-----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, EUvrM5oYyGe6R61e64GLTG517Tq5bQlnl7piqQrCt7ULn01wdy+rFqJh34NM5diM rzNLc/0sYVpmLnMzDwfCEQ== 0000806085-00-000035.txt : 20000417 0000806085-00-000035.hdr.sgml : 20000417 ACCESSION NUMBER: 0000806085-00-000035 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000229 FILED AS OF DATE: 20000414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEHMAN BROTHERS HOLDINGS INC CENTRAL INDEX KEY: 0000806085 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 133216325 STATE OF INCORPORATION: DE FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09466 FILM NUMBER: 601928 BUSINESS ADDRESS: STREET 1: AMERICAN EXPRESS TWR STREET 2: 3 WORLD FINANCIAL CNTR CITY: NEW YORK STATE: NY ZIP: 10285 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 LEHMAN BROTHERS HOLDINGS INC. 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 February 29, 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 (I.R.S. Employer Identification No.) of incorporation or organization) 3 World Financial Center New York, New York 10285 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code: (212) 526-7000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ______ As of March 31, 2000, 120,843,134 shares of the Registrant's Common Stock, par value $0.10 per share, were outstanding. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED FEBRUARY 29, 2000 INDEX Part I. FINANCIAL INFORMATION Page Number Item 1. Financial Statements - (unaudited) Consolidated Statement of Income - Three Months Ended February 29, 2000 and February 28, 1999...........3 Consolidated Statement of Financial Condition - February 29, 2000 and November 30, 1999...........4 Consolidated Statement of Cash Flows - Three Months Ended February 29, 2000 and February 28, 1999...........6 Notes to Consolidated Financial Statements........8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.....17 Part II. OTHER INFORMATION Item 1. Legal Proceedings.................................34 Item 4. Submission of Matters to a Vote of Security.......35 Holders Item 6. Exhibits and Reports on Form 8-K..................36 Signature ............................................................37 EXHIBIT INDEX 38 Exhibits LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of INCOME (Unaudited) (In millions)
Three months ended ------------------------------------- February 29 February 28 2000 1999 ---------------- ---------------- Revenues Principal transactions $ 1,114 $ 534 Investment banking 602 313 Commissions 229 146 Interest and dividends 4,313 3,581 Other 82 17 ---------------- ---------------- Total revenues 6,340 4,591 Interest expense 4,138 3,473 ---------------- ---------------- Net revenues 2,202 1,118 ---------------- ---------------- Non-interest expenses Compensation and benefits 1,145 567 Technology and communications 84 82 Brokerage and clearance 58 58 Business development 35 28 Professional fees 32 22 Occupancy 30 28 Other 24 24 ---------------- ---------------- Total non-interest expenses 1,408 809 ---------------- ---------------- Income before taxes and dividends on trust preferred securities 794 309 Provision for income taxes 239 96 Dividends on trust preferred securities 14 2 ---------------- ---------------- Net income $ 541 $ 211 ================ ================ Net income applicable to common stock $ 482 $ 198 ================ ================ Earnings per common share Basic $ 3.92 $ 1.62 ================ ================ Diluted $ 3.69 $ 1.57 ================ ================
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of FINANCIAL CONDITION (Unaudited) (In millions)
February 29 November 30 2000 1999 ------------------ ------------------ ASSETS Cash and cash equivalents $ 2,789 $ 5,186 Cash and securities segregated and on deposit for regulatory and other purposes 3,177 1,989 Securities and other financial instruments owned: Governments and agencies 26,293 29,959 Mortgages and mortgage-backed 24,385 22,643 Corporate equities 13,948 12,790 Derivatives and other contractual agreements 13,863 10,306 Corporate debt and other 13,414 11,096 Certificates of deposit and other money market instruments 665 2,265 ------------------ ------------------ 92,568 89,059 ------------------ ------------------ Collateralized short-term agreements: Securities purchased under agreements to resell 76,764 62,222 Securities borrowed 23,939 19,397 Receivables: Brokers, dealers and clearing organizations 1,493 1,674 Customers 9,852 9,332 Others 1,304 1,354 Property, equipment and leasehold improvements (net of accumulated depreciation and amortization of $906 in 2000 and $889 in 1999) 479 485 Other assets 1,388 1,408 Excess of cost over fair value of net assets acquired (net of accumulated amortization of $131 in 2000 and $129 in 1999) 136 138 ------------------ ------------------ Total Assets $ 213,889 $ 192,244 ================== ==================
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of FINANCIAL CONDITION - (Continued) (Unaudited) (In millions, except share data)
