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 August 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ___________
Commission file number 1-9466
Lehman Brothers Holdings Inc.
(Exact Name of Registrant As Specified In Its Charter)
Delaware 13-3216325
(State or other jurisdiction of incorporation(I.R.S.Employer Identification No.)
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 October 5, 2000, 119,251,627 shares of the Registrant's Common Stock, par
value $0.10 per share, were outstanding.
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED AUGUST 31, 2000
INDEX
Part I. FINANCIAL INFORMATION Page
Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Income -
Three and Nine Months Ended 3
August 31, 2000 and August 31, 1999....................
Consolidated Statement of Financial Condition -
August 31, 2000 and November 30, 1999................. 5
Consolidated Statement of Cash Flows -
Nine Months Ended
August 31, 2000 and August 31, 1999................... 7
Notes to Consolidated Financial Statements ............9
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.........19
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.....................................40
Item 6. Exhibits and Reports on Form 8-K......................43
Signature ................................................................44
EXHIBIT INDEX ................................................................45
Exhibits
--------------------------------------------------------------------------------
2
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions, except per share data)
<TABLE>
<CAPTION>
Three months ended
-------------------------------------
August 31 August 31
2000 1999
---------------- ----------------
<S> <C> <C>
Revenues
Principal transactions $ 1,071 $ 492
Investment banking 582 499
Commissions 234 151
Interest and dividends 5,461 3,590
Other 11 33
---------------- ----------------
Total revenues 7,359 4,765
Interest expense 5,307 3,409
---------------- ----------------
Net revenues 2,052 1,356
---------------- ----------------
Non-interest expenses
Compensation and benefits 1,067 688
Technology and communications 80 79
Brokerage and clearance 68 56
Business development 52 33
Professional fees 53 31
Occupancy 35 29
Other 24 23
---------------- ----------------
Total non-interest expenses 1,379 939
---------------- ----------------
Income before taxes and dividends on trust preferred
securities 673 417
Provision for income taxes 202 112
Dividends on trust preferred securities 14 15
---------------- ----------------
Net income $ 457 $ 290
================ ================
Net income applicable to common stock $ 444 $ 279
================ ================
Earnings per common share
Basic $ 3.67 $ 2.30
================ ================
Diluted $ 3.37 $ 2.20
================ ================
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions, except per share data)
<TABLE>
<CAPTION>
Nine months ended
-------------------------------------
August 31 August 31
2000 1999
---------------- ----------------
<S> <C> <C>
Revenues
Principal transactions $ 3,055 $ 1,718
Investment banking 1,664 1,250
Commissions 690 465
Interest and dividends 14,512 10,798
Other 113 57
---------------- ----------------
Total revenues 20,034 14,288
Interest expense 14,025 10,359
---------------- ----------------
Net revenues 6,009 3,929
---------------- ----------------
Non-interest expenses
Compensation and benefits 3,125 1,992
Technology and communications 250 242
Brokerage and clearance 188 175
Business development 128 91
Professional fees 128 82
Occupancy 97 85
Other 68 70
---------------- ----------------
Total non-interest expenses 3,984 2,737
---------------- ----------------
Income before taxes and dividends on trust preferred
securities 2,025 1,192
Provision for income taxes 607 334
Dividends on trust preferred securities 42 28
---------------- ----------------
Net income $ 1,376 $ 830
================ ================
Net income applicable to common stock $ 1,293 $ 745
================ ================
Earnings per common share
Basic $ 10.54 $ 6.12
================ ================
Diluted $ 9.81 $ 5.86
================ ================
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
August 31 November 30
2000 1999
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 4,967 $ 5,186
Cash and securities segregated and on deposit for regulatory and other
purposes 3,059 1,989
Securities and other financial instruments owned:
Governments and agencies 31,642 29,959
Mortgages and mortgage-backed 25,302 22,643
Corporate equities 24,102 12,790
Corporate debt and other 13,571 11,096
Derivatives and other contractual agreements 10,652 10,306
Certificates of deposit and other money market instruments 2,430 2,265
------------------ ------------------
107,699 89,059
------------------ ------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 72,617 62,222
Securities borrowed 22,453 19,397
Receivables:
Brokers, dealers and clearing organizations 1,610 1,674
Customers 9,447 9,332
Others 1,648 1,354
Property, equipment and leasehold improvements (net of
accumulated depreciation and amortization of $859 in 2000
and $889 in 1999) 561 485
Other assets 1,474 1,408
Excess of cost over fair value of net assets acquired (net of accumulated
amortization of $136 in 2000 and $129 in 1999) 133 138
------------------ ------------------
Total Assets $ 225,668 $ 192,244
================== ==================
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION - (Continued)
(Unaudited)
(In millions, except share data)
<TABLE>
<CAPTION>
August 31 November 30
2000 1999
-------------- ----------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt $ 5,667 $ 5,476
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 24,445 22,396
Corporate equities 9,612 12,344
Derivatives and other contractual agreements 9,749 9,582
Corporate debt and other 4,595 2,288
-------------- ----------------
48,401 46,610
-------------- ----------------
Collateralized short-term financing:
Securities sold under agreements to repurchase 97,098 81,083
Securities loaned 9,128 4,568
Payables:
Brokers, dealers and clearing organizations 1,110 1,184
Customers 13,300 10,971
Accrued liabilities and other payables 7,307 4,668
Long-term debt:
Senior notes 32,086 27,375
Subordinated indebtedness 3,321 3,316
-------------- ----------------
Total liabilities 217,418 185,251
-------------- ----------------
Commitments and contingencies
Trust preferred securities subject to mandatory redemption 710 710
STOCKHOLDERS' EQUITY
Preferred stock 850 688
Common stock, $0.10 par value; 300,000,000 shares authorized;
Shares issued: 125,030,511 in 2000 and 122,619,460 in 1999;
Shares outstanding: 120,111,536 in 2000 and 119,912,810 in 1999 12 12
Additional paid-in capital 3,507 3,387
Accumulated other comprehensive income (net of tax) (8) (2)
Retained earnings 3,346 2,094
Other stockholders' equity, net 281 254
Common stock in treasury, at cost: 4,918,975 shares in 2000 and 2,706,650 in 1999 (448) (150)
----------------
--------------
Total stockholders' equity 7,540 6,283
-------------- ----------------
Total liabilities and stockholders' equity $ 225,668 $ 192,244
============== ================
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine months ended
--------------------------------------
August 31 August 31
2000 1999
----------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITES
Net income $ 1,376 $ 830
Adjustments to reconcile net income to net cash provided by
(used in)operating activities:
Depreciation and amortization 72 71
Provisions for losses and other reserves 19 26
Compensation payable in common stock 203 151
Other adjustments 35 40
Net change in:
Cash and securities segregated (1,070) (26)
Securities and other financial instruments owned (18,640) (10,105)
Securities borrowed (3,056) (11,819)
Receivables from brokers, dealers and clearing organizations 64 (432)
Receivables from customers (115) (1,155)
Securities and other financial instruments sold but not yet
purchased 1,791 19,612
Securities loaned 4,560 3,569
Payables to brokers, dealers and clearing organizations (74) 379
Payables to customers 2,329 (1,819)
Accrued liabilities and other payables 2,620 (217)
Other operating assets and liabilities, net (1,177) 437
----------------- ----------------
Net cash provided by (used in) operating activities $ (11,063) $ (458)
----------------- ----------------
</TABLE>
See notes to consolidated financial statements.
7
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS (Continued)
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine months ended
-------------------------------------
August 31 August 31
2000 1999
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITES
Proceeds from issuances of senior notes $ 11,874 $ 7,756
Principal payments of senior notes (6,331) (4,821)
Principal payments of subordinated indebtedness (202)
Net proceeds from commercial paper and short-term debt 191 12
Resale agreements net of repurchase agreements 5,620 (728)
Payments for treasury stock purchases (470) (207)
Dividends paid (122) (117)
Issuances of common stock 68 12
Issuance (redemption) of preferred stock 162 (150)
Issuances of trust preferred securities, net of issuance costs 690
---------------- ----------------
Net cash provided by (used in) financing activities 10,992 2,245
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (148) (54)
---------------- ----------------
Net cash used in investing activities (148) (54)
---------------- ----------------
Net change in cash and cash equivalents (219) 1,733
---------------- ----------------
Cash and cash equivalents, beginning of period 5,186 3,055
---------------- ----------------
Cash and cash equivalents, end of period $ 4,967 $ 4,788
================ ================
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $14,075 and $10,555 for the nine months ended August 31,
2000 and August 31, 1999, respectively. Income taxes paid/(received) totaled
$308 and $(43) for the nine months ended August 31, 2000 and August 31, 1999,
respectively.
