-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KptfF85q6d7lmiy8QuInPJeoYDg4PRHj0fdHjaDfNceBYJkzB13Lhnm+uZ0C9ruA ZDzXP0EpSI7P3wt3371Jig== 0000806085-97-000129.txt : 19970723 0000806085-97-000129.hdr.sgml : 19970723 ACCESSION NUMBER: 0000806085-97-000129 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970531 FILED AS OF DATE: 19970715 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEHMAN BROTHERS HOLDINGS INC CENTRAL INDEX KEY: 0000806085 STANDARD INDUSTRIAL CLASSIFICATION: 6211 IRS NUMBER: 133216325 STATE OF INCORPORATION: DE FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-09466 FILM NUMBER: 97640909 BUSINESS ADDRESS: STREET 1: AMERICAN EXPRESS TWR STREET 2: 3 WORLD FINANCIAL CNTR CITY: NEW YORK STATE: NY ZIP: 10048 BUSINESS PHONE: 2125267000 MAIL ADDRESS: STREET 1: AMERICAN EXPRESS TOWER 15TH FL STREET 2: 2 WORLD TRADE CENTER CITY: NEW YORK STATE: NY ZIP: 10048 FORMER COMPANY: FORMER CONFORMED NAME: SHEARSON LEHMAN HUTTON HOLDINGS INC DATE OF NAME CHANGE: 19901017 10-Q 1 HOLDINGS 10-Q (2ND QUARTER) SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended May 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 1-9466 Lehman Brothers Holdings Inc. (Exact Name of Registrant As Specified In Its Charter) Delaware 13-3216325 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 3 World Financial Center New York, New York 10285 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code: (212) 526-7000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ______ As of June 30, 1997, 101,562,887 shares of the Registrant's Common Stock, par value $.10 per share, were outstanding. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED MAY 31, 1997 INDEX Part I. FINANCIAL INFORMATION Page Number Item 1. Financial Statements - (unaudited) Consolidated Statement of Operations - Three and Six Months Ended May 31, 1997 and 1996 ........................ 3 Consolidated Statement of Financial Condition - May 31, 1997 and November 30, 1996 .......... 5 Consolidated Statement of Cash Flows - Six Months Ended May 31, 1997 and 1996........................ 7 Notes to Consolidated Financial Statements....... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 14 Part II. OTHER INFORMATION Item 1. Legal Proceedings ............................... 29 Item 6. Exhibits and Reports on Form 8-K ........... 30 Signatures............................................................... 31 EXHIBIT INDEX .......................................................32 Exhibits LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of OPERATIONS (Unaudited) (In millions, except per share data) Three months ended May 31 May 31 1997 1996 --------------- ---------- Revenues Principal transactions $ 326 $ 398 Investment banking 274 223 Commissions 91 94 Interest and dividends 3,099 2,749 Other 16 12 -------- ------- Total revenues 3,806 3,476 Interest expense 2,952 2,643 ------ ----- Net revenues 854 833 ------- ------ Non-interest expenses Compensation and benefits 433 422 Brokerage, commissions and 61 58 clearance fees Professional services 47 39 Communications 36 38 Occupancy and equipment 34 37 Business development 26 25 Depreciation and amortization 21 22 Other 24 23 ------- ------- Total non-interest expenses 682 664 ------ ------ Income before taxes 172 169 Provision for income taxes 51 61 ------- ------- Net income $ 121 $ 108 ===== ===== Net income applicable to common stock $ 114 $ 102 ===== ===== Average common and common equivalent shares outstanding 120.4 114.8 ===== ===== Earnings per common share $0.95 $0.89 ===== ===== See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of OPERATIONS (Unaudited) (In millions, except per share data) Six months ended May 31 May 31 1997 1996 --------------- ---------- Revenues Principal transactions $ 672 $ 811 Investment banking 514 433 Commissions 188 190 Interest and dividends 6,377 5,405 Other 54 23 -------- ------- Total revenues 7,805 6,862 Interest expense 6,026 5,208 ------ ----- Net revenues 1,779 1,654 ----- ----- Non-interest expenses Compensation and benefits 902 839 Brokerage, commissions and 118 115 clearance fees Professional services 88 73 Communications 70 78 Occupancy and equipment 69 77 Business development 51 52 Depreciation and amortization 43 46 Other 47 47 ------- ------- Total non-interest expenses 1,388 1,327 ----- ----- Income before taxes 391 327 Provision for income taxes 126 115 ------ ------ Net income $ 265 $ 212 ===== ===== Net income applicable to common $ 252 $ 195 stock ===== ===== Average common and common equivalent shares outstanding 119.4 115.9 ===== ===== Earnings per common share $2.11 $1.68 ===== ===== See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (Unaudited) (In millions)
May 31 November 30 ASSETS 1997 1996 -------- ------------ Cash and cash equivalents $ 2,120 $ 2,149 Cash and securities segregated and on deposit for regulatory and other purposes 1,348 688 Securities and other financial instruments owned: Governments and agencies 28,145 26,638 Corporate stocks 10,294 6,937 Corporate debt and other 10,214 8,821 Mortgages and mortgage-backed 8,847 8,314 Derivatives and other contractual agreements 7,477 6,909 Certificates of deposit and other money market instruments 3,332 3,834 --------- --------- 68,309 61,453 --------- -------- Collateralized short-term agreements: Securities purchased under agreements to resell 40,093 32,340 Securities borrowed 22,085 20,651 Receivables: Brokers, dealers and clearing organizations 1,832 2,878 Customers 6,594 5,813 Others 1,352 1,253 Property, equipment and leasehold improvements (net of accumulated depreciation and amortization of $699 in 1997 and $668 in 1996) 467 477 Deferred expenses and other assets 750 722 Excess of cost over fair value of net assets acquired (net of accumulated amortization of $107 in 1997 and $103 in 1996) 168 172 ------------ ------------ Total assets $145,118 $128,596 ======== ========
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (Continued) (Unaudited) (In millions, except share data)
May 31 November 30 1997 1996 LIABILITIES AND STOCKHOLDERS' EQUITY Commercial paper and short-term debt $ 11,089 $ 8,202 Securities and other financial instruments sold but not yet purchased: Governments and agencies 17,343 13,202 Corporate stocks 8,467 4,971 Corporate debt and other 1,818 1,375 Derivatives and other contractual agreements 6,663 6,816 -------- ------- 34,291 26,364 ------- ------ Collateralized short-term financings: Securities sold under agreements to repurchase 57,179 56,119 Securities loaned 6,904 6,296 Payables: Brokers, dealers and clearing organizations 1,230 1,004 Customers 8,748 7,582 Accrued liabilities and other payables 3,594 3,233 Long-term debt: Senior notes 14,409 12,571 Subordinated indebtedness 3,536 3,351 --------- --------- Total liabilities 140,980 124,722 ------- ------- Commitments and contingencies STOCKHOLDERS' EQUITY Preferred Stock, $1 par value; 38,000,000 shares authorized: 5% Cumulative Convertible Voting, Series A, 13,000,000 shares authorized, issued and outstanding; $39.10 liquidation preference per share 508 508 Redeemable Voting, 1,000 shares issued and outstanding; $1.00 liquidation preference per share Common Stock, $.10 par value; 300,000,000 shares authorized; shares issued: 107,888,042 in 1997 and 106,793,538 in 1996; shares outstanding: 101,541,385 in 1997 and 100,449,144 in 1996 11 11 Common Stock issuable 346 326 Additional paid-in capital 3,222 3,198 Foreign currency translation adjustment 3 20 Retained earnings (deficit) 194 (43) Common Stock in treasury at cost: 6,346,657 shares in 1997 and 6,344,394 shares in 1996 (146) (146) ------------ ------------ Total stockholders' equity 4,138 3,874 ----------- ----------- Total liabilities and stockholders' equity $145,118 $128,596 ======== ========
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (In millions) (Unaudited)
Six months ended May 31 May 31 1997 1996 ---------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 265 $ 212 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 43 46 Provisions for losses and other reserves 19 22 Deferred tax benefit (33) Other adjustments 42 23 Net change in: Cash and securities segregated (660) 328 Securities and other financial instruments owned (6,856) (3,962) Securities purchased under agreements to resell (7,753) (7,627) Securities borrowed (1,434) (3,005) Receivables from brokers, dealers and clearing organizations 1,046 (103) Receivables from customers (781) (3,466) Securities and other financial instruments sold but not yet purchased 7,927 5,858 Securities sold under agreements to repurchase 1,060 6,297 Securities loaned 608 2,284 Payables to brokers, dealers and clearing organizations 226 215 Payables to customers 1,166 1,508 Accrued liabilities and other payables 342 (186) Other operating assets and liabilities, net (289) (74) ------- -------- Net cash used in operating activities $(5,062) $(1,630) ------- -------
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Continued) (In millions) (Unaudited)