February 29 November 30 2000 1999 -------------- ---------------- LIABILITIES AND STOCKHOLDERS' EQUITY Commercial paper and short-term debt $ 5,825 $ 5,476 Securities and other financial instruments sold but not yet purchased: Governments and agencies 27,279 22,396 Corporate equities 16,929 12,344 Derivatives and other contractual agreements 10,382 9,582 Corporate debt and other 4,288 2,288 -------------- ---------------- 58,878 46,610 -------------- ---------------- Collateralized short-term financing: Securities sold under agreements to repurchase 84,308 81,083 Securities loaned 4,948 4,568 Payables: Brokers, dealers and clearing organizations 1,654 1,184 Customers 12,781 10,971 Accrued liabilities and other payables 5,885 4,668 Long-term debt: Senior notes 28,996 27,375 Subordinated indebtedness 3,318 3,316 -------------- ---------------- Total liabilities 206,593 185,251 -------------- ---------------- Commitments and contingencies Trust preferred securities subject to mandatory redemption 710 710 STOCKHOLDERS' EQUITY Preferred stock 600 688 Common stock, $0.10 par value; 300,000,000 shares authorized; Shares issued: 122,642,213 in 2000 and 122,619,460 in 1999; Shares outstanding: 120,150,218 in 2000 and 119,912,810 in 1999 12 12 Additional paid-in capital 3,350 3,387 Accumulated other comprehensive income (net of tax) (13) (2) Retained earnings 2,563 2,094 Other stockholders' equity, net 232 254 Common stock in treasury, at cost: 2,491,995 shares in 2000 and 2,706,650 in 1999 (158) (150) ---------------- -------------- Total stockholders' equity 6,586 6,283 ============== ================ Total liabilities and stockholders' equity $ 213,889 $ 192,244 ============== ================
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of CASH FLOWS (Unaudited) (In millions)
Three months ended -------------------------------------- February 29 February 28 2000 1999 ----------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITES Net income $ 541 $ 211 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 24 24 Provisions for losses and other reserves 9 9 Compensation payable in common stock 68 47 Other adjustments 12 33 Net change in: Cash and securities segregated (1,188) (89) Securities and other financial instruments owned (3,509) (12,459) Securities borrowed (4,542) 1,483 Receivables from brokers, dealers and clearing organizations 181 404 Receivables from customers (520) 439 Securities and other financial instruments sold but not yet purchased 12,268 4,756 Securities loaned 380 3,708 Payables to brokers, dealers and clearing organizations 470 698 Payables to customers 1,810 (958) Accrued liabilities and other payables 1,208 (417) Other operating assets and liabilities, net (213) 484 ----------------- ---------------- Net cash provided by (used in) operating activities $ 6,999 $ (1,627) ----------------- ----------------
See notes to consolidated financial statements. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES CONSOLIDATED STATEMENT of CASH FLOWS (Continued) (Unaudited) (In millions)
Three months ended ------------------------------------- February 29 February 28 2000 1999 ---------------- ---------------- CASH FLOWS FROM FINANCING ACTIVITES Proceeds from issuances of senior notes $ 3,776 $ 1,222 Principal payments of senior notes (1,914) (1,845) Net proceeds from commercial paper and short-term debt 349 511 Resale agreements net of repurchase agreements (11,317) 2,162 Payments for treasury stock purchases (112) (40) Dividends paid (73) (71) Issuances of common stock 7 Redemption of preferred stock (88) Issuances of trust preferred securities, net of issuance costs 316 ---------------- ---------------- Net cash provided by (used in) financing activities (9,379) 2,262 ---------------- ---------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, equipment and leasehold improvements (17) (20) ---------------- ---------------- Net cash used in investing activities (17) (20) ---------------- ---------------- Net change in cash and cash equivalents (2,397) 615 ---------------- ---------------- Cash and cash equivalents, beginning of period 5,186 3,055 ================ ================ Cash and cash equivalents, end of period $ 2,789 $ 3,670 ================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions) Interest paid totaled $4,226 and $3,491 for the three months ended February 29, 2000 and February 28, 1999, respectively. Income taxes paid totaled $59 and $26 for the three months ended February 29, 2000 and February 28, 1999, 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 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 three months ended February 29, 2000, the Company issued $3,776 million of long-term debt (all of which were senior notes). Of the total issuances during the period, $2,271 million were U.S. dollar fixed rate, $769 million were U.S. dollar floating rate, $684 million were foreign currency denominated fixed rate, and $52 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 $736 million, $681 million were effectively swapped to U.S. Dollars, with the remainder match funding foreign currency denominated capital needs. The Company had $1,914 million of long-term debt mature during the three months ended February 29, 2000. 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 February 29, 2000, LBI's regulatory net capital, as defined, of $1,656 million exceeded the minimum requirement by $1,524 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 February 29, 2000, LBIE's financial resources of approximately $2,056 million exceeded the minimum requirement by approximately $575 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 February 29, 2000, had net capital of approximately $374 million which was approximately $161 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 February 29, 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 February 29, 2000, LBFP and LBDP each had capital which exceeded the requirement of the most stringent rating agency by approximately $114 million and $30 million, respectively. 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. 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). 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.
