0000950136-01-501565.txt : 20011019 0000950136-01-501565.hdr.sgml : 20011019 ACCESSION NUMBER: 0000950136-01-501565 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010831 FILED AS OF DATE: 20011015 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: 1934 Act SEC FILE NUMBER: 001-09466 FILM NUMBER: 1759395 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 file001.txt QUARTERLY REPORT ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ COMMISSION FILE NUMBER 1-9466 LEHMAN BROTHERS HOLDINGS INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3216325 (STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.) OR ORGANIZATION) 3 WORLD FINANCIAL CENTER NEW YORK, NEW YORK 10285 (ADDRESS OF PRINCIPAL (ZIP CODE) EXECUTIVE OFFICES)
(212) 526-7000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) 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 SEPTEMBER 30, 2001, 238,305,895 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 AUGUST 31, 2001 INDEX
PAGE PART I. FINANCIAL INFORMATION NUMBER ------------- Item 1. Financial Statements - (unaudited) Consolidated Statement of Income - Three and Nine Months Ended August 31, 2001 and August 31, 2000................................ 3 Consolidated Statement of Financial Condition - August 31, 2001 and November 30, 2000.............................. 5 Consolidated Statement of Cash Flows - Nine Months Ended August 31, 2001 and August 31, 2000................................ 7 Notes to Consolidated Financial Statements......................... 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................... 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 33 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................ 34 Item 6. Exhibits and Reports on Form 8-K................................. 35 SIGNATURE ........................................................................... 37 EXHIBIT INDEX........................................................................ 38 EXHIBITS
2 LEHMAN BROTHERS HOLDINGS AND SUBSIDIARIES PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA) Three months ended ---------------------- August 31 August 31 2001 2000 --------- --------- Revenues Principal transactions $ 637 $1,071 Investment banking 491 582 Commissions 253 234 Interest and dividends 3,657 5,461 Other 19 11 ------ ------ Total revenues 5,057 7,359 Interest expense 3,429 5,307 ------ ------ Net revenues 1,628 2,052 ------ ------ Non-interest expenses Compensation and benefits 830 1,067 Technology and communications 131 80 Brokerage and clearance 82 68 Business development 43 51 Professional fees 38 53 Occupancy 53 35 Other 16 25 ------ ------ Total non-interest expenses 1,193 1,379 ------ ------ Income from operations before taxes and dividends on trust preferred securities 435 673 Provision for income taxes 112 202 Dividends on trust preferred securities 14 14 ====== ====== Net income $ 309 $ 457 ====== ====== Net income applicable to common stock $ 298 $ 444 ====== ====== Earnings per common share Basic $ 1.24 $ 1.83 ====== ====== Diluted $ 1.14 $ 1.68 ====== ====== See notes to consolidated financial statements. 3 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA) Nine months ended ----------------------- August 31 August 31 2001 2000 ---------- --------- Revenues Principal transactions $ 2,619 $ 3,055 Investment banking 1,539 1,664 Commissions 827 690 Interest and dividends 13,070 14,512 Other 38 113 ------- ------- Total revenues 18,093 20,034 Interest expense 12,560 14,025 ------- ------- Net revenues 5,533 6,009 ------- ------- Non-interest expenses Compensation and benefits 2,822 3,125 Technology and communications 376 249 Brokerage and clearance 232 188 Business development 147 126 Professional fees 126 128 Occupancy 138 97 Other 59 71 ------- ------- Total non-interest expenses 3,900 3,984 ------- ------- Income from operations before taxes and dividends on trust preferred securities 1,633 2,025 Provision for income taxes 466 607 Dividends on trust preferred securities 42 42 ------- ------- Net income $ 1,125 $ 1,376 ======= ======= Net income applicable to common stock $ 1,041 $ 1,293 ======= ======= Earnings per common share Basic $ 4.28 $ 5.27 ======= ======= Diluted $ 3.91 $ 4.91 ======= ======= See notes to consolidated financial statements. 4 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (UNAUDITED) (IN MILLIONS)
August 31 November 30 2001 2000 --------- --------- ASSETS Cash and cash equivalents $ 3,488 $ 5,160 Cash and securities segregated and on deposit for regulatory and other purposes 2,531 2,434 Securities and other financial instruments owned: Governments and agencies 26,221 27,381 Mortgages and mortgage-backed 32,908 24,670 Corporate equities 22,261 24,042 Corporate debt and other 18,274 16,098 Derivatives and other contractual agreements 13,269 9,583 Certificates of deposit and other money market instruments 2,190 3,433 -------- -------- 115,123 105,207 -------- -------- Collateralized short-term agreements: Securities purchased under agreements to resell 86,944 81,242 Securities borrowed 22,084 17,618 Receivables: Brokers, dealers and clearing organizations 1,898 1,662 Customers 7,200 7,585 Others 985 1,135 Property, equipment and leasehold improvements (net of accumulated depreciation and amortization of $809 in 2001 and $855 in 2000) 893 671 Other assets 2,020 1,826 Excess of cost over fair value of net assets acquired (net of accumulated amortization of $148 in 2001 and $138 in 2000) 171 180 -------- -------- Total assets $243,337 $224,720 ======== ========