See notes to consolidated financial statements.
8
<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, 1999 (the "Form 10-K"). The Consolidated
Statement of Financial Condition at November 30, 1999 was derived from the
audited financial statements.
The nature of the Company's business is such that the results of any interim
period may vary significantly from quarter to quarter and may not be indicative
of the results to be expected for the fiscal year. Certain prior period amounts
reflect reclassifications to conform to the current period's presentation.
2. Long-Term Debt:
During the nine months ended August 31, 2000, the Company issued $11,874 million
of long-term debt (all of which were senior notes). Of the total issuances
during the period, $4,151 million were U.S. dollar fixed rate, $3,944 million
were U.S. dollar floating rate, $2,463 million were foreign currency denominated
fixed rate, and $1,316 million were foreign currency denominated floating rate.
These issuances were primarily utilized to refinance current maturities of
long-term debt in 2000 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 denominated
new issuances totaling $3,779 million, $711 million were effectively swapped to
U.S. Dollars, with the remainder match funding foreign currency denominated
capital needs.
The Company had $6,331 million of long-term debt mature during the nine months
ended August 31, 2000.
9
<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 August 31, 2000, LBI's regulatory net capital, as defined, of $1,828
million exceeded the minimum requirement by $1,689 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 August 31, 2000, LBIE's financial resources of approximately $1,914
million exceeded the minimum requirement by approximately $442 million. Lehman
Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the
capital requirements of the Financial Supervisory Agency and, at August 31,
2000, had net capital of approximately $373 million which was approximately $175
million in excess of the specified levels required. Lehman Brothers Bank, FSB
(the "Bank"), the Company's thrift subsidiary, is regulated by the Office of
Thrift Supervision ("OTS"). The Bank exceeds all regulatory capital requirements
and is considered well capitalized by the OTS. 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 August 31, 2000,
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 August
31, 2000, LBFP and LBDP each had capital which exceeded the requirement of the
most stringent rating agency by approximately $63 million and $26 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).
10
<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* Nine Months Ended
August 31, 2000 August 31, 2000
(in millions) Assets Liabilities Assets Liabilities
-------------------------------------------------------- -------------- -- --------------- -------------- --- ---------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $ 4,680 $ 3,673 $ 4,853 $ 3,938
Foreign exchange forward contracts and
options 1,092 1,515 893 1,262
Other fixed income securities contracts
(including options and TBAs) 328 333 899 781
Equity contracts (including equity swaps,
warrants and options) 4,552 4,228 7,525 7,194
-------------- -- --------------- -------------- --- ---------------
Total $ 10,652 $ 9,749 $ 14,170 $ 13,175
-------------- -- --------------- -------------- --- ---------------
</TABLE>
* Amounts represent carrying value (exclusive of collateral) and do not
include receivables or payables related to exchange-traded futures
contracts.
11
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Average Fair Value*
Fair Value* Twelve Months Ended
November 30, 1999 November 30, 1999
---------------------------------- ---------------------------------
(in millions) Assets Liabilities Assets Liabilities
-------------------------------------------------------- -------------- -- ---------------- --------------- - ---------------
<S> <C> <C> <C> <C>
Interest rate and currency swaps and options
(including caps, collars and floors) $ 4,807 $ 3,633 $ 4,406 $ 3,030
Foreign exchange forward contracts and
options 878 1,310 1,226 1,287
Other fixed income securities
contracts (including options and TBAs) 254 195 257 240
Equity contracts (including equity swaps,
warrants and options) 4,367 4,444 2,478 3,291
Commodity contracts (including swaps,
forwards and options) 15 5
-------------- -- ---------------- --------------- - ---------------
Total $ 10,306 $ 9,582 $ 8,382 $ 7,853
</TABLE>
* Amounts represent carrying value (exclusive of collateral) and do not
include receivables or payables related to exchange-traded futures
contracts.
Assets included in the table above 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 August 31, 2000 represents the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral. Included within the $10,652 million fair value of assets at August
31, 2000 was $9,445 million related to swaps and other OTC contracts and $1,207
million related to exchange-traded option and warrant contracts. Included within
the $10,306 million fair value of assets at November 30, 1999 was $9,002 million
related to swaps and other OTC contracts and $1,304 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 $6,058 million at August 31, 2000, 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 August 31, 2000 for OTC contracts based upon actual ratings made by
external rating agencies or by equivalent ratings established and utilized by
the Company's Credit Risk Management Department.
12
<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 9%
2 AA-/Aa3 or higher 37%
3 A-/A3 or higher 34%
4 BBB-/Baa3 or higher 15%
5 BB-/Ba3 or higher 4%
6 B+/B1 or lower 1%
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 $3.1 billion at
August 31, 2000 and $4.2 billion at November 30, 1999. These commitments require
borrowers to provide acceptable collateral, as defined in the agreements, when
amounts are drawn under the lending facilities. Advances made under the above
lending arrangements are typically at variable interest rates and generally
provide for over-collateralization based upon the borrowers' creditworthiness.
The Company, through its high grade and high yield sales, trading and
underwriting activities, makes commitments to extend credit in loan syndication
transactions and then participates out a significant portion of these
commitments. The Company had lending commitments to high grade borrowers of $3.4
billion and $2.9 billion at August 31, 2000 and November 30, 1999, respectively,
and has established a facility for third parties to purchase a majority of these
commitments when they are funded. In addition, lending commitments to high yield
borrowers totaled $1.1 billion and $1.4 billion at August 31, 2000 and November
30, 1999, respectively. All of these commitments and any related draw-downs of
these facilities are typically secured against the borrowers' assets, have fixed
maturity dates and are generally contingent upon certain representations,
warranties and contractual conditions applicable to the borrower. Total
commitments are not indicative of actual risk or funding requirements as the
commitments may not be drawn or fully utilized, and the Company will continue to
syndicate and/or sell these commitments.
13
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
At August 31, 2000 and November 30, 1999, the Company had commitments to invest
up to $455 million and $411 million, respectively, directly and through
partnerships, in private equity-related investments. These commitments will be
funded as required through the end of the respective investment periods,
principally expiring in 2004.
In addition to these specific commitments, the Company had various other
commitments of approximately $300 million at both August 31, 2000 and November
30, 1999, 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. Segments:
Lehman Brothers operates in three business segments: Investment Banking, Capital
Markets, and Client Services.
The Investment Banking Division provides advice to corporate, institutional and
government clients throughout the world on mergers, acquisitions, and other
financial matters. The Division also raises capital for clients by underwriting
public and private offerings of debt and equity securities.
The Capital Markets Division includes the Company's institutional sales,
trading, research and financing activities in equity and fixed income cash and
derivatives products. Through the Division, the Company is a global market-maker
in numerous equity and fixed income products, including U.S., European and Asian
equities, government and agency securities, money market products, corporate
high grade, high yield and emerging market securities, mortgage- and
asset-backed securities, municipal securities, bank loans, foreign exchange and
derivatives products. The Division also includes the Company's risk arbitrage
and secured financing businesses as well as realized and unrealized gains and
losses related to the Company's direct private equity investments. The financing
business manages the Company's equity and fixed income matched book activities,
supplies secured financing to institutional clients and customers, and provides
secured funding for the Company's inventory of equity and fixed income products.
14
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
Client Services revenues reflect earnings from the Company's private client and
private equity businesses. Private client revenues reflect the Company's
high-net-worth retail customer flow activities as well as asset management fees
earned from these clients. Private equity net revenues include the management
and incentive fees earned in the Company's role as General Partner for seventeen
merchant banking and venture capital partnerships. In addition, these revenues
also include the appreciation of its general partnership interests.