Average Fair Value* Fair Value* Three Months Ended February 29, 2000 February 29, 2000 --------------------------------- ---------------------------------- (in millions) Assets Liabilities Assets Liabilities - -------------------------------------------------------- -------------- -- --------------- -------------- --- --------------- Interest rate and currency swaps and options (including caps, collars and floors) $ 4,928 $ 3,526 $ 4,251 $ 3,716 Foreign exchange forward contracts and options 712 1,095 2,147 1,805 Other fixed income securities contracts (including options and TBAs) 186 224 392 270 Equity contracts (including equity swaps, warrants and options) 8,037 5,537 5,452 3,808 -------------- -- --------------- -------------- --- --------------- Total $ 13,863 $ 10,382 $ 12,242 $ 9,599 -------------- -- --------------- -------------- --- ---------------
* Amounts represent carrying value (exclusive of collateral) and do not include receivables or payables related to exchange-traded futures contracts. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS
Average Fair Value* Fair Value* Twelve Months Ended November 30, 1999 November 30, 1999 ---------------------------------- --------------------------------- (in millions) Assets Liabilities Assets Liabilities - -------------------------------------------------------- -------------- -- ---------------- --------------- - --------------- 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 -------------- -- ---------------- --------------- - ---------------
* 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 February 29, 2000 represents the Company's net receivable/payable for derivative financial instruments before consideration of collateral. Included within the $13,863 million fair value of assets at February 29, 2000 was $11,613 million related to swaps and other OTC contracts and $2,250 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 $6,062 million at February 29, 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 February 29, 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. 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 10% 2 AA-/Aa3 or higher 24% 3 A-/A3 or higher 40% 4 BBB-/Baa3 or higher 19% 5 BB-/Ba3 or higher 3% 6 B+/B1 or lower 4% 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 $3.5 billion at February 29, 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 $2.4 billion and $2.9 billion at February 29, 2000 and November 30, 1999, respectively. In addition, lending commitments to high yield borrowers totaled $1.5 billion and $1.4 billion at February 29, 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. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS At February 29, 2000 and November 30, 1999, the Company had commitments to invest up to $522 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 February 29, 2000 and November 30, 1999. 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. 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. 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 fifteen 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 first quarter of 2000 and 1999 is presented below and was developed consistent with the accounting policies used to prepare the Company's consolidated financial statements.
Investment Capital Client Banking Markets Services Total ------------------ -------------- ----------------- --------------------- February 29, 2000 Net revenue $ 593 $ 1,339 $ 270 $ 2,202 ================== ============== ================= ===================== Earnings before taxes (1) $ 179 $ 506 $ 109 $ 794 ================== ============== ================= ===================== Segment assets (billions) $1.9 $ 202.2 $ 9.8 $ 213.9 ================== ============== ================= ===================== February 28, 1999 Net revenue $ 309 $ 687 $ 122 $ 1,118 ================== ============== ================= ===================== Earnings before taxes (1) $ 84 $ 203 $ 22 $ 309 ================== ============== ================= ===================== Segment assets (billions) $1.0 $ 172.6 $ 5.7 $ 179.3 ================== ============== ================= =====================
(1) And before dividends on trust preferred securities. The following are net revenues by geographic region: February 29 February 28 2000 1999 ------------------ ------------------- Americas* $ 1,265 $ 640 Europe 704 373 Asia Pacific 233 105 ------------------ ------------------- Total $ 2,202 $ 1,118 ================== =================== * Includes non-U.S. revenues of $20 million and $9 million in the first quarter of 2000 and 1999, respectively. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS The following information describes the Company's methods of allocating consolidated net revenues to geographic regions. Net revenues, if syndicated or trading-related, have been distributed based upon the location where the primary or secondary position was fundamentally risk managed; if fee-related, by the location of the senior coverage banker; if commission-related, by the location of the salespeople. In addition, certain revenues associated with domestic products and services which resulted from relationships with international clients and customers have been reclassified as international revenues using an allocation consistent with the Company's internal reporting. 7. Incentive Plans: In the first quarter of 2000, the Company transferred 2.0 million shares of its common stock held in treasury into the RSU Trust. The RSU Trust is included in the Consolidated Statement of Financial Condition as a component of other stockholders' equity. The transfer had no impact on the total stockholders' equity of the Company, as the decrease in treasury stock was offset by a corresponding decrease in additional paid-in capital and other stockholders' equity. At February 29, 2000 and November 30, 1999, 25.6 million and 24.8 million outstanding shares, respectively, were held in the RSU Trust. In February 2000, the Company granted to senior officers options to acquire 7.1 million shares of its common stock that expire in approximately five years. No compensation expense has been recognized for these stock options as they were granted with an exercise price at the market price of the common stock on the date of the grant. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES NOTES to CONSOLIDATED FINANCIAL STATEMENTS 8. Earnings Per Common Share: Earnings per share was calculated as follows (in millions, except for per share data):