Six months ended May 31 May 31 1997 1996 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of senior notes $3,120 $1,271 Principal payments of senior notes (1,101) (1,171) Proceeds from issuance of subordinated indebtedness 395 975 Principal payments of subordinated indebtedness (209) (246) Net proceeds from commercial paper and short-term debt 2,887 1,773 Payment for repurchase of preferred stock (200) Payments for treasury stock purchases (118) Dividends paid (25) (32) ------- ------- Net cash provided by financing activities 5,067 2,252 ----- ----- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, equipment and leasehold improvements (34) (19) ------- ------- Net cash used in investing activities (34) (19) ------- ------- Net change in cash and cash equivalents (29) 603 ------- ------ Cash and cash equivalents, beginning of period 2,149 874 ------ ------ Cash and cash equivalents, end of period $2,120 $1,477 ====== ====== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions) Interest paid totaled $5,781 and $5,213 for the six months ended May 31, 1997 and 1996, respectively. Income taxes paid totaled $71 and $50 for the six months ended May 31, 1997 and 1996, respectively.
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation: The consolidated financial statements include the accounts of Lehman Brothers Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or "Lehman Brothers"). Lehman Brothers is one of the leading global investment banks serving institutional, corporate, government and high-net- worth individual clients and customers. The Company's worldwide headquarters in New York and regional headquarters in London and Tokyo are complemented by offices in additional locations in North America, Europe, the Middle East, Latin and South America and the Asia Pacific Region. The Company is engaged primarily in providing financial services. The principal U.S. subsidiary of Holdings is Lehman Brothers Inc. ("LBI"), a registered broker-dealer. All material intercompany accounts and transactions have been eliminated in consolidation. The Company's financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q and reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Pursuant to such rules and regulations, certain footnote disclosures which are normally required under generally accepted accounting principles have been omitted. The Consolidated Statement of Financial Condition at November 30, 1996 was derived from the audited financial statements. It is recommended that these consolidated financial statements be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the twelve months ended November 30, 1996 (the "Form 10-K"). The nature of the Company's business is such that the results of any interim period may vary significantly from quarter to quarter and may not be indicative of the results to be expected for the fiscal year. Certain prior period amounts reflect reclassifications to conform to the current period's presentation. 2. Long-Term Debt: During the six months ended May 31, 1997, the Company issued $3,515 million of long-term debt (comprised of $3,120 million of senior notes and $395 million of subordinated debt). Of the total issuances for the first six months of 1997, $1,501 million were U.S. dollar fixed rate, $834 million were U.S. dollar floating rate, $519 million were foreign currency denominated fixed rate, and $661 million were foreign currency denominated floating rate. The issuances were primarily utilized to refinance current and prefund the remaining maturities of long-term debt in 1997 and to increase total capital (stockholders' equity plus long-term debt). The Company's floating rate new issuances contain contractual interest rates based primarily on London Interbank Offered Rates ("LIBOR"). All of the Company's fixed rate new issuances were effectively converted to floating rate obligations through the use of interest rate swaps. The Company had approximately $1,310 million of long-term debt mature during the six months ended May 31, 1997. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS 3. Capital Requirements: The Company operates globally through a network of subsidiaries with several being subject to regulatory requirements. In the United States, LBI, as a registered broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined. At May 31, 1997, LBI's regulatory net capital, as defined, of $1,619 million exceeded the minimum requirement by $1,515 million. Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered broker-dealer and subsidiary of Holdings, is subject to the capital requirements of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial resources, as defined, must exceed the total financial resources requirement of the SFA. At May 31, 1997, LBIE's financial resources were $303 million in excess of regulatory requirements. Lehman Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the capital requirements of the Japanese Ministry of Finance and, at May 31, 1997, had net capital of $130 million in excess of the specified levels required. Certain other non-U.S. subsidiaries are subject to various securities, commodities and banking regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. At May 31, 1997, these other subsidiaries were in compliance with their applicable local capital adequacy requirements. The Company's triple-A rated derivatives subsidiary, Lehman Brothers Financial Products Inc. ("LBFP"), has established certain capital and operating restrictions which are reviewed by various rating agencies. At May 31, 1997 LBFP had capital which exceeded the requirement of the most stringent rating agency by $100 million. There are no restrictions on Holdings' present ability to pay dividends on its common stock, other than Holdings' obligation first to make dividend payments on its preferred stock and the governing provisions of the Delaware General Corporation Law. 4. Derivative Financial Instruments: In the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end user. Acting in a trading capacity, the Company enters into derivative transactions to satisfy the needs of its clients and to manage the Company's own exposure to market and credit risks resulting from its trading activities in cash instruments (collectively, "Trading-Related Derivative Activities"). For a further discussion of the Company's derivative related activities, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Off-Balance Sheet Financial Instruments and Derivatives" and Note 12 to the Consolidated Financial Statements, included in the Form 10-K. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS Trading-Related Derivative Activities The Company records its Trading-Related Derivative Activities on a mark-to-market basis with realized and unrealized gains (losses) recognized in principal transactions. The Company currently records unrealized gains and losses on derivative contracts on a net basis in the Consolidated Statement of Financial Condition for those transactions with counterparties executed under a legally enforceable master netting agreement. Listed in the following table is the fair value and average fair value of the Company's Trading-Related Derivative Activities (in millions):
Average Fair Value* Fair Value* Six Months Ended May 31, 1997 May 31, 1997 ------------ ------------ Assets Liabilities Assets Liabilities - - --------------------------------------------------------------------------------------------------------------------------- Interest rate and currency swaps and options (including caps, collars and floors) $4,056 $2,868 $4,369 $2,819 Foreign exchange forward contracts and options 1,228 1,358 1,162 1,515 Options on other fixed income securities, mortgage-backed securities forward contracts and options 216 248 218 213 Equity contracts (including equity swaps, warrants and options) 1,622 1,634 1,706 1,405 Commodity contracts (including swaps, forwards, and options) 355 555 381 630 -------------------------------------------------------- Total $7,477 $6,663 $7,836 $6,582 --------------------------------------------------------
Average Fair Value* Fair Value* Twelve Months Ended November 30, 1996 November 30, 1996 ----------------- ----------------- Assets Liabilities Assets Liabilities - - --------------------------------------------------------------------------------------------------------------------------- Interest rate and currency swaps and options (including caps, collars and floors) $4,008 $3,185 $3,446 $1,945 Foreign exchange forward contracts and options 970 1,206 903 1,200 Options on other fixed income securities, mortgage-backed securities forward contracts and options 226 286 239 238 Equity contracts (including equity swaps, warrants and options) 1,167 1,304 1,118 1,076 Commodity contracts (including swaps, forwards, and options) 538 835 451 587 ------------------------------------------------------ Total $6,909 $6,816 $6,157 $5,046 -----------------------------------------------------