See notes to consolidated financial statements. 5 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - (CONTINUED) (UNAUDITED) (IN MILLIONS, EXCEPT SHARE DATA)
August 31 November 30 2001 2000 --------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Commercial paper and short-term debt $ 4,502 $ 5,800 Securities and other financial instruments sold but not yet purchased: Governments and agencies 28,498 14,998 Corporate equities 6,177 6,623 Derivatives and other contractual agreements 11,401 8,568 Corporate debt and other 6,366 5,096 --------- --------- 52,442 35,285 --------- --------- Collateralized short-term financing: Securities sold under agreements to repurchase 103,418 110,225 Securities loaned 12,834 7,242 Payables: Brokers, dealers and clearing organizations 910 1,922 Customers 11,475 11,637 Accrued liabilities and other payables 9,599 8,735 Long-term debt: Senior notes 36,402 32,106 Subordinated indebtedness 2,934 3,127 --------- --------- Total liabilities 234,516 216,079 --------- --------- Commitments and contingencies Preferred securities subject to mandatory redemption 710 860 STOCKHOLDERS' EQUITY Preferred stock 700 700 Common stock, $0.10 par value; 600,000 shares authorized; Shares issued 255,510,055 in 2001 and 251,629,126 in 2000; Shares outstanding: 239,046,975 in 2001 and 236,395,332 in 2000 25 25 Additional paid-in capital 3,399 3,589 Accumulated other comprehensive income (net of tax) (9) (8) Retained earnings 4,698 3,713 Other stockholders' equity, net 496 597 Common stock in treasury, at cost: 16,463,080 shares in 2001 and 15,233,794 shares in 2000 (1,198) (835) --------- --------- Total stockholders' equity 8,111 7,781 --------- --------- Total liabilities and stockholders' equity $ 243,337 $ 224,720 ========= =========
See notes to consolidated financial statements. 6 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (IN MILLIONS)
Nine Months Ended ---------------------- August 31 August 31 2001 2000 --------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,125 $ 1,376 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 143 72 Compensation payable in common stock 300 203 Other adjustments (13) 54 Net change in: Cash and securities segregated (97) (1,070) Securities and other financial instruments owned (9,021) (18,640) Securities borrowed (4,466) (3,056) Receivables from brokers, dealers and clearing organizations (236) 64 Receivables from customers 385 (115) Securities and other financial instruments sold but not yet purchased 17,157 1,791 Securities loaned 5,592 4,560 Payables to brokers, dealers and clearing organizations (1,012) (74) Payables to customers (162) 2,329 Other operating assets and liabilities, net 1,235 1,443 -------- -------- Net cash provided by (used in) operating activities 10,930 (11,063) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of senior notes $ 8,817 $ 11,874 Principal payments of senior notes (5,461) (6,331) Principal payments of subordinated indebtedness (204) -- Net proceeds from (payments for) commercial paper and short-term debt (1,298) 191 Resale agreements net of repurchase agreements (12,509) 5,620 Payments for treasury stock purchases (1,498) (470) Dividends paid (137) (122) Issuances of common stock 54 68 (Redemption) issuance of preferred stock (100) 162 -------- -------- Net cash provided by (used in) financing activities (12,336) 10,992 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, equipment and leasehold improvements (266) (148) -------- -------- Net cash used in investment activities (266) (148) -------- -------- Net change in cash and cash equivalents (1,672) (219) -------- -------- Cash and cash equivalents, beginning of period 5,160 5,186 -------- -------- Cash and cash equivalents, end of period $ 3,488 $ 4,967 ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS) Interest paid totaled $12,659 and $14,075 for the nine months ended August 31, 2001 and August 31, 2000, respectively. Income taxes paid totaled $570 and $308 for the nine months ended August 31, 2001 and August 31, 2000, respectively. See notes to consolidated financial statements. 7 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 incorporated by reference in the Company's Annual Report on Form 10-K for the twelve months ended November 30, 2000 (the "Form 10-K"). The Consolidated Statement of Financial Condition at November 30, 2000 was derived from the audited financial statements. The nature of the Company's business is such that the results of any interim period may vary significantly from quarter to quarter and may not be indicative of the results to be expected for the fiscal year. Certain prior period amounts reflect reclassifications to conform to the current period's presentation. 