Three Months Ended ------------------------------------- February 29 February 28 2000 1999 ----------------- ---------------- Numerator: Net income $541 $211 Preferred stock dividends (59) (13) ----------------- ---------------- Numerator for basic earnings per share-income available to common stockholders 482 198 Convertible preferred stock dividends 2 ----------------- ---------------- Numerator for diluted earnings per share-income available to common stock-holders (adjusted for assumed conversion of preferred stock) $484 $198 ================= ================ Denominator: Denominator for basic earnings per share - weighted-average shares 123.0 121.9 Effect of dilutive securities: Employee stock options 4.9 2.3 Employee restricted stock units 2.1 1.6 Preferred shares assumed converted into common 1.2 ----------------- ---------------- Dilutive potential common shares 8.2 3.9 ================= ================ Denominator for diluted earnings per share - adjusted weighted-average shares 131.2 125.8 ================= ================ Basic earnings per share $3.92 $1.62 ================= ================ Diluted earnings per share $3.69 $1.57 ================= ================
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). 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. Financial Advisory activities on a global basis continued at record levels. Industrywide, the volume of announced merger and acquisition transactions in the first quarter soared to $1.1 trillion. The first quarter also reflected continued activity involving European companies and cross-border mergers and acquisitions. Merger and acquisition activities continued to reflect the trends of consolidation, deregulation and globalization across industry sectors and across borders. Equity new issuance this quarter was at record levels worldwide, more than doubling as compared to the same period last year. In the U.S., new equity issuance more than tripled as compared to the first quarter last 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 and the European Central Bank. At the same time, economic growth in the United States remained very strong during the first quarter of 2000, and equity trading volumes continued to be healthy. New economy stocks, as measured by the NASDAQ rose 40% during the quarter to a new high, but have since corrected. In anticipation of further rate hikes, the price of old economy stocks, as measured by the Dow Jones Industrial Index, declined by 7% over the quarter, through the 10,000 level, but later recovered. In the fixed income markets, the 10-year U.S. Treasury bond yield initially rose during the quarter, reaching 6.78% in mid-January. However, as the Dow slid and the U.S. Treasury announced plans for the early retirement of certain Treasury borrowings, bond yields fell-back to end the quarter at 6.4%, just 20 basis points above where they had started. In response to the strength of continued growth, the Fed, as expected, raised the Federal Funds rate on February 2nd by 25 basis points to 5.75%, the fourth 25 basis point increase since June 1999. In February, while European business and consumer confidence had risen to new cyclical and all-time highs, inflationary pressures also started to rise. Pushed up by higher oil prices and a weaker euro, European inflation rose to 2% in January from 1.5% in November, while core inflation also inched higher. Responding to rising inflationary pressures and a weaker euro, the European Central Bank raised its key two-week repo rate by 25 basis points on February 3rd. Although the rate hike by the ECB matched that by the Federal Reserve, the euro continued to fall against the dollar, hitting a new low of $0.94/euro on February 28th, but later stabilizing at around $0.97/euro. For the period as a whole, European markets outperformed the broad U.S. index with a return of 8% in local currency terms (FTSE World Europe), but all of this gain was achieved by LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS the end of December. In Japan, the economy and financial markets gave out mixed signals in the first quarter of the financial year. Recovery generally remained hesitant and uneven. Even though concerns continued to mount about the sustainability of public financing, the continued weakness of real activity and residual evidence of deflation allowed long-term bond yields to remain below 2.0%. Evidence of corporate restructuring and accelerated diffusion of the information technology revolution encouraged the continued rally of the stock market. Notwithstanding increased foreign portfolio inflows, the yen declined against the dollar, falling around 8% to (Y)/U.S.$110 by the end of the quarter. Other Asian markets recorded modest returns in the three months ending February in local currency terms, again with these gains being front-loaded into December and dominated by the "New Economy" sectors. 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 February 29, 2000 and February 28, 1999 The Company reported record net income of $541 million for the first quarter ended February 29, 2000, representing an increase of 156% from net income of $211 million for the first quarter ended February 28, 1999. Earnings per common share (diluted) increased to $3.69 for the first quarter of 2000 from $1.57 for the first quarter of 1999 or an increase of 135%. Excluding the impact of the special preferred dividend of $50 million, earnings per share rose 160%. These results reflect the ongoing successful execution of the Company's strategy to grow its high margin investment banking and equities businesses; increase its presence in certain strategic businesses in Europe; and at the same time maintain a strict 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; and (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 helped to increase the Company's operating margin to 36.1% in the first quarter of 2000 from 27.6% in the first quarter of 1999. Non-personnel expenses increased only 8.7% in the first quarter of 2000, despite a 97% increase in net revenues from first quarter 1999. The Company's compensation and benefits ratio increased to 52% of net revenues from 50.7%, as the Company stepped up its rate of investment to accelerate its growth, and take advantage of rapidly expanding opportunities in a number of businesses, particularly investment banking, equities, and Europe. The Company also increased its investment in information technology and e-commerce activities to support its growth strategy. 