The Company's segment information for the three months and nine months ended
August 31, 2000 and August 31, 1999 is presented below.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
----------------------------------- ------------------------------------
August 31 August 31 August 31 August 31
2000 1999 2000 1999
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Investment Banking:
Net Revenue $ 571 $ 495 $ 1,635 $ 1,239
================ ================ ================ ================
Earnings before taxes(1) $ 143 $ 168 $ 381 $ 404
================ ================ ================ ================
Segment assets (billions) $ 0.4 $ 0.3 $ 0.4 $ 0.3
================ ================ ================ ================
Capital Markets:
Net Revenue $ 1,282 $ 700 $ 3,703 $ 2,265
================ ================ ================ ================
Earnings before taxes(1) $ 471 $ 207 $ 1,412 $ 685
================ ================ ================ ================
Segment assets (billions) $ 212.7 $ 191.1 $ 212.7 $ 191.1
================ ================ ================ ================
Client Services:
Net Revenue $ 199 $ 161 $ 671 $ 425
================ ================ ================ ================
Earnings before taxes(1) $ 59 $ 43 $ 232 $ 104
================ ================ ================ ================
Segment assets (billions) $ 12.6 $ 10.7 $ 12.6 $ 10.7
================ ================ ================ ================
Total:
Net Revenue $ 2,052 $ 1,356 $ 6,009 $ 3,929
================ ================ ================ ================
Earnings before taxes(1) $ 673 $ 418 $ 2,025 $ 1,193
================ ================ ================ ================
Segment assets (billions) $ 225.7 $ 202.1 $ 225.7 $ 202.1
================ ================ ================ ================
</TABLE>
(1) And before dividends on trust preferred securities.
15
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
The following are net revenues by geographic region:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------------------ ------------------------------------------
August 31 August 31 August 31 August 31
2000 1999 2000 1999
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C>
Americas* $ 1,292 $ 752 $ 3,472 $ 2,323
Europe 629 522 1,900 1,274
Asia Pacific 131 82 637 332
------------------- ------------------- ------------------- -------------------
Total $ 2,052 $ 1,356 $ 6,009 $ 3,929
=================== =================== =================== ===================
</TABLE>
* Includes non-U.S. revenues of $18 million and $13 million for the three months
ended August 31, 2000 and August 31, 1999 respectively, and includes non-U.S.
revenues of $56 million and $32 million for the nine months ended August 31,
2000 and August 31, 1999, respectively.
16
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
7. Incentive Plans:
In the third quarter of 2000, the Company delivered 5.7 million shares of its
common stock to current and former employees in satisfaction of RSUs awarded in
1995. Substantially all of the shares delivered were funded from the RSU Trust.
The Company increased additional paid-in capital by approximately $150 million
for the tax effect of the appreciation in the Company's stock price from the
grant date to the delivery date. The Company also received 1.8 million shares
from current and former employees in satisfaction of applicable tax withholding
requirements. Shares received were recorded as treasury stock at an aggregate
value of $168 million. At August 31, 2000 and November 30, 1999, 21.5 million
and 24.8 million shares were held in the RSU Trust, respectively.
8. Earnings Per Common Share:
Earnings per share was calculated as follows (in millions, except for per share
data):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
August 31 August 31
------------------------------------- ---------------------------------
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Numerator:
Net income $ 457 $ 290 $ 1,376 $ 830
Preferred stock dividends (13) (11) (83) (85)
----------------- ----------------- --------------- --------------
Numerator for basic earnings per
share-income available to
common stockholders 444 279 1,293 745
Convertible preferred stock
dividends 2 4 6 14
Numerator for diluted earnings per
share-income available to
common stock-holders (adjusted
for assumed conversion of
preferred stock) $ 446 $ 283 $ 1,299 $ 759
================= ================= =============== ==============
Denominator:
Denominator for basic earnings per
share - weighted-average shares 121.1 121.3 122.6 121.8
Effect of dilutive securities:
Employee stock options 7.5 3.0 6.1 2.7
Employee restricted stock units 2.7 2.2 2.4 2.0
Preferred shares assumed
converted into common 1.2 2.6 1.2 3.1
----------------- ----------------- -------------- ---------------
Dilutive potential common shares 11.4 7.8 9.7 7.8
----------------- ----------------- --------------- --------------
Denominator for diluted earnings
per share - adjusted weighted-
average shares 132.5 129.1 132.3 129.6
================= ================= =============== ==============
Basic earnings per share $ 3.67 $ 2.30 $ 10.54 $ 6.12
================= ================= =============== ==============
Diluted earnings per share $ 3.37 $ 2.20 $ 9.81 $ 5.86
================= ================= =============== ==============
</TABLE>
Preferred Shares are convertible into common shares at a conversion price of
approximately $123.00 per share. However, for purposes of calculating diluted
earnings per share, preferred shares are assumed to be converted into common
shares when basic earnings per share exceeds preferred dividends per share
obtainable upon conversion (approximately $1.54 on a quarterly basis).
17
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
9. Subsequent Event:
On September 20, 2000, Lehman's Board of Directors declared a two-for-one common
stock split, to be effected in the form of a 100% stock dividend, payable on
October 20, 2000 to stockholders of record on October 5, 2000. The par value of
the common stock will remain at $0.10 per share. Accordingly, an adjustment from
paid-in capital to common stock will be required to preserve the par value of
the post-split shares. Pro forma earnings per share, giving retroactive effect
to the two-for-one common stock split, for the three- and nine-month periods
ended August 31, 2000 and August 31, 1999, respectively, follow:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
August 31 August 31 August 31 August 31
2000 1999 2000 1999
------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Earnings per common share:
Basic $ 1.83 $ 1.15 $ 5.27 $ 3.06
Diluted $ 1.68 $ 1.10 $ 4.91 $ 2.93
Weighted average shares:
Basic 242.2 242.6 245.2 243.6
Diluted 265.0 258.2 264.6 259.2
</TABLE>
Financial information contained elsewhere in these financial statements has not
been adjusted to reflect the impact of the common stock split.
18
<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. As a result, revenues and earnings may vary significantly from
quarter to quarter and from year to year.
The favorable market and economic conditions in the United States during 1999
continued through April 2000, became choppy throughout the remaining half of the
second fiscal quarter, and then turned positive again in the third fiscal
quarter. Boosted by a wealth effect stemming from previous gains in the stock
market, consumer spending soared during 2000. In response to strong growth and
rising inflation fears, the Federal Reserve raised the Federal Funds rate by a
total of 100 basis points to 6.50% over the first half of the year, with the
last increase occurring on May 16, 2000. In the third fiscal quarter, concerns
about possible future rate hikes mitigated as the Federal Reserve left rates
unchanged.
As a result of the changing economic climate, the U.S. equity markets were very
volatile during the nine-month period ending August 31, 2000. By the middle of
January 2000, in anticipation of further Fed rate hikes, the price of
old-economy stocks, as measured by the Dow Jones Industrial Average, started to
decline, falling briefly through the 10,000 barrier in late January and early
February before recovering to end the three-quarter period at 11,215.
New-economy stocks, as measured by the NASDAQ Composite, experienced
significantly more volatility: climbing 40% to a new all-time high of 5,133 in
early March, before slipping 41% to 3,043 in late May. The NASDAQ Composite then
moved 38% above the May low to 4,206 at the end of August as the market unwound
its prior expectations for further Fed tightening in the months ahead. The S&P
500 Index, a broader market barometer, rallied to a new all-time high of 1,553
in March prior to correcting 14% into mid-April. The S&P 500 Index then
recovered to close the quarter at 1,518 at August 30.
Benign U.S. inflation, coupled with a more subdued U.S. equity market, paved the
way for the Federal Reserve to conclude its interest rate-hike campaign on May
16, 2000. Increased U.S. Treasury buybacks, lower volumes of U.S. corporate debt
issuance, and revised forecasts for higher future U.S. budget surpluses in the
first half of 2000, led to improved market fundamentals during the third fiscal
quarter of 2000. Investors' appetite for credit spread products improved in
early June and set the tone for renewed vigor in the new issuance calendar.
Nominal bid spreads above comparable U.S. Treasuries for U.S. investment-grade
corporate debt crested in May and declined 10 basis points to 176 basis points
by August 31, 2000.
In Europe, the ten-year bellwether Bund rose 17 basis points from 5.12% on
December 1, 1999 to 5.29% on August 31, 2000, as the European Central Bank
continued its tightening mode campaign to combat the threat of higher inflation
and a weak euro.
19
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Activity in the European corporate bond market for the nine months ended August
31, 2000, slowed significantly compared to the same period in 1999. Issuance of
fixed rate euro-denominated corporate debt declined by 36%, as a result of
higher yields, a flatter government yield curve, and rising investor concern
around corporate credit quality. Credit spreads widened by 20 basis points since
the beginning of 2000, leading to an underperformance of corporate bonds
compared to government securities. Trading activity also became more muted,
affected by a shift in investor focus to equities, as well as volatile trading
conditions in high profile sectors such as telecommunications.
European equity markets were among the leading performers in the nine months to
August 2000, returning 15% in local currency terms (FTSE World Index). However,
the bulk of these gains were achieved in the first four months of the period.