2. LONG-TERM DEBT: During the nine months ended August 31, 2001, the Company issued $8,817 million of long-term debt (all of which were senior notes). Of the total issuances during the period, $3,252 million were U.S. dollar fixed rate, $3,245 million were U.S. dollar-floating rate, $970 million were foreign currency denominated fixed rate, and $1,350 million were foreign currency denominated floating rate. These issuances were primarily utilized to refinance current maturities of long-term debt in 2001 and to increase total capital (stockholders' equity, long-term debt and preferred securities subject to mandatory redemption). The Company's floating rate new issuances contain contractual interest rates based primarily on London Interbank Offered Rates ("LIBOR"). Of the fixed rate new issuances totaling $4,222 million, $3,693 million were effectively converted to floating rate obligations through the use of interest rate swaps. Of the foreign denominated new issuances totaling $2,320 million, $969 million were effectively swapped to U.S. Dollars, with the remainder match funding foreign currency denominated capital needs. The Company had $5,665 million of long-term debt mature during the nine months ended August 31, 2001. Long-term debt at August 31, 2001, scheduled to mature within one year totaled $7,883 million. 3. CAPITAL REQUIREMENTS: The Company operates globally through a network of subsidiaries, with several being subject to regulatory requirements. In the United States, LBI, as a registered broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined. At August 31, 2001, LBI's regulatory net capital, as defined, of $1,618 million exceeded the minimum requirement by $1,512 million. 8 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered broker-dealer and subsidiary of Holdings, is subject to the capital requirements of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial resources, as defined, must exceed the total financial resources requirement of the SFA. At August 31, 2001, LBIE's financial resources of approximately $2,168 million exceeded the minimum requirement by approximately $847 million. Lehman Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the capital requirements of the Financial Services Agency and at August 31, 2001, had net capital of approximately $357 million which was approximately $174 million in excess of the specified levels required. Lehman Brothers Bank, FSB (the "Bank"), the Company's thrift subsidiary is regulated by the Office of Thrift Supervision ("OTS"). The Bank exceeds all regulatory capital requirements and is considered well capitalized by the OTS. Certain other non-U.S. subsidiaries are subject to various securities, commodities and banking regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. At August 31, 2001, these other subsidiaries were in compliance with their applicable local capital adequacy requirements. In addition, the Company's "AAA" rated derivatives subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman Brothers Derivative Products Inc. ("LBDP"), have established certain capital and operating restrictions which are reviewed by various rating agencies. At August 31, 2001, LBFP and LBDP each had capital which exceeded the requirement of the most stringent rating agency by approximately $58 million and $26 million, respectively. The regulatory rules referred to above, and certain covenants contained in various debt agreements may restrict Holdings' ability to withdraw capital from its regulated subsidiaries, which in turn could limit its ability to pay dividends to shareholders. 4. DERIVATIVE FINANCIAL INSTRUMENTS: Effective December 1, 2000, the Company adopted Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," which requires that all derivative instruments be reported on the consolidated statement of financial condition at fair value and establishes criteria for designation and effectiveness of hedging relationships. The adoption of SFAS No.133, as of December 1, 2000, did not have a material effect on the Company's consolidated statement of financial condition or the results of operations. Most of the Company's derivative transactions are entered into for trading-related activities for which the adoption of SFAS No. 133 had no impact. The Company's trading-related derivative activities are marked-to-market through earnings as a component of Principal Transactions revenues. The Company also utilizes derivatives for non-trading purposes as an end user to modify the market risk exposures of certain assets and liabilities. In this regard, the Company primarily enters into fair value hedges utilizing interest rate swaps to convert a substantial portion of the Company's fixed rate long-term debt and certain term fixed rate secured financing activities to a floating interest rate. The ineffective portion of the fair value hedges were included in "Interest Expense" on the Consolidated Statement of Income and were not material to the Company's results for the three and nine months ended August 31, 2001. Market or fair value for trading-related instruments is generally determined by either quoted market prices (for exchange-traded futures and options) or pricing models (for over-the-counter swaps, forwards and options). Pricing models utilize a series of market inputs to determine the present value of future cash flows, with adjustments, as required for credit risk 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 represent estimates of expected losses which incorporate business and economic 9 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS conditions, historical experience, concentrations, 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 of the Company's trading-related derivative activities. Assets and liabilities represent net unrealized gains (amounts receivable from counterparties) and net unrealized losses (amounts payable to counterparties), respectively.