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.) Three Months Ended February 29, 2000 and February 28, 1999 - --------------------------------- --------------- -- --------------- -- (in millions) Three Months Ended ---------------------------------- Feb 29 Feb 28 2000 1999 --------------- --------------- Investment Banking $ 593 $ 309 Capital Markets 1,339 687 Client Services 270 122 =============== =============== Total $ 2,202 $ 1,118 =============== =============== - --------------------------------- --------------- -- --------------- -- 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 92% in the first quarter of 2000 to $593 million from $309 million in the first quarter of 1999, principally as a result of an increase in equity underwriting and financial advisory services. The increased net revenues are an outgrowth of the Company's ongoing efforts to grow its Investment Banking franchise. The record results in equity underwriting were driven by issuances in the communications/media sector and a significant increase in convertible offerings. European revenues continued to be strong. The Company improved its ranking for European equity transactions, from #19 for the first quarter of 1999 to #4 in the first quarter of 2000. The Company also recorded record results in financial advisory services, benefiting from a continued robust merger and acquisition environment. The Company's ranking for global completed transactions increased to #4 for the first quarter of 2000 from #8 for the first quarter of 1999. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Debt underwriting revenues increased slightly from the first quarter of 1999 despite challenging market conditions resulting from yield curve volatility. Global debt underwriting volume was down 25% versus the first quarter of 1999. Despite these difficult market conditions, the Company was ranked #1 in high grade and #5 in high yield debt underwriting. Investment Banking Net Revenues ------------------------ ------------------------------ (in millions) Three Months Ended February 29 February 28 2000 1999 ------------------------ --------------- -------------- Equity Underwriting $ 261 $ 59 Debt Underwriting 153 150 Financial Advisory 179 100 ------------------------ --------------- -------------- $ 593 $ 309 ------------------------ --------------- -------------- 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 $1,339 million for the first quarter of 2000 and $687 million for the first quarter of 1999. Customer flow sales and trading volumes continued to increase at healthy rates, significantly contributing to this increase. Net revenues from the equity component of Capital Markets increased 321% to $868 million in the first quarter of 2000 from $206 million in the first quarter of 1999. Revenues benefited in the first quarter of 2000 from significantly increased institutional customer flow activity in cash and derivative products as well as contributions from equity arbitrage. In addition, the Company realized gains of approximately $150 million on a principal investment it had in VerticalNet, Inc. Consistent with its overall strategy, the Company also experienced continued growth and improved performance in its European franchise. Capital Markets Net Revenues ---------------------- --------------------------------- (in millions) Three Months Ended February 29 February 28 2000 1999 - -------------------------------------------------------- Equities $ 868 $ 206 Fixed Income 471 481 ---------------------- --------------- ----------------- $ 1,339 $ 687 ---------------------- --------------- ----------------- LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Net revenues from the fixed income component of Capital Markets decreased slightly to $471 million in the first quarter of 2000 from $481 million in the first quarter of 1999. Strong customer flow trading in areas such as high grade and high yield were offset by challenging market conditions overall and the Y2K induced slowdown earlier in the quarter. 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 fifteen merchant banking and venture capital partnerships. Client Services Net Revenues ---------------------- --------------------------------- (in millions) Three Months Ended February 29 February 28 1999 1998 ---------------------- -------------- ------------------ Private Client $ 260 $ 119 Private Equity 10 3 ---------------------- -------------- ------------------ $ 270 $ 122 ---------------------- -------------- ------------------ Client Services' net revenues were $270 million in the first quarter of 2000 and $122 million in the first quarter of 1999. The 121% increase was driven by record customer activity due in part to the Company's active syndicate calendar, as well as, performance fees resulting from high portfolio returns from the Company's London-based managed assets. Non-Interest Expenses Non-interest expenses were $1,408 million for the first quarter of 2000 and $809 million for the first quarter of 1999. Compensation and benefits expense as a percentage of net revenues increased to 52.0% for the quarter compared to the prior year quarter of 50.7%. This increase reflects the Company's continued expansion of its investment banking, equities and European franchises as well as investment needs in technology and e-commerce capabilities. Nonpersonnel expenses were $263 million for the first quarter of 2000 and $242 million for the first quarter of 1999, an increase of 8.7%, reflecting the impact of increased investments in personnel and growth in net revenues. However, nonpersonnel expenses declined as a percentage of net revenues to 11.9% for the first quarter of 2000 from 21.7% for the first quarter of 1999 as the Company's net revenues increased at a significantly faster rate. Income Taxes The Company's income tax provision was $239 million for the first quarter of 2000 compared to $96 million for the first quarter of 1999. The effective tax rate was 30.1% for the first quarter of 2000 and 31.0% for the first quarter of 1999. The decrease reflects a favorable change in the geographic mix of earnings and an increase in income and transactions that are subject to preferential tax treatment. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Funding, Capital Resources and Liquidity Funding and Capital Policies The Company's Finance Committee is responsible for establishing and managing the funding and liquidity policies of the Company. These policies include recommendations for capital and balance sheet size as well as the allocation of capital and balance sheet to product areas. Members of the Company's treasury department and business unit financing groups work with the Finance Committee to ensure coordination of global funding efforts and implementation of the funding and liquidity policies. Regional asset and liability committees in the Company's principal funding centers are responsible for implementing funding strategies for their respective regions. The primary goal of the Company's funding policies is to provide sufficient liquidity and availability of funding sources to meet the needs of the Company's businesses. The key elements of these policies are to: (1) Maintain a total capital structure that supports the business activities in which the Company is engaged. (2) Finance the Company's assets, primarily on a secured basis. Together with Total Capital, secured funding provides a stable funding base and enables the Company to minimize its reliance on short-term unsecured debt. (3) Maintain funding availability in excess of actual utilization and 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 $39.6 billion at February 29, 2000 compared to $37.7 billion at November 30, 1999. The net increase in Total Capital resulted from a net increase in long-term debt of $1.6 billion, the retention of earnings, and amortization associated with RSU awards. These were offset by repurchases of common stock (to fund restricted stock units and option awards) and $88 million (2.3 million shares) of convertible Series B Preferred Stock. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS February 29 November 30 (in millions) 2000 1999 - ------------------------------------------------------------------------------- Long-term Debt Senior Notes $ 28,996 $ 27,375 Subordinated Indebtedness 3,318 3,316 ------- ------- 32,314 30,691 Trust Preferred Securities 710 710 Stockholders' Equity Preferred Equity 600 688 Common Equity 5,986 5,595 ----- ----- 6,586 6,283 - ------------------------------------------------------------------------------- Total Capital $ 39,610 $ 37,684 - ------------------------------------------------------------------------------- During the first three months of 2000, the Company issued $3.8 billion in long-term debt, which was $1.9 billion in excess of its maturing debt. Long-term debt increased to $32.3 billion at February 29, 2000 from $30.7 billion at November 30, 1999 with a weighted-average maturity of 3.8 years at February 29, 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 February 29, 2000 and November 30, 1999, $138 billion and $123 billion, respectively, of the Company's total balance sheet of $214 billion and $192 billion at February 29, 2000 and November 30, 1999, respectively, was financed on a secured basis. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS By maximizing its use of secured funding, the Company minimizes its reliance on unsecured financing. As of February 29, 2000 and November 30, 1999, commercial paper and short-term debt outstanding totaled $5.8 billion and $5.5 billion, respectively. Of these amounts, commercial paper outstanding as of February 29, 2000 and November 30, 1999, was $3.7 billion and $3.6 billion, respectively. Back-Up Credit Facilities Holdings maintains a Revolving Credit Agreement (the "Credit Agreement") with a syndicate of banks. Under the terms of the Credit Agreement, the banks have committed to provide up to $2 billion for up to 364 days. Any loans outstanding on the commitment termination date may be extended for up to an additional year at the option of Holdings. The Credit Agreement contains covenants which require, among other things, that the Company maintain a specified level of tangible net worth. In July 1999, 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 $213.9 billion at February 29, 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 $137.1 billion at February 29, 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 reflects higher levels of securities owned and borrowed associated with increased customer flow activities. The Company's balance sheet consists primarily of cash and cash equivalents, securities and other financial instruments owned, and collateralized short-term financing agreements. The liquid nature of these assets provides the Company with flexibility in financing and managing its business. The majority of these assets are funded on a secured basis through collateralized short-term financing agreements with the remaining assets being funded through short-term unsecured financing and Total Capital 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 February 29, 2000 was 18.8x, relatively unchanged from 18.6x at November 30, 1999. Due to the nature of the Company's sales and trading activities, the overall size of the Company's assets and liabilities fluctuates from time to time and at specific points in time may be higher than the fiscal quarter ends or the quarterly average. [GRAPHIC OMITTED] 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. As of February 29, 2000 the short- and long-term debt ratings of Holdings and 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 IBCA, Inc. 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 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 market value, and unrealized gains or losses for these securities are reflected in the Company's Consolidated Statement of Income. The Company's portfolio of such instruments at February 29, 2000 and November 30, 1999 included long positions with an aggregate market value of approximately $3.4 billion and $3.0 billion, respectively, and short positions with an aggregate market value of approximately $415 million and $290 million, respectively. The Company may, from time to time, mitigate its net exposure to any single issuer through the use of derivatives and other financial instruments. Additional information about the Company's High Yield Securities and Lending Activities, including related commitments, can be found in Note 5 to the Consolidated Financial Statements (Other Commitments and Contingencies). The Company has investments in fifteen merchant banking and venture capital-related partnerships, for which the Company acts as general partner, as well as related direct investments. At February 29, 2000, the Company's investment in these partnerships totaled $127 million and related direct investments totaled $531 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. 