Recent months have been a more difficult environment for stock markets,
reflecting a rollover in regional growth expectations and a rise in euro area
inflation and short-term interest rates. Trading volume increased on levels of a
year ago and announced merger and acquisition activity continued to run at high
levels, although there is some evidence that the trend peaked in late-1999.
Financial advisory activities on a global basis continued at record levels.
Industrywide, the volume of announced merger and acquisition transactions in the
nine months ended August 31, 2000 soared to $ 2.7 trillion, even though
influenced by the announcement of a few large transactions. The first nine
months of the year also reflected continued activity involving European
companies and cross-border mergers and acquisitions. The forces of
consolidation, deregulation and globalization across industry sectors continued
to drive strategic combinations. Equity new issuance during the first nine
months ended August 31, 2000 was at record levels worldwide, with volumes more
than doubling over the same period last year. In the U.S., equity issuance more
than tripled year-over-year. Fueling the domestic market was increased IPO
activity and continued equity raising in the technology, telecommunications and
new media sectors. Debt issuance was initially dampened by the outward shift in
the yield curve in January and later by the inversion of the yield curve and the
anticipation of future interest rate hikes by the Federal Reserve. However, as
it becomes apparent that the Fed was on hold, market fundamentals improved
during the third fiscal quarter of 2000.
In the Far East, Japanese stocks lost over 5% of their value over the period as
a whole (TOPIX) on evidence that the cyclical recovery was losing momentum at a
time when the Bank of Japan was preparing markets for the end of the zero
interest rate policy in August. On August 11, 2000, the Bank of Japan abandoned
its 17-month "zero-rate" policy, thereby raising interest rates. The ten-year
JGB bellwether climbed 4 basis points from 1.84% on December 1, 1999 to 1.88% on
August 31, 2000. Outside of Japan, Asian markets achieved a respectable 8% local
currency return, helped by diminishing concerns over the need for US rates to
move sharply higher, and Latin American stock markets gained 11%, led by Brazil.
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.
20
<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 August 31, 2000 and August 31, 1999
The Company reported net income of $457 million for the third quarter ended
August 31, 2000, representing an increase of 58% from net income of $290 million
for the third quarter ended August 31, 1999. Earnings per common share (diluted)
rose to $3.37 for the third quarter of 2000 from $2.20 for the third quarter of
1999, an increase of 53%.
The quarter represented the second highest quarterly revenues, net income and
earnings per common share posted by the Company. These results reflect the
continued execution of the Company's growth strategy into higher margin
businesses such as investment banking and equities; increasing its presence in
certain strategic businesses in Europe; and, at the same time, maintaining a
discipline with regard to its expenses. The Company's strategy is based on the
belief that: (1) these businesses generate higher returns on equity because they
are less capital intensive; (2) their rapid growth accelerates the Company's
overall rate of growth; and (3) they help reduce earnings volatility by
diversifying the Company's revenue base.
The Company's emphasis on these high margin businesses generated operating
margins of 32.8% in the third quarter of 2000 compared with 30.8% in the third
quarter of 1999. Net revenues increased 51% in the third quarter of 2000 to
$2,052 million from $1,356 million in the third quarter of 1999. Non-personnel
expenses as a percentage of net revenues decreased to 15.2% compared to 18.5% in
the third quarter of 1999. Non-personnel expenses in total increased 24%
compared to the third quarter of 1999, reflecting the Company's growth plan,
however this rate of growth continues to be substantially less than the
Company's revenue growth rate. Return on common equity was 27.5% for the quarter
ended August 31, 2000, compared with 22.1% a year ago. The Company's
compensation and benefits ratio increased to 52% of net revenues from 50.7%,
although unchanged from the first and second quarters of 2000, reflecting the
Company's continued expansion of its investment banking, equities, and European
franchises as well as its investments in technology and e-commerce capabilities.
In the following tables, the Company's results have been segregated into three
business segments: Investment Banking, Capital Markets and Client Services. Each
segment represents a group of activities and products with similar
characteristics. These business activities result in revenues from both
institutional clients as well as high-net-worth retail clients and are
recognized within the different revenue categories in the Company's Consolidated
Statement of Income. Net revenues by segment contain certain internal
allocations, including funding costs, which are centrally managed.
21
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Three Months Ended August 31, 2000 and August 31, 1999
-----------------------------------------------------------------------------
(in millions)
-----------------------------------------------------------------------------
Three Months Ended
----------------------------------
August 31 August 31
2000 1999
--------------- ---------------
Investment Banking $ 571 $ 495
Capital Markets 1,282 700
Client Services 199 161
--------------- ---------------
Total $ 2,052 $ 1,356
=============== ===============
-----------------------------------------------------------------------------
The following discussion provides an analysis of the Company's net revenues for
the periods above.
Investment Banking This segment's net revenues result from fees earned by the
Company for underwriting public and private offerings of fixed income and equity
securities, raising capital and advising Investment Banking Net Revenues clients
on merger and acquisition activities and other services. Investment Banking's
net revenues increased 15% in the third quarter of 2000 to $571 million from
$495 million in the third quarter of 1999, principally as a result of an
increase in financial advisory and equity underwriting activities partially
offset by a decrease in debt underwriting activities.
Investment Banking Net Revenues
------------------------ ------------------------------
(in millions) Three Months Ended
August 31 August 31
2000 1999
------------------------ --------------- --------------
Equity Underwriting $ 194 $ 116
Debt Underwriting 150 239
Financial Advisory 227 140
------------------------ --------------- --------------
$ 571 $ 495
---------------------------------------------------------------
Equity underwriting revenues increased 67% to $194 million in the third quarter
of 2000 from $116 million in the third quarter of 1999, as the markets recovered
from the April/May sell-off and deal flow remained strong through mid-August.
Debt underwriting revenues decreased 37% from the third quarter of 1999 as
global debt underwriting volumes lagged 1999 levels due to continued nervousness
surrounding interest rates. High yield and mortgage backed products were
particularly impacted. However, debt underwriting revenue increased
approximately 30% from the second quarter of 2000, as market conditions started
to become more favorable.
Financial advisory revenues increased 62% to a record $227 million in the third
quarter of 2000 from $140 million in the third quarter of 1999. The Company's
market share for completed M&A transactions increased to 8.9% on a calendar
year-to-date basis from 7.7% for calendar year 1999.
22
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Capital Markets This segment's net revenues reflect institutional flow
activities and secondary trading and financing activities related to a broad
spectrum of fixed income and equity products principally related to its customer
flow business. These products include dollar and non-dollar government
securities, mortgages, mortgage- and asset-backed securities, money market
products, dollar and non-dollar corporate debt securities, emerging market
securities, municipal securities, foreign exchange, fixed income and equity
related derivatives, convertible securities and common and preferred Capital
Markets Net Revenues equity securities. Capital Markets' net revenues were
$1,282 million for the third quarter of 2000 compared to $700 million for the
third quarter of 1999, an increase of 83%.
Capital Markets Net Revenues
------------------ ---------------------------------
(in millions) Three Months Ended
August 31 August 31
2000 1999
------------------ --------------- -----------------
Equities $ 725 $ 466
Fixed Income 557 234
------------------ --------------- -----------------
$ 1,282 $ 700
------------------ --------------- -----------------
Net revenues from the equity component of Capital Markets increased 56% to $725
million in the third quarter of 2000 from $466 million in the third quarter of
1999. Revenues benefited in the third quarter of 2000 from continued strong
institutional customer flow and trading volumes primarily in European cash
products, which experienced a record quarter. An unrealized gain of
approximately $100 million from a direct investment in the Company's private
equity portfolio also contributed to the increase.
Net revenues from the fixed income component of Capital Markets increased 138%
to $557 million in the third quarter of 2000 from $234 million in the third
quarter of 1999. Market conditions improved during the quarter as interest rate
concerns subsided and institutional flows increased across most fixed income
products.
Client Services Client Services net revenues reflect earnings from the Company's
private client and private equity businesses. Private client net revenues
reflect the Company's high-net-worth retail customer flow activities as well as
asset management fees. Private equity net revenues include the management and
incentive fees earned in the Company's role as General Partner for seventeen
merchant banking and venture capital partnerships.