FAIR VALUE* FAIR VALUE* AUGUST 31, 2001 NOVEMBER 30, 2000 ---------------- --------------- ----------------- --------------- (in millions) ASSETS LIABILITIES ASSETS LIABILITIES ---------------- --------------- ----------------- --------------- Interest rate and currency swaps and options (including caps, collars and floors) $ 5,121 $ 4,235 $ 4,349 $ 3,390 Foreign exchange forward contracts and options 886 1,393 902 1,361 Other fixed income securities contracts (including options and TBAs) 808 857 496 418 Equity contracts (including equity swaps, warrants and options) 6,454 4,916 3,836 3,399 ------- ------- ------- ------- TOTAL $13,269 $11,401 $ 9,583 $ 8,568 ------- ------- ------- -------
* 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 represent the Company's net receivable/payable for derivative financial instruments before consideration of collateral. Included within the $13,269 million fair value of assets at August 31, 2001 was $10,894 million related to swaps and other OTC contracts and $2,375 million related to exchange-traded option and warrant contracts. Included within the $9,583 million fair value of assets at November 30, 2000 was $8,643 million related to swaps and other OTC contracts and $940 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 $6,662 million at August 31, 2001, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral. Presented below is an analysis of the Company's net credit exposure at August 31, 2001 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. COUNTERPARTY S&P/MOODY'S NET CREDIT RISK RATING EQUIVALENT EXPOSURE ----------- ---------- -------- 1 AAA/Aaa 16 % 2 AA-/Aa3 or higher 26 % 3 A-/A3 or higher 35 % 4 BBB-/Baa3 or higher 18 % 5 BB-/Ba3 or higher 3 % 6 B+/B1 or lower 2 % 10 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, exchange clearinghouses require counterparties to futures contracts to post margin upon the origination of all contracts and for any changes in the market value of the contracts 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, incorporated by reference in the Form 10-K. 5. SECURITIZATIONS: The Company is a market leader in the mortgage- and asset-backed securitization market. In connection with these activities, the Company securitizes commercial and residential mortgages, home equity loans, government and corporate bonds, and lease and trade receivables. Lehman Brothers may retain an interest in the financial assets it securitizes ("Retained Interests") which may include assets in the form of residual interests or one or more subordinate tranches. The Company records its Securities and Other Financial Instruments Owned, including Retained Interests, at fair value, with changes in fair value reported in earnings. Fair value is determined based upon listed market prices, if available. Where listed market prices are not available, fair value is determined based on other relevant factors, including broker or dealer price quotations and valuation pricing models which take into account time value and volatility factors underlying the financial instruments, among other factors. Retained interests in securitized assets were not material as of August 31, 2001. During the third quarter of 2001, the Company securitized approximately $21.6 billion of financial assets. 6. OTHER COMMITMENTS AND CONTINGENCIES: In connection with its financing activities, the Company had outstanding commitments under certain collateralized lending arrangements of approximately $2.6 billion, $3.5 billion and $3.2 billion at August 31, 2001, May 31, 2001 and November 30, 2000, respectively. These commitments require borrowers to provide acceptable collateral, as defined in the agreements, when amounts are drawn under the lending facilities. Advances made under the above lending arrangements are typically at variable interest rates and generally provide for over-collateralization based upon the borrowers' creditworthiness. In addition, 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 $5.9 billion, $5.6 billion and $4.4 billion at August 31, 2001, May 31, 2001 and November 30, 2000, respectively. In addition, lending commitments to high yield borrowers totaled $1.5 billion, $1.3 billion and $1.3 billion at August 31, 2001, May 31, 2001 and November 30, 2000, 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. 11 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At August 31, 2001 and November 30, 2000, the Company had commitments to invest up to $569 million and $357 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 the normal course of its business, the Company has been named a defendant in a number of lawsuits and other legal proceedings. Although there can be no assurances as to the ultimate outcome, the Company has denied, or believes it has a meritorious defense and will deny, liability in all significant cases pending against it, and intends to defend vigorously each such case, and based on information currently available, the Company believes that the eventual outcome of the actions against it will not, in the aggregate, have a material adverse effect on the consolidated financial position or results of operations of the Company. At August 31, 2001, the net fair value of securities received as collateral that have not been sold or repledged totaled approximately $5 billion. The gross fair value of securities received as collateral where the Company was permitted to sell or repledge the securities was approximately $225 billion. Of this collateral, approximately $220 billion has been sold or repledged, generally as collateral under repurchase agreements or to cover securities and other financial instruments sold but not yet purchased. 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, incorporated by reference in the Form 10-K. 7. SEGMENTS: The Company operates in three 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. 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 derivative products. The Capital Markets Division also includes the Company's risk arbitrage and secured financing businesses, as well as realized and unrealized gains and losses related to the Company's interests in private equity investments. The financing businesses manage the Company's equity and fixed income matched book activities, supply secured financing to institutional clients and customers, and provide secured funding for the Company's inventory of equity and fixed income products. 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 12 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS asset management fees earned from these clients. Private equity revenues include the management and incentive fees earned in the Company's role as general partner for twenty-five private equity partnerships. The Company's segment information for the three and nine months ended August 31, 2001 and August 31, 2000 is presented below and was developed consistent with the accounting policies used to prepare the Company's consolidated financial statements.