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). LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Risk Management As a leading global investment banking company, risk is an inherent part of the Company's businesses. Global markets, by their nature, are prone to uncertainty and subject participants to a variety of risks. The Company has developed policies and procedures to identify, measure and monitor each of the risks involved in its trading, brokerage and investment banking activities on a global basis. The principal risks of Lehman Brothers are market, credit, liquidity, legal and operational risks. Risk Management is considered to be of paramount importance. The Company devotes significant resources across all of its worldwide trading operations to the measurement, management and analysis of risk, including investments in personnel and technology. The Company seeks to reduce risk through the diversification of its businesses, counterparties and activities in geographic regions. The Company accomplishes this objective by allocating the usage of capital to each of its businesses, establishing trading limits for individual products and traders and setting credit limits for individual counterparties, including regional concentrations. The Company seeks to achieve adequate returns from each of its businesses commensurate with the risks that they assume. Overall risk management policy is established by a Risk Management Committee (the "Committee") comprised of the Chief Executive Officer, the Global Risk Manager, the Chief Financial and Administrative Officer, the Head of Equities, the Head of Fixed Income, the Head of Global Sales and Research, 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. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS The CRM Department manages the credit exposure related to trading activities by giving initial credit approval for counterparties, establishing credit limits by counterparty, country and industry group and by requiring collateral in appropriate circumstances. In addition, the CRM Department strives to ensure that master netting agreements are obtained whenever possible. The CRM Department also considers the duration of transactions in making its credit decisions, along with the potential credit exposure for complex derivative transactions. The CRM Department is responsible for the continuous monitoring and review of counterparty credit exposure and creditworthiness and recommending, where appropriate, valuation adjustments to the market value of derivative related contracts. 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, 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. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS The Company participates globally in interest rate, equity, and foreign exchange markets. The Company's Fixed Income division has a broadly diversified market presence in U.S. and foreign government bond trading, emerging market securities, corporate debt (investment and non-investment grade), money market instruments, mortgages and mortgage-backed securities, asset-backed securities, municipal bonds, and interest rate derivatives. The Company's Equities division facilitates domestic and foreign trading in equity instruments, indices, and related derivatives. The Company's foreign exchange businesses are involved in trading currencies on a spot and forward basis as well as through derivative products and contracts. The Company incurs short-term interest rate risk when facilitating the orderly flow of customer transactions through the maintenance of government and high grade corporate bond inventories. Market-making in high yield instruments exposes the Company to additional risk due to potential variations in credit spreads. Trading in international markets exposes the Company to spread risk between the term structure of interest rates in differing countries. 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. Equity risk exposures are aggregated and reported to management on a regular basis. The Company enters into foreign exchange transactions in order to facilitate the purchase and sale of non-dollar instruments, including equity and interest rate securities. The Company is exposed to foreign exchange risk on its holdings of non-dollar assets and liabilities. The Company is active in many foreign exchange markets and has exposure to the euro, Japanese yen, British pound, Swiss franc, and Canadian dollar as well as a variety of developed and emerging market currencies. The Company hedges its risk exposures primarily through the use of currency forwards, swaps, futures, and options. Value at Risk For purposes of Securities and Exchange Commission ("SEC") risk disclosure requirements, the Company discloses an entity-wide value at risk analysis of virtually all of the Company's trading activities. The value at risk calculation measures the potential loss in expected revenues with a 95% confidence level. The methodology incorporates actual trading revenues over a standardized 250-day historical period. A confidence level of 95% implies, on average, that daily trading revenues or losses will exceed daily expected trading revenues by an amount greater than value at risk one out of every 20 trading days. LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION and RESULTS of OPERATIONS Average value at risk computed in this manner was $27.5 million and $30.9 million for the periods ended February 29, 2000 and November 30, 1999, respectively. Value at risk at February 29, 2000 and November 30, 1999 was $18.8 million and $19.2 million, respectively. Value at risk is one measurement of potential losses in revenues that may result from adverse market movements over a specified period of time with a selected likelihood of occurrence. Value at risk has substantial limitations, including its reliance on historical performance and data as valid predictors of the future. Consequently, value at risk is only one of a number of tools the Company utilizes in its daily risk management activities. As discussed throughout Management's Discussion and Analysis, the Company seeks to reduce risk through the diversification of its businesses and a focus on customer flow activities. This diversification and focus, combined with the Company's risk management controls and processes, helps mitigate the net revenue volatility inherent in the Company's trading activities. Although historical performance is not necessarily indicative of future performance, the Company believes its focus on business diversification and customer flow activities should continue to help mitigate the volatility of future net trading revenues. 