Client Services Net Revenues
--------------------- ----------------------------------
(in millions) Three Months Ended
August 31 August 31
2000 1999
--------------------- -------------- -------------------
Private Client $ 186 $ 165
Private Equity 13 (4)
--------------------- -------------- -------------------
$ 199 $ 161
--------------------- -------------- -------------------
Client Services' net revenues were $199 million in the third quarter of 2000 and
$161 million in the third quarter of 1999. The 24% increase reflected continued
strength in retail trading volume, particularly in equities, which was in part
driven by the higher sales activity related to the Company's 10 Uncommon Values
campaign. In addition, Private Equity management fees increased as the Company
continues to sponsor new funds.
23
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Non-Interest Expenses Non-interest expenses were $1,379 million for the third
quarter of 2000 and $939 million for the third quarter of 1999. Compensation and
benefits expense as a percentage of net revenues increased to 52% for the
quarter compared to the prior year's ratio of 50.7%. The increase reflects the
Company's continued expansion of its investment banking, equities and European
franchises as well as investment spending in technology and e-commerce
capabilities. Nonpersonnel expenses were $312 million for the third quarter of
2000 and $251 million for the third quarter of 1999, an increase of 24.3% that
reflected the impact of the Company's growth plan. However, nonpersonnel
expenses as a percentage of net revenues declined to 15.2% for the third quarter
of 2000 from 18.5% for the third quarter of 1999 as the Company's net revenues
continued to grow at a faster rate than spending. Increased spending in
personnel, business development, recruiting (professional fees), real estate
(occupancy) and technology were consistent with the Company's planned growth.
Higher brokerage and clearance costs were a result of increased customer volumes
in equity cash products.
Income Taxes The Company's income tax provision was $202 million for the third
quarter of 2000 compared to $112 million for the third quarter of 1999. The
effective tax rate was 30.0% for the third quarter of 2000 and 26.9% for the
third quarter of 1999. This higher tax rate reflected the overall increase in
the level of pre-tax income, which reduced the relative impact of certain tax
preference revenues.
24
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Results of Operations
For the Nine Months Ended August 31, 2000 and August 31, 1999
The Company reported record net income of $1,376 million for the nine months
ended August 31, 2000, representing an increase of 66% from net income of $830
million for the nine months ended August 31, 1999. Earnings per common share
(diluted) rose to $9.81 for the nine months of 2000 from $5.86 for the
comparable period in 1999, an increase of 67%. Earnings per share computations
for both periods include the recognition of $50 million in dividends on the
Company's Redeemable Voting Preferred Stock.
These results reflected the Company's continued ability to execute its strategy
of growing its high margin investment banking and equities businesses;
increasing its presence in certain strategic businesses in Europe; and, at the
same time, maintaining a strict discipline with regard to its expenses. Net
revenues increased to a record $6,009 million for the nine months of 2000 from
$3,929 million for the nine months of 1999, surpassing full fiscal year 1999
revenues of $5,340. The Company's emphasis on high margin businesses supported
an increase in the Company's operating margin to 33.7% for the nine months of
2000 from 30.3% for the nine months of 1999. Return on equity (excluding the
impact of the $50 million in dividends on the Company's Redeemable Voting
Preferred Stock) increased to 29.2% from 21.9% for the comparable period.
Revenues in each of the Company's three segments grew by over 30% compared to
the first nine months of the prior year. Non-personnel expenses increased only
15% in the nine months of 2000, despite an overall 53% increase in net revenues.
As the result of the Company's continued emphasis on expense discipline,
non-personnel expenses as a percentage of revenues has declined to 14.3% from
19.0%. The Company's compensation and benefits ratio increased to 52% of net
revenues from 50.7% as the Company continued to increase headcount, making
significant additions in areas where the Company is focusing its growth.
In the following tables, the Company's results have been segregated into three
business segments: Investment Banking, Capital Markets and Client Services. Each
segment represents a group of activities and products with similar
characteristics. These business activities result in revenues from both
institutional clients as well as high-net-worth retail clients and are
recognized within the different revenue categories in the Company's Consolidated
Statement of Income. (Net revenues by segment contain certain internal
allocations, including funding costs, which are centrally managed.)
25
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Nine Months Ended August 31, 2000 and August 31, 1999
-------------------------------------------------------------------------------
(in millions)
Nine Months Ended
---------------------------------
August 31 August 31
2000 1999
--------------- ---------------
Investment Banking $ 1,635 $ 1,239
Capital Markets 3,703 2,265
Client Services 671 425
--------------- ---------------
Total $ 6,009 $ 3,929
=============== ===============
-------------------------------------------------------------------------------
The following discussion provides an analysis of the Company's net revenues for
the periods above.
Investment Banking This segment's net revenues result from fees earned by the
Company for underwriting public and private offerings of fixed income and equity
securities, raising capital and advising clients on merger and acquisition
activities and other services. Investment Banking's net revenues increased 32%
in the nine months of 2000 to $1,635 million from $1,239 million in the prior
year, principally as a result of a significant increase in equity underwriting
and financial advisory activities partially offset by lower debt underwriting
activities. Equity underwriting revenues increased 127% to $682 million in the
nine months of 2000 and have exceeded full year 1999 amounts. Investment Banking
Net Revenues The strong results in equity underwriting were driven by increased
issuances in the communications/media and technology sectors and strong growth
in the European banking franchise.
Investment Banking Net Revenues
------------------------ ----------------------------
(in millions) Nine Months Ended
August 31 August 31
2000 1999
------------------------ ------------- --------------
Equity Underwriting $ 682 $ 301
Debt Underwriting 419 563
Financial Advisory 534 375
------------------------ ------------- --------------
$ 1,635 $ 1,239
------------------------ ------------- --------------
Debt underwriting revenues decreased 26% to $419 million in the nine months of
2000 from $563 million in the nine months of 1999. The decrease resulted from
challenging market conditions, which commenced in fiscal 2000, as rising
interest rates led to decreased underwriting volume most prominently in the high
yield market. Global debt underwriting volume was down 20% versus the nine
months ended August 31, 1999 and high yield issuance was down 50% on the same
basis.
Financial advisory revenues increased 42% to $534 million in the nine months of
2000 as the Company continued its expansion in the investment banking segment
and the overall M&A market remained robust. The value of the Company's completed
M&A deals through the end of August 2000 was 50% higher than the value through
the end of August 1999. In addition, market share for completed M&A transactions
increased to 8.9% on a calendar year-to-date basis from 7.7% for calendar year
1999.
26
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Capital Markets This segment's net revenues reflect institutional flow
activities and secondary trading and financing activities related to a broad
spectrum of fixed income and equity products. These products include dollar and
non-dollar government securities, mortgages, mortgage- and asset-backed
securities, money market products, dollar and non-dollar corporate debt
securities, emerging market securities, municipal securities, foreign exchange,
fixed income and equity related derivatives, convertible securities and common
and preferred equity securities.
Capital Markets' net revenues were $3,703 million for the nine Capital Markets
Net Revenues months of 2000 and $2,265 million for the nine months of 1999.
Customer flow sales and trading volumes continued to increase at healthy rates,
significantly contributing to this increase.
Capital Markets Net Revenues
----------------- ---------------------------------
(in millions) Nine Months Ended
August 31 August 31
2000 1999
----------------- --------------- -----------------
Equities $ 2,300 $ 1,105
Fixed Income 1,403 1,160
----------------- --------------- -----------------
$ 3,703 $ 2,265
----------------- --------------- -----------------
Net revenues from the equity component of Capital Markets increased 108% to
$2,300 million in the nine months of 2000 from $1,105 million in the comparable
1999 period. Revenues benefited from significantly increased institutional
customer flow activity in cash products, and record performance in equity
derivatives driven by higher levels of market volatility, particularly in the
first half of this year.
Net revenues from the fixed income component of Capital Markets increased 21% to
$1,403 million in the nine months of 2000 from $1,160 million in the comparable
period last year. This was a result of increased institutional flow across most
fixed income products.
Client Services Client Services net revenues reflect earnings from the Company's
private client and private equity businesses. Private client net revenues
reflect the Company's high-net-worth retail customer flow activities as well as
asset management fees. Private equity net revenues include the management and
incentive fees earned in the Company's role as General Partner for seventeen
merchant banking and venture capital partnerships.
Client Services Net Revenues
---------------------- --------------------------------
(in millions) Nine Months Ended
August 31 August 31
2000 1999
---------------------- -------------- -----------------
Private Client $ 638 $ 420
Private Equity 33 5
---------------------- -------------- -----------------
$ 671 $ 425
---------------------- -------------- -----------------
Client Services' net revenues were $671 million in the nine months of 2000 and
$425 million in the nine months of 1999. The 58% increase was driven by record
customer activity due in part to the Company's increased equity syndicate
activity, as well as performance fees resulting from higher portfolio returns in
the Company's London-based managed assets in the first quarter of 2000. In
addition, Private Equity management fees increased as the Company continues to
sponsor new funds.