Three Months Ended Nine Months Ended ------------------------------- ------------------------------- August 31 August 31 August 31 August 31 (in millions) 2001 2000 2001 2000 ------------- -------------- -------------- -------------- Investment Banking: Net Revenue $ 460 $ 571 $1,482 $1,635 ====== ====== ====== ====== Earnings before taxes (1) $ 79 $ 143 $ 272 $ 381 ====== ====== ====== ====== Segment assets (billions) $ 1.4 $ 1.1 $ 1.4 $ 1.1 ====== ====== ====== ====== Capital Markets: Net Revenue $ 965 $1,282 $3,447 $3,703 ====== ====== ====== ====== Earnings before taxes (1) $ 298 $ 471 $1,214 $1,412 ====== ====== ====== ====== Segment assets (billions) $237.1 $219.0 $237.1 $219.0 ====== ====== ====== ====== Client Services: Net Revenue $ 203 $ 199 $ 604 $ 671 ====== ====== ====== ====== Earnings before taxes (1) $ 58 $ 59 $ 147 $ 232 ====== ====== ====== ====== Segment assets (billions) $ 4.8 $ 5.6 $ 4.8 $ 5.6 ====== ====== ====== ====== Total: Net Revenue $1,628 $2,052 $5,533 $6,009 ====== ====== ====== ====== Earnings before taxes (1) $ 435 $ 673 $1,633 $2,025 ====== ====== ====== ====== Segment assets (billions) $243.3 $225.7 $243.3 $225.7 ====== ====== ====== ======
(1) And before dividends on preferred securities. The following are net revenues by geographic region:
Three Months Ended Nine Months Ended ------------------------------- ------------------------------- August 31 August 31 August 31 August 31 (in millions) 2001 2000 2001 2000 ------------- -------------- -------------- -------------- Americas $ 1,084 $ 1,274 $ 3,618 $ 3,416 Europe 430 630 1,498 1,900 Asia Pacific and other 114 148 417 693 ------- ------- ------- ------- Total $ 1,628 $ 2,052 $ 5,533 $ 6,009 ======= ======= ======= =======
The following information describes the Company's methods of allocating consolidated net revenues to geographic regions. Net revenues, if syndicate, trading or sales related, have been allocated 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. In addition, certain revenues associated with domestic products and services which resulted from relationships with international clients and customers have 13 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS been reclassified as international revenues using an allocation consistent with the Company's internal reporting. 8. COMMON STOCK: In April 2001, the Company's shareholders' approved the adoption of an amendment to the Company's Restated Certificate of Incorporation to increase the aggregate number of authorized shares of common stock from 300 million to 600 million. 9. INCENTIVE PLANS: During the third quarter, the Company delivered 8.2 million shares of its common stock to current and former employees in satisfaction of RSUs awarded in 1996. Substantially all of the shares delivered were funded from the Company's irrevocable grantor trust for restricted stock units (the "RSU Trust"). The Company increased additional paid-in capital by approximately $236 million for the tax effect of the appreciation in the Company's stock price from the grant date to the delivery date. The Company received 2.6 million shares from current and former employees in satisfaction of applicable tax withholding requirements. Shares received were recorded as treasury stock at an aggregate value of $205 million. At August 31, 2001 and November 30, 2000, 46.3 million and 42.4 million shares were held in the RSU Trust, respectively. 10. EARNINGS PER COMMON SHARE: Earnings per share was calculated as follows (in millions, except for per share data):
Three Months Ended Nine Months Ended ------------------------------- ------------------------------- Aug. 31 Aug. 31 Aug. 31 Aug. 31 2001 2000 2001 2000 -------------- ------------- -------------- ------------- NUMERATOR: Net income $ 309 $ 457 $1,125 $1,376 Preferred stock dividends (11) (13) (84) (83) ------- ------- ------ ------ Numerator for basic earnings per share- income available to common stockholders 298 444 1,041 1,293 Convertible preferred stock dividends -- 2 -- 6 ------- ------- ------ ------ Numerator for diluted earnings per share- income available to common stockholders (adjusted for assumed conversion of preferred stock) $ 298 $ 446 $1,041 $1,299 ======= ======= ====== ====== DENOMINATOR: Denominator for basic earnings per share- weighted-average shares 240.4 242.3 243.5 245.3 Effect of dilutive securities: Employee stock options 15.8 14.9 16.5 12.2 Employee restricted stock units 5.6 5.4 6.3 4.7 Preferred shares assumed converted into common -- 2.4 -- 2.4 ------- ------- ------ ------ Dilutive potential common shares 21.4 22.7 22.8 19.3 ------- ------- ------ ------ Denominator for diluted earnings per share - adjusted weighted-average shares 261.8 265.0 266.3 264.6 ======= ======= ====== ====== BASIC EARNINGS PER SHARE $ 1.24 $ 1.83 $ 4.28 $ 5.27 ======= ======= ====== ====== DILUTED EARNINGS PER SHARE $ 1.14 $ 1.68 $ 3.91 $ 4.91 ======= ======= ====== ======
