQUITY> 191,543
<TRADING-REVENUE> 1,189
<INTEREST-DIVIDENDS> 7,208
<COMMISSIONS> 314
<INVESTMENT-BANKING-REVENUES> 788
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 6,950
<COMPENSATION> 1,305
<INCOME-PRETAX> 775
<INCOME-PRE-EXTRAORDINARY> 540
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 540
<EPS-BASIC> 3.82
<EPS-DILUTED> 3.66
</TABLE>