27
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Non-Interest Expenses Non-interest expenses were $3,984 million for the nine
months of 2000 and $2,737 million for the comparable period in 1999.
Compensation and benefits expense as a percentage of net revenues increased to
52.0% compared to 50.7% in 1999. This increase reflects the Company's continued
expansion of its investment banking, equities and European franchises as well as
its investments in technology and e-commerce capabilities. Nonpersonnel expenses
were $859 million for the nine months of 2000 and $745 million for the nine
months of 1999, an increase of 15.3% that reflected the impact of the Company's
strategic growth plan. However, nonpersonnel expenses declined as a percentage
of net revenues to 14.3% for the nine months of 2000 from 19.0% in the prior
year's period, as the Company's net revenues increased at a significantly faster
rate than expenses.
Income Taxes The Company's income tax provision was $607 million for the nine
months of 2000 compared to $334 million for the nine months of 1999. The
effective tax rate was 30.0% for the first half of 2000 and 28.0% for prior
year's period. The higher rate reflected an overall increase in the level of
pre-tax income, which lessened the relative impact of certain tax preference
revenues.
28
<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 the Company's product
areas. Members of the Company's treasury department and business unit financing
groups work with the Finance Committee to ensure coordination of global funding
efforts and implementation of the funding and liquidity policies. Regional asset
and liability committees in the Company's principal funding centers are
responsible for implementing funding strategies for their respective regions.
The primary goal of the Company's funding policies is to provide sufficient
liquidity and availability of funding sources to meet the needs of the Company's
businesses. The key elements of these policies are to:
(1) Maintain a total capital structure that supports the business activities
in which the Company is engaged.
(2) Finance the Company's assets, primarily on a secured basis. Together with
Total Capital, secured funding provides a stable funding base and enables
the Company to minimize its reliance on short-term unsecured debt.
(3) Maintain funding availability in excess of actual utilization and obtain
diversified funding through a global investor base which increases
liquidity and reduces concentration risk.
(4) Maintain sufficient financial resources to enable the Company to meet its
obligations in periods of financial stress, defined as any event that
severely constrains the Company's access to unsecured funding sources.
Total Capital Total Capital (defined as long-term debt, trust preferred
securities and stockholders' equity) was $43.7 billion at August 31, 2000
compared to $37.7 billion at November 30, 1999. The increase in Total Capital
resulted from a net increase in long-term debt of $4.7 billion, the retention of
earnings, amortization associated with RSU awards, the exercise of stock options
granted to employees, tax credits arising from stock-based employee awards, and
the issuance of $250 million of Series E Preferred Stock. These were offset by
repurchases of common stock (to fund RSUs and option awards) and of $88 million
(2.3 million shares) in convertible Series B Preferred Stock.
29
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
<TABLE>
<CAPTION>
August 31 November 30
(in millions) 2000 1999
---------------------------------------- -------------------------------------- --------------------------------------
Long-term Debt
<S> <C> <C>
Senior Notes $ 32,086 $ 27,375
Subordinated Indebtedness 3,321 3,316
--------- ---------
35,407 30,691
Trust Preferred Securities 710 710
Stockholders' Equity
Preferred Equity 850 688
Common Equity 6,690 5,595
--------- ---------
7,540 6,283
---------------------------------------- -------------------------------------- --------------------------------------
Total Capital $ 43,657 $ 37,684
---------------------------------------- -------------------------------------- --------------------------------------
</TABLE>
During the nine months of 2000, the Company issued $11,874 million in long-term
debt, which was $5,543 million in excess of its maturing debt. Long-term debt
increased to $35.4 billion at August 31, 2000 from $30.7 billion at November 30,
1999 with a weighted-average maturity of 3.9 years at August 31, 2000 and 3.7
years at November 30, 1999.
Secured Funding The Company strives to maximize the portion of the Company's
balance sheet that is funded on a secured basis. Secured funding includes
securities and other financial instruments sold but not yet purchased, as well
as collateralized short-term financings, defined as securities sold under
agreements to repurchase ("repos") and securities loaned. Because of their
secured nature, repos have historically been a stable financing source
irrespective of market conditions. At August 31, 2000 and November 30, 1999,
$145 billion and $123 billion, respectively, of the Company's total balance
sheet of $226 billion and $192 billion at August 31, 2000 and November 30, 1999,
respectively, was financed on a secured basis.
By maximizing its use of secured funding, the Company minimizes its reliance on
unsecured financing. As of August 31, 2000 and November 30, 1999, commercial
paper and short-term debt outstanding totaled $5.7 billion and $5.5 billion,
respectively. Of these amounts, commercial paper outstanding was $3.4 billion
and $3.6 billion at August 31, 2000 and November 30, 1999, 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
a specified level of tangible net worth.
30
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
In July 2000, the Company entered into a $1 billion Committed Securities
Repurchase Facility (the "Facility") for LBIE, the Company's major operating
entity in Europe. The Facility provides secured multi-currency financing for a
broad range of collateral types. 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.
Balance Sheet The Company's total assets increased to $225.7 billion at August
31, 2000 from $192.2 billion at November 30, 1999. The Company's adjusted total
assets, defined as total assets less the lower of securities purchased under
agreements to resell or securities sold under agreements to repurchase were
$153.1 billion at August 31, 2000 compared to $130.0 billion at November 30,
1999. The Company believes adjusted total assets is a more effective measure of
evaluating balance sheet usage when comparing companies in the securities
industry. The increase in adjusted total assets primarily reflects higher levels
of securities owned and borrowed associated with increased customer flow
activities across most of its Capital Markets businesses.
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.
31
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
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
ratio based on adjusted total assets at both August 31, 2000 and November 30,
1999 was 18.6x. 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.
[CHART NOT REPRODUCED]
32
<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 September 14, 2000, Moody's Investors Service
placed the ratings of Lehman Brothers Holdings Inc. as well as those of its
rated subsidiaries, on review for possible upgrade. As of August 31, 2000 the
short- and long-term debt ratings of Holdings and LBI were as follows:
<TABLE>
<CAPTION>
Holdings LBI
----------------------------------- -----------------------------------
Short-term Long-term Short-term Long-term**
------------------------------------------- ---------------- ------------------ --- --------------- -------------------
<S> <C> <C>
Fitch F-1 A F-1 A/A-
Moody's P-2 A3 P-1 A2*/A3
Standard & Poor's Corp. A-1 A A-1 A+*/A
Thomson BankWatch TBW-1 A TBW-1 A+/A
* Provisional ratings on shelf registration
** Senior/subordinated
</TABLE>
33
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Other
The Company underwrites, trades, invests and makes markets in high yield
corporate debt securities. The Company also syndicates, trades and invests in
loans to below investment grade-rated companies. For purposes of this
discussion, high yield debt instruments are defined as securities or loans to
companies rated BB+ or lower, or equivalent ratings by recognized credit rating
agencies, as well as non-rated securities or loans which, in the opinion of
management, are non-investment grade. Non-investment grade securities generally
involve greater risks than investment grade securities due to the issuer's
creditworthiness and the liquidity of the market for such securities. In
addition, these issuers have higher levels of indebtedness, resulting in an
increased sensitivity to adverse economic conditions. The Company recognizes
these risks and aims to reduce market and credit risk through the
diversification of its products and counterparties. High yield debt instruments
are carried at fair value, and unrealized gains or losses from these instruments
are recognized in the Company's Consolidated Statement of Income. Such
instruments at August 31, 2000 and November 30, 1999 included long positions
with an aggregate market value of approximately $3.2 billion and $3.0 billion,
respectively, and short positions with an aggregate market value of
approximately $514 million and $290 million, respectively. The Company mitigates
its aggregate and single issuer net exposure through the use of derivatives,
sole-recourse securitization financing 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).
The Company has investments in seventeen merchant banking and venture
capital-related partnerships, for which the Company acts as general partner, as
well as related direct investments. At August 31, 2000, the Company's investment
in these partnerships totaled $162 million and related direct investments
totaled $793 million. The Company's policy is to carry its investments,
including the appreciation of its general partnership interests, at fair value
based upon the Company's assessment of the underlying investments. Additional
information about the Company's private equity activities, including related
commitments, can be found in Note 5 to the Consolidated Financial Statements
(Other Commitments and Contingencies).