14 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For August 31, 2000, Convertible Voting Preferred outstanding shares were convertible into common shares at a conversion price of approximately $61.50 per share. For purposes of calculating diluted earnings per share, these preferred shares were assumed to be converted into common shares since basic earnings per share exceeded preferred dividends per share obtainable upon conversion ($0.77 on a quarterly basis). During December 2000, the Company redeemed all outstanding Convertible Voting Preferred shares. 11. SUBSEQUENT EVENTS: As a result of damage sustained from the September 11, 2001, terrorist attacks on the World Trade Center in New York, the Company's workforce located in the World Financial Center complex and the World Trade Center was displaced. Key business activities and necessary support functions were quickly relocated to the Company's back-up facilities in Jersey City, New Jersey, and to various other temporary sites. The Company has been informed that its offices in the World Financial Center complex can be repaired, although no timetable has yet been established for completion. In October 2001, the Company signed a letter of intent to acquire a new one million square foot building at 745 Seventh Avenue in New York City. The Company intends to relocate its principal executive offices to this site. The displacement and relocation of the Company's workforce, the closure of certain markets for certain periods following the terrorist attacks and other issues directly related to the September 11th tragedy have impacted the Company's business and may affect the business for the fourth quarter. The Company has substantial insurance in place covering the loss of its offices at the World Trade Center and damages to facilities at the World Financial Center complex, as well as for losses resulting from business interruption and for extra expenses associated with the Company's temporary relocation efforts. 15 ITEM 2. LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS ENVIRONMENT The principal business activities of Lehman Brothers Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or "Lehman Brothers") are investment banking and securities trading and sales, which by their nature are subject to volatility, primarily due to changes in interest and foreign exchange rates and security valuations, global economic and political trends and industry competition. As a result, revenues and earnings may vary significantly from quarter to quarter and from year to year. The September 11, 2001, terrorist attacks on the World Trade Center and the Pentagon caused securities market and other business closures and disruptions and forced the Company to temporarily relocate its New York headquarters and operations. The terrorist attacks, the allied military response and subsequent developments may impact the global economy. All of these factors may affect the Company's future results of operations. In October of 2001, Lehman Brothers signed a letter of intent to acquire a new building at 745 Seventh Avenue in New York City, which contains approximately one million square feet of space and is not expected to be ready for occupancy until sometime in fiscal 2002. The Company intends to relocate its principal executive offices to this site. Marketplace uncertainties experienced in the second half of 2000 and the first half of 2001 continued into the third quarter of 2001 as lower corporate profits and a slower pace of economic growth resulted in generally weak market conditions. In response to these conditions, the Federal Reserve lowered interest rates twice during the fiscal third quarter bringing the Federal Funds rate to 3.5%. Total reductions in the federal funds rates for the first nine months of 2001 have totaled 300 basis points. In September, the Federal Reserve lowered interest rates an additional half of a percentage point shortly following the terrorist attacks on the World Trade Center and the Pentagon in order to make funds more accessible to consumers, and boost consumer confidence and the economy. In October, the Federal Reserve again cut the Federal Funds rate another 50 basis points bringing the overnight bank lending rates to their lowest levels in nearly 40 years. During the quarter, all of the major U.S. equity indices declined as a result of the poor economic conditions. The Dow Jones Industrial Average ("DJIA") finished the quarter at 9,950, down 9% from the end of the fiscal second quarter. The NASDAQ decreased 14% during the fiscal third quarter and the S&P 500 ended down 10% from the end of the fiscal second quarter. In first week of resumed trading following the terrorist attacks, the DJIA and the NASDAQ declined 14% and 16%, respectively. By mid-October, however, both indices had recovered from those levels. Globally, other world markets experienced the same slowing of economic growth and recessionary fears which resulted in declines in equity market indexes. The FTSE 100 decreased 8% during the quarter while the DAX decreased 15%. In Asia, the Nikkei was down almost 20%, resulting in a 17-year low. To attempt to alleviate the economic slowdown, the Bank of England and the European Central Bank both cut interest rates 25 basis points during the fiscal quarter. For the European Central Bank, this was the second consecutive quarter