* Amounts represent carrying value (exclusive of collateral) of contracts and do not include receivables or payables related to exchange-traded futures contracts. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS Assets included in the previous table represent the Company's unrealized gains, net of unrealized losses for situations in which the Company has a master netting agreement. Similarly, liabilities represent net amounts owed to counterparties. Therefore, the fair value of assets related to derivative contracts at May 31, 1997 represents the Company's net receivable for derivative financial instruments before consideration of collateral. Included within the $7,477 million fair value of assets at May 31, 1997 was $7,036 million related to swaps and OTC contracts and $441 million related to exchange-traded option and warrant contracts. With respect to OTC contracts, the Company views its net credit exposure to be $4,038 million at May 31, 1997, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral of $2,998 million. Presented below is an analysis of the Company's net credit exposure for OTC contracts based upon internal designations of counterparty credit quality. Counterparty S&P/Moody's May 31, 1997 Risk Rating Equivalent Net Credit Exposure - - ------------ ------------------------- ------------------- 1 AAA/Aaa 22% 2 AA-/Aa3 or higher 22% 3 A-/A3 or higher 39% 4 BBB-/Baa3 or higher 10% 5 BB-/Ba3 or higher 5% 6 B+/B1 or lower 2% - - -------------------------------------------------------------------------------- These designations are based on actual ratings made by external rating agencies or by equivalent ratings established and utilized by the Company's Corporate Credit Department. The Company is also subject to credit risk related to its exchange-traded derivative contracts. Exchange-traded contracts, including futures and certain options, are transacted directly on the exchange. To protect against the potential for a default, all exchange clearing houses impose net capital requirements for their membership. Additionally, the exchange clearing house requires counterparties to futures contracts to post margin upon the origination of the contract and for any changes in the market value of the contract on a daily basis (certain foreign exchanges extend settlement to three days). Therefore, the potential for losses from exchange-traded products is limited. 5. Other Commitments and Contingencies: In the normal course of its business, the Company has been named a defendant in a number of lawsuits and other legal proceedings. After considering all relevant facts, available insurance coverage and the advice of outside counsel, in the opinion of the Company such litigation will not, in the aggregate, have a material adverse effect on the Company's consolidated financial position or results of operations. As a leading global investment bank, risk is an inherent part of all of the Company's businesses and activities. The extent to which the Company properly and effectively identifies, assesses, monitors and manages each of the various types of risks involved in its trading (including derivatives), brokerage, and investment banking activities is critical to the success and profitability of the Company. The principal types of risks involved in the Company's activities are market risk, credit or counterparty risk and transaction risk. Management has developed a control infrastructure to monitor and manage each type of risk on a global basis throughout the Company. For further discussion of these matters, refer to Note 14 to the Consolidated Financial Statements, in the Form 10-K. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS 6. Incentive Plans: In the first quarter of 1997, the Company granted approximately 2.3 million options (the "1997 Options") under the 1996 Management Ownership Plan to members of the Corporate Management Committee and to certain senior officers. The 1997 Options become exercisable in four and one-half years and expire five years after grant date; exercisability is accelerated ratably in one-third increments at such time as the closing price of the Company's common stock meets, or exceeds, $39, $42, and $45 for fifteen out of twenty consecutive trading days. No compensation expense has been recognized for these stock options as they were issued with an exercise price above the market price of the common stock on the date of the grant. 7. Severance Charge: The Company recorded an $84 million severance charge ($50 million aftertax) in the fourth quarter of 1996 related to certain strategic actions taken to improve ongoing profitability. The 1996 severance charge reflected the culmination of a worldwide business unit economic performance review which was undertaken in the fourth quarter of 1996 to focus the Company on its core investment banking, equity and fixed income sales and trading areas. This formalized review resulted in personnel reductions of approximately 270 people across a number of underperforming fixed income and equity businesses, including exiting the precious metals business in the U.S., Europe and Asia; exiting energy trading in the U.S. and Europe; consolidating Asian fixed income risk management activities into one center in Tokyo; refocusing foreign exchange trading activities and combining the Company's New York Private Client Services offices. Additionally, the charge reflects various other strategic personnel reductions which were aimed at delayering management. The severance charge is expected to lead to personnel cost savings beginning in fiscal 1997 of $90 million annually. The charge is also expected to result in a permanent decrease in nonpersonnel expenses of approximately $20 million annually. The Company intends to reinvest substantially all these savings into certain businesses to expedite the Company's strategic initiatives; these actions are expected to result in improved operating revenues. Cash outlays relating to the charge were approximately $19 million in the fourth quarter of 1996 and approximately $53 million during the first six months of 1997. The remaining residual payments will be paid by the end of the third quarter of 1997 as deferred payment arrangements are completed. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Business Environment Market conditions in the first half of 1997 reflected record corporate advisory activities, strong underwriting volumes in worldwide fixed income products, and generally active trading activities in worldwide debt and equity markets. These favorable conditions were mitigated in part by significantly reduced equity underwriting volumes and increased volatility in the foreign exchange markets, particularly in Europe and Asia. Global fixed income markets were robust throughout most of the first quarter of 1997, with heavy trading volumes in both the U.S. and Europe. Trading activity in the U.S. continued to reflect investor optimism that the environment of sustained growth and low inflation levels would continue. Additionally, U.S. trading activity was bolstered by active purchases of U.S. securities by foreign investors due to the favorable U.S. macroeconomic environment and the strong dollar. In late March 1997, a strong pattern of growth in the U.S. economy prompted the Federal Reserve to raise the Federal Funds rate by 25 basis points to 5 1/2%. This rate hike precipitated a general decline in trading volumes and origination activities in the U.S. fixed income market. Rising interest rates and fears of additional rate hikes by the Federal Reserve continued to depress U.S. trading and origination activities through March and into April. However, by mid-April, economic data reinforced the view that U.S. interest rates would remain stable as GDP growth decelerated and inflation indicators remained low. This led to a recovery of the U.S. fixed income markets in late April as interest rates began to decline and trading volumes regained strength. This recovery further accelerated in May and into June, with interest rates on the 30-year U.S. Treasury declining to 6.65% on June 20, 1997 from a peak of 7.17% on April 11th. Trading activities in worldwide equity markets continued to show strength in 1997. U.S. trading volumes improved over prior year record levels, as investor demand remained strong and the equity markets benefited from increasing capital flows. The U.S. equity markets, while experiencing a correction in the second quarter, continued to show strength surpassing prior year valuation levels. The trough in the S&P 500 was also on April 11 when the index reached 738; the U.S. stock market is up more than 20% since then. European equity markets saw improved trading volumes and valuations in 1997, despite a valuation adjustment in March, as the stronger U.S. dollar and declining European rate environment contributed to a favorable equity environment. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Worldwide underwriting volumes in fixed income products remained strong in the first half of 1997. U.S. underwriting volumes, while experiencing a slowdown in March and April, strengthened over the prior year. The improvement was fueled in part by straight debt financings timed in anticipation of higher interest rates, as well as favorable pricing in the spread sectors. Equity and related underwriting volumes declined considerably from the strong 1996 levels, as rising interest rates and the U.S. equity market correction had a negative effect on the timing of equity offerings. New issuance activity was also negatively impacted by the volatility experienced in the international markets, as the weakening of the Yen and certain Asian markets caused equity-market selloffs and corresponding reductions in new issuance activities. Elections and EMU uncertainty also contributed to reduced European issuance activity. Corporate finance advisory activities outpaced the record 1996 levels, reflecting increased consolidation and globalization across industry sectors and the overall strength in the global capital markets. The pace of strategic merger and acquisition activity is expected to remain strong throughout 1997. While fiscal 1996 and 1997 have been characterized by favorable financial markets, nevertheless, the financial services industry is cyclical. As a result, the Company's businesses are evaluated across the market cycles for operating profitability and their contribution to the Company's long-term strategic product base, its global presence, and its risk management practices. Note: Except for the historical information contained herein, this Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that are based on current expectations, estimates and projections about the industries in which the Company operates. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations For the Three Months Ended May 31, 1997 and 1996 The Company reported net income of $121 million for the second quarter ended May 31, 1997, representing an increase of 12% from net income of $108 million for the second quarter ended May 31, 1996. Earnings per common share increased to $0.95 for the second quarter of 1997 from $0.89 for the second quarter of 1996. Net revenues increased to $854 million for the second quarter of 1997 from $833 million for the second quarter of 1996. The increase in net revenues from the second quarter of 1996 resulted from particular strength in a number of strategic, higher margin businesses that the Company is focusing on, including the global merger and acquisition advisory, merchant banking, equity derivatives, and mortgage businesses. Compensation and benefits expense as a percentage of net revenues was 50.7% for both the second quarter of 1997 and 1996, reflecting the ninth successive quarter of consistent compensation levels relative to net revenues. Nonpersonnel expenses increased to $249 million in the second quarter of 1997 from $242 million in the second quarter of 1996; however, nonpersonnel expenses as a percentage of net revenues were 29.1% for the second quarter of 1997, relatively unchanged from 29.0% for the second quarter of 1996. The Company, through its subsidiaries, is a market-maker of equity and fixed income products in major domestic and international markets. As part of its market-making activities, the Company maintains inventory positions of varying amounts across a broad range of financial instruments that are marked-to-market on a daily basis and along with the Company's proprietary trading positions, give rise to principal transactions revenues. The Company utilizes various hedging strategies to minimize its exposure to significant movements in interest and foreign exchange rates and the equity markets. Net revenues from the Company's market-making and trading activities in fixed income and equity products are recognized as either principal transactions or net interest revenues depending upon the method of financing and/or hedging related to specific inventory positions. The Company evaluates its trading strategies on an overall profitability basis which includes both principal transactions revenues and net interest. Therefore, changes in net interest should not be viewed in isolation but should be viewed in conjunction with revenues from principal transactions. Principal transactions and net interest revenues decreased to $473 million for the second quarter of 1997 from $504 million for the second quarter of 1996. The decrease in combined revenues from principal transactions and net interest in the second quarter of 1997 was due to reduced revenues from customer flow activities in certain fixed income and equity products and higher interest expenses resulting from the Company's increased level of long-term debt. The decrease was partially offset by increases in equity financing and derivative transactions. The following table of net revenues by business unit and the accompanying discussion have been prepared in order to present the Company's net revenues in a format that reflects the manner in which the Company manages its businesses. For internal management purposes, the Company has been segregated into four major business units: Fixed Income, Equity, Corporate Finance Advisory, and Merchant Banking. Each business unit represents a grouping of financial activities and products with similar characteristics. These business activities result in revenues that are recognized in multiple revenue categories contained in the Company's Consolidated Statement of Operations. Net revenues by business unit contain certain internal allocations, including funding costs, which are centrally managed.
Three Months Ended May 31, 1997 Principal Transactions and Investment Net Interest Commissions Banking Other Total - - --------------------------------------------------------------------------------------------------------------------------- Fixed Income $358 $11 $71 $ 5 $445 Equity 122 76 41 2 241 Corporate Finance Advisory (3) 83 80 Merchant Banking (4) 80 76 Other 4 (1) 9 12 - - --------------------------------------------------------------------------------------------------------------------------- $473 $91 $274 $16 $854 - - ---------------------------------------------------------------------------------------------------------------------------
Three Months Ended May 31, 1996 Principal Transactions and Investment Net Interest Commissions Banking Other Total - - --------------------------------------------------------------------------------------------------------------------------- Fixed Income $411 $15 $74 2 $502 Equity 96 74 71 3 244 Corporate Finance Advisory 57 57 Merchant Banking (5) 20 15 Other 2 5 1 7 15 - - --------------------------------------------------------------------------------------------------------------------------- $504 $94 $223 $12 $833 - - ---------------------------------------------------------------------------------------------------------------------------
Fixed Income. The Company's fixed income net revenues reflect customer flow activities (both institutional and high-net-worth retail), secondary trading, debt underwriting, syndicate and financing activities related to fixed income products. Fixed income products include dollar- and non-dollar government securities, mortgage- and asset-backed securities, money market products, dollar- and non-dollar corporate debt securities, emerging market securities, municipal securities, financing (global access to debt financing sources including repurchase and reverse repurchase agreements), foreign exchange and fixed income derivative products. Fixed income net revenues decreased 11% to $445 million for the second quarter of 1997 from $502 million for the second quarter of 1996. The reduction in the second quarter results versus the prior year quarter reflected reduced customer flow activities from a number of fixed income products including foreign exchange, high yield, and firm financing partially offset by improved results in mortgages and governments. Investment banking revenues, as a component of fixed income revenues, were relatively unchanged, decreasing to $71 million for the second quarter of 1997 from $74 million for the second quarter of 1996. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Equity. Equity net revenues reflect customer flow activities (both institutional and high-net-worth retail), secondary trading, equity underwriting, equity finance, equity derivatives and equity arbitrage activities. The Company's equity net revenues decreased to $241 million for the second quarter of 1997 from $244 million for the second quarter of 1996 as customer trading and underwriting activities were negatively impacted by the market correction. Increased revenues from derivatives and equity financing activities were offset by a decline in NASDAQ, U.S. listed and international equity trading revenues for the second quarter of 1997. Investment banking revenues, as a component of equity revenues, decreased to $41 million for the second quarter of 1997 from $71 million for the second quarter of 1996 as the higher interest rate environment prompted a correction in the U.S. equity markets, resulting in lower levels of underwriting volume. Corporate Finance Advisory. Corporate finance advisory net revenues, classified in the Consolidated Statement of Operations as a component of investment banking revenues, result primarily from fees earned by the Company in its role as strategic advisor to its clients. This role consists of advising clients on mergers and acquisitions, divestitures, leveraged buyouts, financial restructurings, and a variety of cross-border