34
<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. Consequently, 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 Officer, the Chief Administrative Officer, the
Co-Heads of Capital Markets, the Head of Investment Banking and the Head of
Private Equity. The Committee brings together senior management with the sole
intent of discussing risk-related issues and provides an effective forum for
managing risk at the highest levels within the Company. The Committee meets on a
monthly basis, or more frequently if required, to discuss, among other matters,
significant market exposures, concentrations of positions (e.g., counterparty,
market risk), potential new transactions or positions and risk limit exceptions.
The Global Risk Management Group (the "Group") supports the Committee, is
independent of the trading areas and reports directly to the Chief Executive
Officer. The Group combines two departments, credit risk management and market
risk management, into one unit. This facilitates the analysis of counterparty
credit and market risk exposures and leverages personnel and information
technology resources in a cost-efficient manner. The Group maintains staff in
each of the Company's regional trading centers and has daily contact with
trading staff at all levels within the Company. These discussions include a
review of trading positions and risk exposures.
Credit Risk Credit risk represents the possibility that a counterparty will be
unable to honor its contractual obligations to the Company. Credit risk
management is therefore an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department")
has global responsibility for implementing the Company's overall credit risk
management framework.
35
<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
valuation adjustments where appropriate. Credit limits are reviewed periodically
to ensure that they remain appropriate in light of market events or the
counterparty's financial condition.
Market Risk Market risk represents the potential change in value of a portfolio
of financial instruments due to changes in market rates, prices and
volatilities. Market risk management also is an essential component of the
Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for implementing the
Company's overall market risk management framework. It is responsible for the
preparation and dissemination of risk reports, developing and implementing the
firmwide Risk Management Guidelines and evaluating adherence to these
guidelines. These guidelines provide a clear framework for risk management
decision-making. To that end the MRM Department identifies and quantifies risk
exposures, develops limits, and reports and monitors these risks with respect to
the approved limits. The identification of material market risks inherent in
positions includes, but is not limited to, interest rate, equity, and foreign
exchange risk exposures. In addition to these risks, the MRM Department also
evaluates liquidity risks, and credit and sovereign concentrations.
The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.
Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client-driven market-making transactions, the size of the Company's
proprietary and arbitrage positions, and the volatility of financial instruments
traded. The Company seeks to mitigate, whenever possible, excess market risk
exposures through the use of futures and option contracts and offsetting cash
market instruments.
The Company participates globally in interest rate, equity, and foreign exchange
markets. The Company's Fixed Income division has a broadly diversified market
presence in U.S. and foreign government bond trading, emerging market
securities, corporate debt (investment and non-investment grade), money market
instruments, mortgages and mortgage-backed securities, asset-
36
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
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. Mortgages
and mortgage-related securities are subject to prepayment risk and changes in
the level of interest rates. Trading in derivatives and structured products
exposes the Company to changes in the level and volatility of interest rates.
The Company actively manages interest rate risk through the use of interest rate
futures, options, swaps, forwards, and offsetting cash market instruments.
Inventory holdings, concentrations and agings are monitored closely and used by
management to selectively hedge or liquidate undesirable exposures.
The Company is a significant intermediary in the global equity markets through
its market-making in U.S. and non-U.S. equity securities, including common
stock, convertible debt, exchange-traded and OTC equity options, equity swaps
and warrants. These activities expose the Company to market risk as a result of
price and volatility changes in its equity inventory. Inventory holdings are
also subject to market risk resulting from concentrations, aging and liquidity
that may adversely impact market valuation. Equity market risk is actively
managed through the use of index futures, exchange-traded and OTC options, swaps
and cash instruments.
The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar as well as a variety of developed and emerging
market currencies. The Company hedges its risk exposures primarily through the
use of currency forwards, swaps, futures, and options.
Value-at-Risk For purposes of Securities and Exchange Commission ("SEC") risk
disclosure requirements, the Company discloses an estimate of an entity-wide
value-at-risk for virtually all of its trading activities. In general,
value-at-risk measures potential loss of revenues at a given confidence level
over a specified time horizon. Value-at-risk over a one-day holding period
measured at a 95% confidence level implies that potential loss of daily trading
revenue will be at least as large as the value-at-risk amount on one out of
every 20 trading days.
Our methodology estimates a reporting day value-at-risk using actual daily
trading revenues over the previous 250 trading days. This estimate is measured
as the loss, relative to the median daily trading revenue. We also estimate an
average value-at-risk measure over 250 rolling reporting days, thus looking back
a total of 500 trading days.
37
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Estimated value-at-risk as described above at August 31, 2000 and November 30,
1999 was $20.5 million and $19.2 million, respectively. Average estimated
value-at-risk as described above was $20.4 million and $30.9 million for the
periods ended August 31, 2000 and November 30, 1999, respectively.
Value-at-risk is one measure of potential loss in trading revenues that may
result from adverse market movements over a specified period of time with a
selected likelihood of occurrence. As with all measures of value-at-risk, our
estimate has substantial limitations due to its reliance on historical
performance, which is not necessarily a predictor of the future Consequently,
this value-at-risk estimate 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.
38
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
New Accounting Developments
In September 1999, the FASB issued an Exposure Draft, "Business Combinations and
Intangible Assets." The proposal would eliminate the use of the
pooling-of-interests method and require that all business combinations be
accounted for using the purchase method. The provisions of the Exposure Draft
related to business combinations are expected to be applied only for those
business combinations initiated after the issuance of a final statement,
projected to be in the first quarter of 2001.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), 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 133 by one year. In June 2000, the FASB
issued SFAS No. 138, which amended SFAS 133. The Company will adopt SFAS 133 as
amended on December 1, 2000 (Fiscal Year 2001).
SFAS 133 will not affect the accounting for Lehman's Trading-Related Derivative
Activities as such derivatives are already recognized on a mark-to-market basis
through earnings. Rather, SFAS 133 will affect the accounting for derivatives
utilized as hedging instruments as part of Lehman's end user activities. As an
end user, Lehman primarily utilizes derivatives to modify the interest rate
characteristics of its long-term debt and secured financing activities ("End
User Derivative Activities"). The Company currently accounts for its End-User
Derivative activities on an accrual basis provided that the derivative is deemed
a highly effective hedge. SFAS 133 generally will require Lehman to recognize
its end user derivatives at fair value through earnings, with an offset
recognized through earnings for changes in the fair value of the hedged item.
Any ineffectiveness in a hedging relationship generally will require immediate
earnings recognition. In addition to these changes, SFAS 133, will result in
certain derivatives no longer qualifying for hedge accounting, requiring such
derivatives to be marked to market through earnings without offset. Derivatives
not likely to qualify for hedge accounting under SFAS 133 include U.S. dollar
and foreign currency basis swaps.
The Company has devoted significant resources preparing for the adoption of SFAS
133. While the impact of adopting SFAS 133 will be ultimately dependent upon the
fair value of the end user derivatives portfolio at December 1, 2000 and their
related hedge designations, the Company expects adoption will not materially
impact the Company's stockholders' equity, results of operations, or statement
of financial condition.
39
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms,
including the Company.
Although there can be no assurance as to the ultimate outcome, the Company
has denied, or believes it has meritorious defenses and will deny, liability in
all significant cases pending against it, including the matters described below,
and intends to defend vigorously each such case, and based on information
currently available and established reserves, the Company believes that the
eventual outcome of the actions against it, including the matters described
below, will not, in the aggregate, have a material adverse effect on its
business or consolidated financial condition.
Lehman Brothers Commercial Corporation and Lehman Brothers Special
Financing Inc. v. Minmetals International Non-Ferrous Metals Trading Company
(Reported in Holdings' 1999 Annual Report on Form 10-K)
On August 10, 2000, the Court denied both parties' motions for summary
judgment. A trial date has not yet been scheduled.
AIA Holdings SA et al. v. Lehman Brothers Inc. and Bear Stearns & Co., Inc.
(Reported in Holdings' 1999 Annual Report on Form 10-K)
The first trial is now scheduled to commence in mid-2001.
Actions Relating to Bre-X Minerals Ltd.
McNamara et al. v. Bre-X Minerals Ltd. et al. (Reported in Holdings'
1999 Annual Report on Form 10-K and Quarterly Report on Form 10-Q for the
quarter ended May 31, 2000)
On July 14, 2000, LBI moved to dismiss the Fourth Amended Complaint.