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 Exposure Draft would also require goodwill arising from the application of the purchase method to be written off over a maximum 20-year amortization period, which is shorter than the current 40-year period. 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 late in 2000. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which requires all derivatives to be recorded on the balance sheet at fair value. In June 1999, the FASB extended the implementation date of SFAS No. 133 by one year. As a result, SFAS No. 133 will now be effective for the Company on December 1, 2000 (Fiscal Year 2001). The expected impact of adoption on the Company's results of operations has not yet been determined, however it is not likely to be material since most of the Company's derivatives are carried at fair value. LEHMAN BROTHERS HOLDINGS INC. and SUSBSIDIARIES 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. In re Mobilemedia Securities Litigation (Reported in Holdings' 1999 Annual Report on Form 10-K) On February 24, 2000, the Court entered an Order and Final Judgment finally approving a settlement and dismissing the action. Pamahi Investment Corp., et al. v. Lehman Brothers Inc., et al. (Reported in Holdings' 1999 Annual Report on Form 10-K) On March 17, 2000, the motion of LBI and its former branch manager to sever the arbitration into a separate case for each set of claimants was granted, and all claims other than those of the lead claimant, Pamahi Investment Corp., were dismissed without prejudice to renewal in a separate proceeding. Pamahi claims damages of $5.96 million; no other Claimants assert claims for damages in excess of that amount. ITEM 4 Submission of Matters to a Vote of Security - Holders ----------------------------------------------------- At the annual meeting of shareholders of the Company held on April 4, 2000, the following matters were submitted to a vote of security holders: A) A proposal was submitted for the election of all Class III Directors. The results for the nominees were: Thomas H. Cruikshank - 107,810,771 votes for, 2,089,680 votes withheld; Henry Kaufman - 107,143,974 votes for, 2,756,477 votes withheld; John D. Macomber - 107,772,421 votes for, 2,128,030 votes withheld. Messrs. Cruikshank, Kaufman, and Macomber were elected to serve until the Annual Meeting in 2003 or until a successor is elected and qualified. B) A proposal was submitted for the ratification of the Company's selection of Ernst & Young LLP as the Company's independent auditors for the 2000 fiscal year. The results were 109,169,222 votes for, 265,208 against and 466,021 abstaining, and the proposal was adopted. C) A proposal was submitted for approval of an amendment to Holdings' 1996 Management Ownership Plan to increase the number of shares of Common Stock with respect to which awards may be granted under the Plan from 15.5 million to 21 million shares. The results were 69,219,693 votes for, 40,046,371 against and 634,387 abstaining, and the proposal was adopted. 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 January 6, 2000, Items 5 and 7. Financial Statements: Exhibit 99.2 Consolidated Statement of Income (Three Months Ended November 30, 1999) (Preliminary and Unaudited) Exhibit 99.3 Consolidated Statement of Income (Twelve Months ended November 30, 1999) (Preliminary and Unadudited). 2. Form 8-K dated February 24, 2000, Item 7. 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: April 14, 2000 By:/s/ David Goldfarb -------------------------- Chief Accounting Officer 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 EX-12 2 LEHMAN BROTHERS HOLDINGS INC. 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)
For the For the For the For the For the For the Twelve Twelve Twelve Twelve Twelve Three Months Months Months Months Months Months Ended Ended Ended Ended Ended Ended February 29 November 30 November 30 November 30 November 30 November 30 2000 1995 1996 1997 1998 1999 ------------- ------------- ------------- -------------- ------------- ------------- Pre-tax earnings from continuing operations $ 369 $ 637 $ 937 $ 1,052 $ 1,631 $ 794 Add: Fixed charges (excluding capitalized interest) 10,449 10,852 13,043 15,813 13,681 4,147 ------------- ------------- ------------- -------------- ------------- ------------- Pre-tax earnings before fixed charges 10,818 11,489 13,980 16,865 15,312 4,941 ============= ============= ============= ============== ============= ============= Fixed charges: Interest 10,405 10,816 13,010 15,781 13,649 4,138 Other(a) 72 50 41 47 71 17 ------------- ------------- ------------- -------------- ------------- ------------- Total fixed charges 10,477 10,866 13,051 15,828 13,720 4,155 ------------- ------------- ------------- -------------- ------------- ------------- Preferred stock dividend requirements 64 58 109 124 174 99 ------------- ------------- ------------- -------------- ------------- ------------- Total combined fixed charges and preferred stock dividends $ 10,541 $ 10,924 $ 13,160 $ 15,952 $ 13,894 $ 4,254 ============= ============= ============= ============== ============= ============= RATIO OF EARNINGS TO FIXED CHARGES 1.03 1.06 1.07 1.07 1.12 1.19 RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS 1.03 1.05 1.06 1.06 1.10 1.16
(a) Other fixed charges consist of the interest factor in rentals and capitalized interest. EX-27 3 FDS -- LEHMAN BROTHERS HOLDINGS INC.
BD This schedule contains summary financial information extracted from the Company's Consolidated Statement of Financial Condition at February 29, 2000 (Unaudited) and the Consolidated Statement of Income for the three months ended February 29, 2000 (Unaudited) and is qualified in its entirety by reference to such financial statements. 3-MOS NOV-30-2000 DEC-01-1999 FEB-29-2000 5,966 12,649 76,764 23,939 92,568 479 213,889 5,825 14,435 84,308 4,948 58,878 32,314 710 600 12 5,974 213,889 1,114 4,313 229 602 0 4,138 1,145 794 541 0 0 541 3.92 3.69
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