transactions. Net revenues from corporate finance advisory activities increased to $80 million for the second quarter of 1997, reflecting a 40% increase from the $57 million recognized in the second quarter of 1996. This increase exemplified continued strength in the overall merger and acquisition market environment. Merchant Banking. The Company is the general partner for six merchant banking partnerships. Current merchant banking investments held by the partnerships include both publicly traded and privately held companies diversified on a geographic and industry basis. Merchant banking net revenues primarily represent the Company's proportionate share of net realized and net unrealized gains and losses from the sale and revaluation of investments held by the partnerships. Such amounts are classified in the Consolidated Statement of Operations as a component of investment banking revenues. Merchant banking net revenues also reflect the net interest expense relating to the financing of the Company's investment in the partnerships. Merchant banking net revenues were $76 million for the second quarter of 1997 and $15 million in the second quarter of 1996. This increase was principally due to a realized gain on the sale of a significant portion of a publicly traded investment held by the partnerships. The Company expects to complete the divestiture of both this investment and an additional investment in the third quarter of 1997. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Non-Interest Expenses. Non-interest expenses were $682 million for the second quarter of 1997 and $664 million for the second quarter of 1996. Compensation and benefits expense as a percentage of net revenues remained unchanged from the prior year quarter at 50.7%. Nonpersonnel expenses increased from $242 million in the second quarter of 1996 to $249 million in the second quarter of 1997; however, nonpersonnel expenses as a percentage of net revenues of 29.1% for 1997 remained relatively unchanged from 29.0% for 1996. Income Taxes. The Company's income tax provision was $51 million for the second quarter of 1997 compared to $61 million for the second quarter of 1996. The effective tax rate was 30% for the second quarter of 1997 and 36% for the second quarter of 1996. The decrease in the effective tax rate reflects an increase in tax benefits attributable to income subject to preferential tax treatment, an increase in the Company's net deferred tax assets resulting from a change in state and local tax laws, partially offset by a decrease in tax benefits from foreign operations. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations For the Six Months Ended May 31, 1997 and 1996 The Company reported net income of $265 million for the six months ended May 31, 1997, representing an increase of 25% from net income of $212 million for the six months ended May 31, 1996. Earnings per common share increased to $2.11 for the six months of 1997 from $1.68 for the six months of 1996. Net revenues increased to $1,779 million for the six months of 1997 from $1,654 million for the six months of 1996. The increase in net revenues from the first half of 1996 resulted from particular strength in a number of strategic, higher margin businesses that the Company is focusing on including the global merger and acquisition advisory, merchant banking and mortgage businesses. Compensation and benefits expense as a percentage of net revenues was 50.7% for both the first half of 1997 and 1996. Nonpersonnel expenses declined as a percentage of net revenues to 27.3% for the six months of 1997 from 29.5% for the comparable period in 1996. The reduction in nonpersonnel expenses from $488 million in the six months of 1996 to $486 million in the six months of 1997 along with the increase in net revenues led to an improvement in the Company's pretax operating margin to 22.0% in the first half of 1997 from 19.7% in the first half of 1996. Principal transactions and net interest revenues increased to $1,023 million for the six months of 1997 from $1,008 million for the six months of 1996. The increase in the combined revenues from principal transactions and net interest in the six months of 1997 was the result of reduced revenues from customer flow activities in certain fixed income and equity products and higher interest expenses resulting from the Company's increased level of long-term debt. This decrease was partially offset by improved results in equity financing activities and international equities trading. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table of net revenues by business unit and the accompanying discussion have been prepared in order to present the Company's net revenues in a format that reflects the manner in which the Company manages its businesses. Net revenues by business unit contain certain internal allocations, including funding costs, which are centrally managed.
Six Months Ended May 31, 1997 Principal Transactions and Investment Net Interest Commissions Banking Other Total - - --------------------------------------------------------------------------------------------------------------------------- Fixed Income $ 826 $ 21 $172 $ 8 $1,027 Equity 205 160 106 3 474 Corporate Finance Advisory (3) 149 146 Merchant Banking (8) 84 76 Other 3 7 3 43 56 - - --------------------------------------------------------------------------------------------------------------------------- $1,023 $188 $514 $54 $1,779 - - ---------------------------------------------------------------------------------------------------------------------------
Six Months Ended May 31, 1996 Principal Transactions and Investment Net Interest Commissions Banking Other Total - - --------------------------------------------------------------------------------------------------------------------------- Fixed Income $ 850 $ 33 $147 $ 4 $1,034 Equity 159 146 124 3 432 Corporate Finance Advisory 107 107 Merchant Banking (8) 54 46 Other 7 11 1 16 35 - - --------------------------------------------------------------------------------------------------------------------------- $1,008 $190 $433 $23 $1,654 - - ---------------------------------------------------------------------------------------------------------------------------
Fixed Income. Fixed income net revenues decreased to $1,027 million for the six months of 1997 from $1,034 million for the six months of 1996. The improved revenues in a number of fixed income products including derivatives and mortgages were offset by reduced customer flow activities in firm financing and foreign exchange. Investment banking revenues, as a component of fixed income revenues, increased to $172 million for the six months of 1997 from $147 million for the six months of 1996 due to increased underwriting volumes and a mix change to higher margin debt products. Equity. The Company's equity net revenues increased to $474 million for the six months of 1997 from $432 million for the six months of 1996. Increased revenues from equity financing and international equities (primarily Europe) were partially offset by a decline in U.S. listed equity trading revenues for the first half of 1997. Investment banking revenues, as a component of equity revenues, decreased to $106 million for the six months of 1997 from $124 million for the six months of 1996 as the higher interest rate environment prompted a correction in the U.S. equity markets, resulting in lower levels of underwriting volume. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Corporate Finance Advisory. Net revenues from corporate finance advisory activities increased to $146 million for the six months of 1997 reflecting a 36% increase from the $107 million recognized in the six months of 1996. This increase reflected continued strength in the overall merger and acquisition market environment. Merchant Banking. Merchant banking net revenues were $76 million for the six months of 1997 and $46 million in the six months of 1996. This increase was principally due to a realized gain on the sale of a significant portion of a publicly traded investment held by the partnerships. The Company expects to complete the divestiture of this and an additional investment in the third quarter of 1997. Other. Other net revenues for the six months of 1997 include approximately $25 million relating to the realization of certain non-core assets. Non-Interest Expenses. Non-interest expenses were $1,388 million for the six months of 1997 and $1,327 million for the six months of 1996. Compensation and benefits expense as a percentage of net revenues remained unchanged from the comparable prior year period at 50.7%. Nonpersonnel expenses declined as a percentage of net revenues to 27.3% for the six months of 1997 from 29.5% for the comparable period in 1996. The reduction in nonpersonnel expenses from $488 million in the six months of 1996 to $486 million in the six months of 1997 along with the increase in net revenues led to an improvement in the Company's pretax operating margin to 22.0% in the first half of 1997 from 19.7% in the first half of 1996. Income Taxes. The Company's income tax provision was $126 million for the first half of 1997 compared to $115 million for the first half of 1996. The effective tax rate was 32% for 1997 and 35% for 1996. The decrease in the effective tax rate reflects an increase in tax benefits attributable to income subject to preferential tax treatment, an increase in the Company's net deferred tax assets resulting from a change in state and local tax laws, partially offset by a decrease in tax benefits from foreign operations. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources Overview As a leading global investment bank that actively participates in the global capital markets, the Company has large and diverse capital requirements. Many of the businesses in which the Company operates are capital intensive. Capital is required to finance, among other things, the Company's securities inventory, underwriting activities, principal investments, merchant banking activities and investments in fixed assets. The Company's total assets increased to $145.1 billion at May 31, 1997 from $128.6 billion at November 30, 1996. The increase in total assets is primarily attributable to an increase in customer flow financing activities as well as an increased level of securities and other financial instruments owned, primarily corporate debt and equity. The Company's balance sheet is highly liquid and consists primarily of cash and cash equivalents, securities and other financial instruments owned, which are marked-to-market daily, and collateralized short-term financing agreements. As the Company's primary activities are based on customer flow transactions, the Company experiences a rapid asset turnover rate. The highly liquid nature of these assets provides the Company with flexibility in financing and managing its business. The overall size of the Company's total assets and liabilities fluctuates from time to time and at specific points in time (such as calendar quarter ends and various month ends) may be higher than at fiscal quarter ends. Funding and Capital Policies The Company's Finance Committee, which includes senior officers from key areas of the Company, is responsible for establishing and managing the funding and liquidity policies of the Company. The Finance Committee's funding and liquidity policies include recommendations for capital and balance sheet size as well as the allocation of capital and balance sheet to product areas. In addition, the treasury staff members of the Finance Committee work with the Regional Asset and Liability Committees to ensure coordination of global funding efforts. The Regional Asset and Liability Committees are aligned with the Company's geographic funding centers and are responsible for implementing funding strategies consistent with the direction set by the Finance Committee and for monitoring and managing liquidity for the region. The primary goal of the Company's funding policies is to provide sufficient liquidity and availability of funding sources across a wide range of market environments. There are five key elements of its funding strategy that the Company attempts to achieve: o To maintain an appropriate Total Capital structure to support the business activities in which the Company is engaged. o To minimize liquidity and refinancing risk by funding the Company's assets on a global basis with unsecured liabilities which have maturities similar to the anticipated liquidation period of the assets. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS o To maintain sufficient liquidity during a period of financial stress through a combination of collateralized short-term financings, Total Capital and a contingency funding plan. Financial stress is defined as any event which severely constrains the Company's access to unsecured funding sources. o To obtain diversified funding through a global investor base which maximizes liquidity and reduces concentration risk. o To maintain funding availability in excess of actual utilization. Short-Term Funding The Company strives to maximize the portion of the Company's balance sheet that is funded through collateralized borrowing sources, which in turn minimizes the reliance placed upon unsecured short-term debt. Collateralized borrowing sources include securities and other financial instruments sold but not yet purchased, as well as collateralized short-term financings, defined as securities sold under agreements to repurchase ("repos") and securities loaned. Because of their secured nature, OECD government repos and other types of collateralized borrowing sources are less credit-sensitive and have historically been a more stable financing source under adverse market conditions. Also, collateralized borrowing sources generally provide the Company with access to lower cost funding. The amount of the Company's collateralized borrowing activities will vary reflecting changes in the mix and overall levels of securities and other financial instruments owned and global market conditions. However, at all times, the vast majority of the Company's assets are funded with collateralized borrowing sources. At May 31, 1997 and November 30, 1996, $98 billion and $89 billion, respectively, of the Company's total balance sheet was financed using collateralized borrowing sources. As of May 31, 1997 and November 30, 1996, commercial paper and short-term debt outstanding was $11.1 billion and $8.2 billion, respectively. Of these amounts, commercial paper outstanding as of May 31, 1997 was $5.6 billion with an average maturity of 72 days, compared to $3.1 billion with an average maturity of 64 days as of November 30, 1996. At May 31, 1997, Holdings maintained a Revolving Credit Agreement with a syndicate of banks. Under the terms of the credit agreement, the banks have committed to provide up to $2 billion for up to 364 days. Any loans outstanding on the commitment termination date may mature on the first anniversary of the commitment termination date at the option of Holdings. The credit agreement contains covenants which require, among other things, that the Company maintain specified levels of liquidity and tangible net worth, as defined. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition, the Company maintained a $1 billion Secured Revolving Credit Facility (the "Facility") for Lehman Brothers International (Europe) ("LBIE"), the Company's major operating entity in Europe. Under the terms of the committed Facility, the bank group has committed to provide up to $1 billion for up to 364 days on a secured basis. The loans provided by the bank group are available in several currencies, including U.S. dollar, British pound sterling, Deutsche mark, ECU, French franc, and Italian lira. The credit agreement contains covenants which require, among other things, that LBIE maintain specified levels of tangible net worth, and regulatory capital, and that the Company maintain specified levels of consolidated stockholders' equity and tangible net worth, as defined. There were no borrowings outstanding under the Facility or the Revolving Credit Agreement as of May 31, 1997. The Company uses the Facility for general corporate purposes from time to time. The Company maintained compliance with the applicable covenants for both the Revolving Credit Agreement and the Facility at all times. Total Capital In accordance with the Company's liquidity plan, the Company increased its Total Capital base in 1997 to $22.1 billion at May 31, 1997 from $19.8 billion at November 30, 1996. Total Capital increased primarily due to an increase in long-term debt and the retention of earnings. May 31 November 30 (in millions) 1997 1996 - - -------------------------------------------------------------------------------- Long-Term Debt Senior Notes $14,409 $12,571 Subordinated Indebtedness 3,536 3,351 ------- ------- 17,945 15,922 Stockholder's Equity Preferred Equity 508 508 Common Equity 3,630 3,366 ------- ------- 4,138 3,874 - - -------------------------------------------------------------------------------- Total Capital $22,083 $19,796 - - -------------------------------------------------------------------------------- During the second quarter of 1997, the Company issued $3,515 billion in long-term debt, which was $2,205 billion in excess of its maturing debt. Long-term debt increased to $17.9 billion at May 31, 1997 from $15.9 billion at November 30, 1996 with a weighted average maturity of 4.1 years at both May 31, 1997 and November 30, 1996. The increase in Total Capital also reflects an increase in stockholders' equity to $4.1 billion at May 31, 1997 from $3.9 billion at November 30, 1996. The net increase in stockholders' equity was primarily due to the retention of earnings partially offset by the payment of dividends. At May 31, 1997, the Company had approximately $4.6 billion available for the issuance of debt securities under various shelf registrations and debt programs. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Capital Resources and Capital Adequacy Balance sheet leverage ratios are one methodology utilized to evaluate the capital adequacy of a company relative to financial risk inherent in the balance sheet. The Company's leverage ratios computed as the ratio of quarter-end assets to quarter-end stockholders' equity were 35.1x and 33.2x at May 31, 1997 and November 30, 1996, respectively. However, the Company's adjusted leverage ratios, a better measure of market risk, defined as total assets less the lower of securities purchased under agreements to resell or securities sold under agreements to repurchase divided by stockholders' equity were 25.4x and 24.8x at May 31, 1997 and November 30, 1996, respectively. As mentioned earlier, the increase in gross leverage is primarily attributable to an increase in customer flow financing activities as well as an increased level of securities and other financial instruments owned, primarily corporate debt and equity. The increase in net leverage is principally attributable to the increased level of securities and other financial instruments owned, primarily corporate debt and equity. Credit Ratings The Company, like other companies in the securities industry, relies on external sources to finance a significant portion of its day-to-day operations. The Company's access and cost of funding is generally dependent upon its short-and long-term debt ratings. As of May 31, 1997, the current short- and long-term senior debt ratings of Holdings and Lehman Brothers Inc. ("LBI") were as follows: Holdings LBI Short-term Long-term Short-term Long-term** - - -------------------------------------------------------------------------------- Duff & Phelps Credit Rating Co. D-1 A D-1 A/A- Fitch Investors Service Inc. F-1 A F-1 A/A- IBCA A1 A- A1 A/A- Moody's P2 Baa1 P2 A3*/Baa1 S&P+ A-1 A A-1 A+*/A Thomson BankWatch TBW-1 A- TBW-1 A/A- - - -------------------------------------------------------------------------------- * Provisional ratings on shelf registration ** Senior/subordinated + Long term ratings outlook revised to negative on September 21, 1994 High Yield Securities The Company underwrites, trades, invests and makes markets in high yield corporate debt securities. The Company also syndicates, trades and invests in loans to below investment grade rated companies. For purposes of this discussion, high yield debt securities are defined as securities or loans to companies rated BB+ or lower, or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans which, in the opinion of management, are non-investment grade. Non-investment grade securities generally involve greater risks than investment grade securities due to the issuer's creditworthiness and the liquidity of the market for such securities. In addition, these issuers have higher levels of indebtedness, resulting in an increased sensitivity to adverse economic conditions. The Company recognizes these risks and aims to reduce market and credit risk through the diversification of its products and counterparties. High yield debt securities are carried at market value and unrealized gains or losses for these securities are reflected in the Company's Consolidated Statement of Operations. The Company's portfolio of such securities at May 31, 1997 and November 30, 1996 included long positions with an aggregate market value of approximately $2.1 billion and $1.7 billion, respectively, and short positions with an aggregate market value of approximately $140 million and $127 million, respectively. The portfolio may from time to time contain concentrated holdings of selected issues. The Company's largest high yield position was $205 million and $80 million at May 31, 1997 and November 30, 1996, respectively. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Merchant Banking Activities The Company's merchant banking activities include investments in six partnerships, for which the Company acts as general partner, as well as direct investments. At May 31, 1997, the investment in merchant banking partnerships was $483 million. The Company's policy is to carry its investments, including its partnership interests, at fair value based upon the Company's assessment of the underlying investments. The Company has a commitment to invest up to $153 million in one of its merchant banking employee investment vehicles. The Company has no remaining commitments to the other five merchant banking partnerships or other direct investments. During 1996, the Company began the process of establishing a new institutional fund for which it will act as general partner. This prospective fund is expected to total $1.5 billion, a portion of which may be contributed by the Company either directly or through an employee investment vehicle. Non-Core Activities and Investments In March 1990, the Company discontinued the origination of partnerships (the assets of which are primarily real estate) and investments in real estate. Currently, the Company acts as a general partner for approximately $3.5 billion of partnership investment capital and manages the remaining real estate investment portfolio. At May 31, 1997, the Company had $20 million of investments in these real estate activities, as well as $50 million of commitments and contingent liabilities under guarantees and credit enhancements, both net of applicable reserves. The Company believes any exposure under these commitments and contingent liabilities has been adequately reserved. In certain circumstances, the Company has elected to provide financial and other support and assistance to such investments to maintain investment values. There is no contractual requirement that the Company continue to provide this support. The Company also has equity, partnership and debt investments made in previous years that are unrelated to its ongoing businesses. The Company has other investments that are also awaiting their disposition or the occurrence of certain events which will ultimately lead to their liquidation. The Company carries these equity, partnership and debt investments at their fair value, which approximates $80 million at May 31, 1997. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's intention with regard to non-core assets is the prudent liquidation of these investments as and when possible. This is evidenced by the realization of certain non-core assets during the first quarter of 1997 which resulted in the recognition of $25 million of revenue. Recent Developments In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, Earnings Per Share, which is effective for annual and interim financial statements issued for periods ending after December 15, 1997. SFAS No. 128 was issued to simplify the standards for calculating earnings per share ("EPS") previously found in APB No. 15, Earnings Per Share. SFAS 128 replaces the presentation of primary EPS with a presentation of basic EPS. The new rules also require dual presentation of basic and diluted EPS on the face of the statement of operations for companies with a complex capital structure. For the Company, basic EPS will exclude the dilutive effects of stock options and certain non-vested RSUs. Diluted EPS for the Company will reflect all potential dilutive securities (similar to fully diluted EPS under APB No. 15). Under the provisions of FAS 128, basic EPS would have been $0.09 and $0.07 higher than the amounts reported in the second quarter of 1997 and 1996, respectively. Additionally, basic EPS would have been $0.18 and $0.14 higher than the amounts reported for the six months of 1997 and 1996, respectively. Diluted EPS would have been the same as the fully diluted amounts. Year 2000 The Company has developed a detailed plan to modify its computer systems in anticipation of the year 2000. Many of the existing systems process transactions based on storing two digits for the year of a transaction, rather than full four digits. If these systems are not identified and reconfigured, year 2000 transactions would be processed with year "00" which would lead to processing inaccuracies and potential inoperability. Any costs incurred relating to this project will be expensed as technology maintenance costs in accordance with generally accepted accounting principles. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES PART II - OTHER INFORMATION ITEM 1 Legal Proceedings Lehman Brothers is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its business. Such proceedings include actions brought against LBI and others with respect to transactions in which LBI acted as an underwriter or financial advisor, actions arising out of LBI's activities as a broker or dealer in securities and commodities and actions brought on behalf of various classes of claimants against many securities and commodities firms of which LBI is one. Although there can be no assurance as to the ultimate outcome, Lehman Brothers has denied, or believes it has meritorious defenses and will deny, liability in all significant cases pending against it including the matters described below, and intends to defend vigorously each such case. Although there can be no assurance as to the ultimate outcome, based on information currently available and established reserves, the Company believes that the eventual outcome of the actions against it, including the matters described below, will not, in the aggregate, have a material adverse effect on its business or consolidated financial condition. Actions Relating to First Capital Holdings Inc. (Reported in Holdings' Annual Report on Form 10-K) FCH Shareholder and Agent Actions. On April 21, 1997, the California District Court entered an order approving the settlement and dismissing the Action. Sonnenfeld v. The City and County of Denver, Colorado, et al (Reported in Holdings' Annual Report on Form 10-K) On May 30, 1997, the parties entered into a Memorandum of Understanding to settle and dismiss the action and are in the process of entering into a definitive settlement agreement which will be submitted to the Court for approval. AIA Holding SA et al. v. Lehman Brothers Inc. and Bear Stearns & Co. Inc. On July 9, 1997, LBI was served with a complaint in the U.S. District Court for the Southern District of New York in which 277 named plaintiffs assert 24 causes of action against LBI and Bear Stearns & Co., Inc. The amount of damages claimed is unspecified. The claims arise from the activities of an individual named Ahmad Daouk, who was employed as an introducing broker who introduced accounts to Shearson Lehman Hutton between 1988 and 1992. Daouk allegedly perpetrated a fraud upon the claimants, who are mostly investors of middle eastern origin, and the compliant alleges that Shearson breached various contractual and common law duties owed to the investors. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K The following exhibits and reports on Form 8-K are filed as part of this Quarterly Report, or where indicated, were heretofore filed and are hereby incorporated by reference: (a) Exhibits: 11 Computation of Per Share Earnings 12.A Computation in Support of Ratio of Earnings to Fixed Charges 12.B Computation in Support of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends 27 Financial Data Schedule (b) Reports on Form 8-K: 1. Form 8-K dated June 26, 1997, Items 5 and 7. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEHMAN BROTHERS HOLDINGS INC. (Registrant) Date: July 15, 1997 By /s/ Richard S. Fuld Jr. -------------------------------- Richard S. Fuld, Jr. Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Date: July 15, 1997 By /s/ Charles B. Hintz ----------------------------- Charles B. Hintz Chief Financial Officer (Principal Financial Officer) EXHIBIT INDEX Exhibit No. Exhibit Exhibit 11 Computation of Per Share Earnings Exhibit 12.A Computation in Support of Ratio of Earnings to Fixed Charges Exhibit 12.B Computation in Support of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends Exhibit 27 Financial Data Schedule Exhibit 11 LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES COMPUTATION of PER SHARE EARNINGS (Unaudited) (In millions, except share data)
Three months Three months Six months Six months ended ended ended ended May 31 May 31 May 31 May 31 1997 1996 1997 1996 Primary: Weighted average shares outstanding: Common stock 101,363,320 101,692,508 101,024,030 102,883,293 Common stock issuable 17,380,026 11,594,020 16,848,491 11,693,861 Common stock equivalents 1,677,387 1,502,160 1,571,726 1,276,455 -------------- ------------- -------------- -------------- Total common stock and common stock equivalents 120,420,733 114,788,688 119,444,247 115,853,609 =========== =========== =========== =========== Net income $ 120.7 $ 108.0 $ 265.1 $ 212.1 Preferred dividends (1) (6.3) (6.4) (12.7) (17.6) ------- ------- ------- -------- Net income applicable to common stock $ 114.4 $ 101.6 $ 252.4 $ 194.5 ======= ======= ======= ======= Earnings Per Common Share $ 0.95 $ 0.89 $ 2.11 $ 1.68 ======== ======== ======== ======== Fully diluted: Weighted average shares outstanding: Common stock 101,363,320 101,692,508 101,024,030 102,883,293 Common stock issuable 17,778,309 11,594,020 17,047,633 11,693,861 Common stock equivalents 2,274,780 1,502,160 1,941,027 1,423,471 ------------- ------------- ------------- ------------- Total common stock and common stock equivalents 121,416,409 114,788,688 120,012,689 116,000,625 =========== =========== =========== =========== Net income $ 120.7 $ 108.0 $ 265.1 $ 212.1 Preferred dividends (1) (6.3) (6.4) (12.7) (17.6) ------- ------- ------- -------- Net income applicable to common stock $ 114.4 $ 101.6 $ 252.4 $ 194.5 ======= ======= ======= ======= Earnings Per Common Share $ 0.94 $ 0.89 $ 2.10 $ 1.68 ======= ======= ======== =======
(1) Amount for the six months ended May 31, 1996 includes $2 million premium paid over par value to repurchase the $200 million 8.44% cumulative preferred stock owned by the American Express Company. Exhibit 12.A LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES COMPUTATION in SUPPORT of RATIO of EARNINGS to FIXED CHARGES (Dollars in millions) (Unaudited)
For the For the For the For the For the year eleven months year year six months ended ended ended ended ended December 31 November 30 November 30 November 30 May 31 -------------------- ----------- ----------- ----------- ------ 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- Fixed Charges: Interest expense: Subordinated indebtedness $ 150 $ 144 $ 158 $ 206 $ 220 $ 127 Bank loans and other borrowings* 5,035 5,224 6,294 10,199 10,596 5,899 Interest component of rentals of office and equipment 74 76 42 44 34 16 Other adjustments** 2 7 4 28 16 7 ---------- --------- --------- ---------- ---------- ---------- TOTAL (A) $5,261 $5,451 $6,498 $10,477 $10,866 $ 6,049 ======= ====== ======== ======= ======= ======= Earnings: Pretax income (loss) from continuing operations $ (247) $ 27 $ 193 $ 369 $ 637 $ 391 Fixed charges 5,261 5,451 6,498 10,477 10,866 6,049 Other adjustments*** _____ (6) (28) (14) (6) ------- ------- --------- --------- ---------- (4) TOTAL (B) $5,014 $5,472 $6,687 $10,818 $11,489 $ 6,434 ====== ====== ====== ======= ======= ======= (B / A) **** 1.00 1.03 1.03 1.06 1.06
* Includes amortization of long-term debt discount. ** Other adjustments include capitalized interest and debt issuance costs and amortization of capitalized interest. *** Other adjustments include adding the net loss of affiliates accounted for at equity whose debt is not guaranteed by the Company and subtracting capitalized interest and debt issuance costs and undistributed net income of affiliates accounted for at equity. **** Earnings were inadequate to cover fixed charges and would have had to increase $247 million in 1992 in order to cover the deficiencies. Exhibit 12.B LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES COMPUTATION in SUPPORT of RATIO of EARNINGS to COMBINED FIXED CHARGES and PREFERRED DIVIDENDS (Dollars in millions) (Unaudited)
For the For the For the For the For the year eleven months year year six months ended ended ended ended ended December 31 November 30 November 30 November 30 May 31 ------------------ ----------- ----------- ----------- ------ 1992 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- Combined Fixed Charges and Preferred Dividends: Interest expense: Subordinated indebtedness $ 150 $ 144 $ 158 $ 206 $ 220 $ 127 Bank loans and other borrowings* 5,035 5,224 6,294 10,199 10,596 5,899 Interest component of rentals of office and equipment 74 76 42 44 34 16 Other adjustments** 2 7 4 28 16 7 ---------- --------- --------- --------- --------- --------- Total fixed charges 5,261 5,451 6,498 10,477 10,866 6,049 Preferred dividends (tax equivalent basis) 48 48 58 64 58 19 -------- -------- -------- --------- --------- --------- TOTAL (A) $5,309 $5,499 $6,556 $10,541 $10,924 $ 6,068 ====== ====== ====== ======= ======= ======= Earnings: Pretax income (loss) from continuing operations $ (247) $ 27 $ 193 $ 369 $ 637 $ 391 Fixed charges 5,261 5,451 6,498 10,477 10,866 6,049 Other adjustments*** _____ (6) (28) (14) (6) -------- ------- -------- -------- -------- (4) TOTAL (B) $5,014 $5,472 $6,687 $10,818 $11,489 $ 6,434 ====== ====== ====== ======= ======= ======= (B / A) **** **** 1.02 1.03 1.05 1.06
* Includes amortization of long-term debt discount. ** Other adjustments include capitalized interest and debt issuance costs and amortization of capitalized interest. *** Other adjustments include adding the net loss of affiliates accounted for at equity whose debt is not guaranteed by the Company and subtracting capitalized interest and debt issuance costs and undistributed net income of affiliates accounted for at equity. **** Earnings were inadequate to cover fixed charges and preferred dividends and would have had to increase $295 million in 1992 and $27 million in 1993 in order to cover the deficiencies. Exhibit 27 EX-27 2 FDS --
BD LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES This schedule contains summary financial information extracted from the Company's Consolidated Statement of Financial Condition at May 31, 1997 (Unaudited) and the Consolidated Statement of Operations for the six months ended May 31, 1997 (Unaudited) and is qualified in its entirety by reference to such financial statements. 1,000,000 6-MOS NOV-30-1997 DEC-01-1996 MAY-31-1997 3,468 9,333 40,093 22,085 68,309 467 144,789 11,089 9,534 57,179 6,904 34,291 17,945 11 0 508 3,619 144,789 672 6,377 188 514 0 6,026 902 391 265 0 0 265 $2.11 $2.10
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