the bank cut rates 25 basis points. For the Bank of England, this was the third consecutive quarter with a 25 basis points cut. Consistent with the action of the U.S. Federal Reserve, major central banks throughout the world also made additional cuts to their respective discount rates subsequent to quarter-end to help spur the global economy, stabilize the markets and boost consumer confidence. In the equity origination markets, global new issuance volume for the fiscal third quarter of 2001 was down slightly from the fiscal second quarter of 2001 and down approximately 20% from the year-ago period as equity markets continued to feel the affects of the uncertain economic outlook. Market volume for initial public offerings ("IPOs") was down 45% when compared to the third quarter of 2000. For the 16 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS first nine fiscal months of 2001 equity origination market volume was down 26% and IPO market volumes were down approximately 60% compared to the first nine fiscal months of 2000, according to Thompson Financial Securities Data Corp ("TFSD"). Fixed income markets, however, continued to benefit from declining interest rates. Global debt new issuances, which were strong during the first half of 2001, continued this pace into the third quarter of 2001. Activity was bolstered globally by interest rate cuts by many central banks as absolute rates continued to be very attractive for borrowing companies. Reflecting this improving market, debt new issuances and high yield new issuances for the quarter were both up 15% over last year's fiscal third quarter and both up over 30% over the fiscal first nine months of 2000, according to TFSD. The value of merger and acquisition advisory activity slowed significantly during the third quarter when compared to the same period a year-ago. Worldwide completed mergers and acquisitions for the fiscal third quarter of 2001 decreased almost 60% when compared to the fiscal third quarter of 2000, according to TFSD. In addition, "deal announcements" industry-wide decreased over 50% when compared to the fiscal third quarter of 2000. -------------------------------------------------------------------------------- SOME OF THE STATEMENTS CONTAINED IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, INCLUDING THOSE RELATING TO THE COMPANY'S STRATEGY AND OTHER STATEMENTS THAT ARE PREDICTIVE IN NATURE, THAT DEPEND UPON OR REFER TO FUTURE EVENTS OR CONDITIONS OR THAT INCLUDE WORDS SUCH AS "EXPECTS," "ANTICIPATES," "INTENDS," "PLANS," "BELIEVES," "ESTIMATES" AND SIMILAR EXPRESSIONS, ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. THESE STATEMENTS ARE NOT HISTORICAL FACTS BUT INSTEAD REPRESENT ONLY THE COMPANY'S EXPECTATIONS, ESTIMATES AND PROJECTIONS REGARDING FUTURE EVENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE CERTAIN RISKS AND UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT, WHICH MAY INCLUDE MARKET, CREDIT OR COUNTERPARTY, LIQUIDITY, LEGAL AND OPERATIONAL RISKS. MARKET RISKS INCLUDE CHANGES IN INTEREST AND FOREIGN EXCHANGE RATES AND SECURITIES VALUATIONS, GLOBAL ECONOMIC AND POLITICAL TRENDS AND INDUSTRY COMPETITION. THE COMPANY'S ACTUAL RESULTS AND FINANCIAL CONDITION MAY DIFFER, PERHAPS MATERIALLY, FROM THE ANTICIPATED RESULTS AND FINANCIAL CONDITION IN ANY SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. 17 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 The Company reported net income of $309 million for the quarter ended August 31, 2001, a decrease of 32% from the third quarter of 2000. Net revenues for the third quarter of 2001 were $1,628 million and earnings per common share (diluted) were $1.14. Pre-tax operating margin for the third quarter was 26.7% and return on equity was 16.2%. These relatively strong results during an extremely difficult market environment demonstrate the growing breadth and depth of the franchise. The Company continues to maintain its discipline toward managing expenses, risk and liquidity as well as capital deployment and utilization. For the quarter, non-personnel expenses remained relatively flat from the second quarter of 2001 and increased 16% from the third quarter of 2000, as compared to a 26% increase in headcount since the third quarter of 2000. The Company is segregated into the following three business segments (each of which is described below): 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 and high-net-worth retail clients which are recognized across the different revenue categories contained in the Company's Consolidated Statement of Income. (Net revenues by segment also contain certain internal allocations, including funding costs, which are centrally managed.) THREE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 -------------------------------------------------------------------- Net Revenues (in millions) for the Three Months Ended ------------------------------ August 31 August 31 2001 2000 -------------- --------------- Investment Banking $ 460 $ 571 Capital Markets 965 1,282 Client Services 203 199 -------------- --------------- Total $ 1,628 $ 2,052 ============== =============== -------------------------------------------------------------------- 18 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides an analysis of the Company's net revenues. 