40
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings - continued
Harold Gillet, et al. v. Goldman Sachs & Co, et al. (Reported in Holdings' 1999
Annual Report on Form 10-K)
On April 29, 1999, LBI and the other defendants moved to dismiss the
Consolidated Amended Complaint. On July 21, 2000, plaintiffs moved for leave to
file a Second Amended Complaint that added a new plaintiff and new factual
allegations. LBI and the other defendants have jointly opposed the plaintiffs'
motion to amend the complaint. Both the defendants' motion to dismiss and the
plaintiffs' motion to amend are pending before the Court.
CHS Electronics, Inc. v. Credit Suisse First Boston Corp., et al.
On August 3, 2000, a class action was filed in the United States District
Court for the Southern District of Florida against 18 underwriters of IPO
securities, including LBI. Plaintiffs seek compensatory and injunctive relief
for alleged violations of the antitrust laws based on the theory that the
defendant underwriters fixed and maintained fees for underwriting certain IPO
securities at supra-competitive levels. On October 2, 2000, LBI and the other
defendants jointly moved to transfer this action to the Southern District of New
York, where the Gillet case (see above) is pending, and to stay all proceedings
in the Southern District of Florida pending the Court's resolution of the motion
to transfer.
Corporacion Nacional del Cobre de Chile v. Lehman Brothers Inc.,
Lehman Brothers Commercial Corp., Lehman Brothers Commodities Ltd. and
Lehman Brothers Holdings Inc. (Reported in Holdings' 1999 Annual Report on
Form 10-K)
On August 31, 2000, the parties settled the matter and dismissed the
arbitration.
Pamahi Investment Corp., et al. v. Lehman Brothers Inc., et al. (Reported
in Holdings' 1999 Annual Report on Form 10-K and Quarterly Report on Form 10-Q
for the quarter ended February 29, 2000)
On August 7, 2000, the parties settled the matter and dismissed the
arbitration.
Bowser v. First Alliance Mortgage Company, et al. (Reported in Holdings'
Quarterly Report on Form 10-Q for the quarter ended May 31, 2000)
On August 15, 2000, the United States Bankruptcy Court for the Central
District of California entered an order dismissing with prejudice plaintiffs'
claims against Holdings.
41
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings - continued
Island Venture Corporation, et al. v. Lehman Brothers Inc. and Lehman Brothers
Securities Asia, Ltd.
On August 3, 2000, Island Venture Corporation, Continental Resources
Corporation, Recola Investment Corporation, Grand Concord Corporation, Goodwell
Industrial Corporation, and Capital Pacific Corporation filed a lawsuit in the
United States District Court for the District of New Jersey against LBI and
Lehman Brothers Securities Asia, Ltd. The complaint arises in connection with
the plaintiffs' purchase of various promissory notes issued by Indonesian
companies in 1997 and upon which the issuers have defaulted. It also asserts
claims relating to an alleged unauthorized liquidation for $8.5 million of a $10
million Asia Investment Grade Default Note ("Basket Note") issued by Lehman
Brothers Holdings PLC. The complaint seeks rescission and damages under various
common law theories of mutual mistake, breach of fiduciary duty, negligence and
constructive fraud, as well as asserting claims under the New Jersey Blue Sky
Laws and Section 10(b) of the Securities Exchange Act of 1934. The plaintiffs
seek to recover damages in the face amount of approximately $66 million on all
the notes they purchased and difference between the liquidation price and the
face value of the Basket Note plus lost coupon payments. The plaintiffs have not
yet served the complaint.
42
<PAGE>
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K
The following exhibits and reports on Form 8-K are filed as part of this
Quarterly Report, or where indicated, were heretofore filed and are hereby
incorporated by reference:
(a) Exhibits:
12 Computation in Support of Ratio of Earnings to Fixed Charges
and Combined Fixed Charges and Preferred Dividends
27 Financial Data Schedule
(b) Reports on Form 8-K:
1. Form 8-K dated June 16, 2000, Items 5 and 7.
Financial Statements:
Exhibit 99.2 Consolidated Statement of Income
(Three Months Ended May 31, 2000)
(Preliminary and Unaudited)
Exhibit 99.3 Consolidated Statement of Income (Nine
Months Ended August 31, 2000)
(Preliminary and Unaudited)
Exhibit 99.4 Segment Net Revenue Information (Three
and Nine Months Ended August 31, 2000)
(Preliminary and Unaudited)
Exhibit 99.5 Selected Statistical Information
(Preliminary and Unaudited)
2. Form 8-K dated July 7, 2000, Item 7.
43
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEHMAN BROTHERS HOLDINGS INC.
-----------------------------
(Registrant)
Date: October 16, 2000 By: /s/ David Goldfarb
Chief Financial Officer
44
<PAGE>
EXHIBIT INDEX
Exhibit No. Exhibit
Exhibit 12 Computation in Support of Ratio of Earnings to Fixed
Charges and Combined Fixed Charges and Preferred
Dividends
Exhibit 27 Financial Data Schedule
45
<PAGE>
Exhibit 12
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
COMPUTATION of RATIOS of EARNINGS to FIXED CHARGES and
COMBINED FIXED CHARGES and PREFERRED STOCK DIVIDENDS
(Dollars in millions)
(Unaudited)
<TABLE>
<CAPTION>
For the For the For the For the For the For the
Twelve Twelve Twelve Twelve Twelve Nine
Months Months Months Months Months Months
Ended Ended Ended Ended Ended Ended
November 30 November 30 November 30 November 30 November 30 August 31
1995 1996 1997 1998 1999 2000
------------- ------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Pre-tax earnings from continuing
operations $ 369 $ 637 $ 937 $ 1,052 $ 1,631 $ 2,025
Add: Fixed charges (excluding
capitalized interest) 10,449 10,852 13,043 15,813 13,681 14,052
------------- ------------- ------------- ------------- ------------- --------------
Pre-tax earnings before fixed
charges 10,818 11,489 13,980 16,865 15,312 16,077
============= ============= ============= ============= ============= ==============
Fixed charges:
Interest 10,405 10,816 13,010 15,781 13,649 14,024
Other(a) 72 50 41 47 71 44
------------- ------------- ------------- ------------- ------------- --------------
Total fixed charges 10,477 10,866 13,051 15,828 13,720 14,068
------------- ------------- ------------- ------------- ------------- --------------
Preferred stock dividend
requirements 64 58 109 124 174 162
------------- ------------- ------------- ------------- ------------- --------------
Total combined fixed charges and
preferred stock dividends $ 10,541 $ 10,924 $ 13,160 $ 15,952 $ 13,894 $ 14,230
============= ============= ============= ============= ============= ==============
RATIO OF EARNINGS TO FIXED
CHARGES 1.03 1.06 1.07 1.07 1.12 1.14
RATIO OF EARNINGS TO
COMBINED FIXED CHARGES
AND PREFERRED STOCK
DIVIDENDS 1.03 1.05 1.06 1.06 1.10 1.13
</TABLE>
(a) Other fixed charges consist of the interest factor in rentals and
capitalized interest.
<PAGE>
Exhibit 27
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
This schedule contains summary financial information extracted from the
Company's Consolidated Statement of Financial Condition at August 31, 2000
(Unaudited) and the Consolidated Statement of Income for the nine months ended
August 31, 2000 (Unaudited) and is qualified in its entirety by reference to
such financial statements.
1,000,000
PERIOD TYPE 9 MOS
FISCAL YEAR END NOV-30-2000
PERIOD START DEC-01-1999
PERIOD END AUG-31-2000
CASH 8,026
RECEIVABLES 12,705
SECURITIES-RESALE 72,617
SECURITIES BORROWED 22,453
INSTRUMENTS OWNED 107,699
PP&E 561
TOTAL ASSETS 225,668
SHORT TERM 5,667
PAYABLES 14,410
REPOS SOLD 97,098
SECURITIES LOANED 9,128
INSTRUMENTS SOLD 48,401
LONG-TERM 35,407
PREFERRED-MANDATORY 710
PREFERRED 850
COMMON 12
OTHER SE 6,678
TOTAL LIABILITY AND EQUITY 225,668
TRADING REVENUE 3,055
INTEREST AND DIVIDENDS 14,512
COMMISSIONS 690
INVESTMENT BANKING 1,664
FEE REVENUE 0
INTEREST EXPENSE 14,025
COMPENSATION 3,125
INCOME-PRETAX 2,025
INCOME PRE-EXTRAORDINARY 1,376
EXTRAORDINARY 0
CHANGES 0
NET INCOME 1,376
EPS-BASIC $10.54
EPS-DILUTED $ 9.81