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, and advising clients on merger and acquisition activities and other services. Investment Banking's net revenues decreased 19% during the third quarter to $460 million from $571 million in the third quarter of 2000, as strong fixed income underwriting activity was more than offset by decreases in equity origination and merger and acquisition activity. ------------------------------------------------------ INVESTMENT BANKING NET REVENUES ------------------------------------------------------ Three Months Ended Aug. 31 Aug. 31 (in millions) 2001 2000 ------------------------------------------------------ Debt Underwriting $ 228 $ 150 Equity Underwriting 101 194 Merger and Acquisition Advisory 131 227 ------------------------------------------------------ $ 460 $ 571 ------------------------------------------------------ Debt underwriting revenues totaled $228 million for the third quarter of 2001, a 52% increase over last year's third quarter. Fixed income origination benefited this quarter as issuers continued to move to raise lower-coupon long-term debt to replace short-term financing. Also contributing to these results was an increase in the Company's global market share for debt origination, which grew to 6.7% for the fiscal third quarter from 5.9% for calendar year 2000, according to TFSD. Equity origination revenues were down 48% compared to the year-ago period, as industry-wide equity underwriting declined. However, during the quarter the Company continued to grow its equity underwriting market share. Global equity origination volume share increased more than 60% to 5.4% through August 31, 2001 year-to-date versus calendar year 2000, according to TFSD. Merger and acquisition advisory fees, essentially flat compared to the second quarter of 2001 fees of $128, decreased 42% compared to last year's third quarter as industry-wide volumes for completed deals decreased almost 60%. CAPITAL MARKETS This segment's net revenues reflect institutional flow activities and secondary trading and financing activities related to fixed income and equity products. These products include a wide range of cash, derivative, secured financing and structured instruments. Capital Markets' net revenues were $965 million for the third quarter of 2001, down 25% from the third quarter of 2000 as strong fixed income results were more than offset by lower equities revenues. Overall, the Company continued to have strong institutional customer flow activity across a wide range of products. This customer flow business provides the Company with a relatively stable form of revenues as customers continually rebalance their portfolios across market cycles with the full array of capital market products that are provided by the Company. ------------------------------------------------------ CAPITAL MARKETS NET REVENUES ------------------------------------------------------ Three Months Ended Aug. 31 Aug. 31 (in millions) 2001 2000 ------------------------------------------------------ Fixed Income $ 663 $ 557 Equities 302 725 ------------------------------------------------------ $ 965 $ 1,282 ------------------------------------------------------ Net revenues from the fixed income component of Capital Markets increased 19% from the third quarter of 2000 to $663 million, principally driven by a strong level of institutional customer flow activity. Central bank easings prompted lower rates, which led to higher volumes across almost all fixed income 19 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS products. Areas that benefited the most from the strength in institutional customer flow included mortgages, governments, high-grade debt and municipals. Net revenues from the equity component of Capital Markets were $302 million in the third quarter of 2001, down significantly from the third quarter of 2000. This decrease was driven by difficult market conditions, a slowdown in the growth of the U.S. economy, a decrease in market volatility and declines in revenues from both private equity and risk arbitrage investments from year-ago levels. 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 twenty-five private equity partnerships. Client Services' net revenues were $203 million in the third quarter of 2001 up slightly from the third quarter of 2000. Although retail market activity declined significantly during the quarter, the high-net-worth sector in which the Company operates was less affected. For the third quarter, high-net-worth sales declined only 8% compared to the third quarter of 2000, driven primarily by weak equity markets. Partially offsetting this decline was record fixed income activity, as investors adjusted their portfolios to compensate for the volatile equity market environment. Private equity revenues more than doubled from the year-ago period due principally to a $20 million incentive fee recognized from the Company's general partner interest in a single Merchant Banking investment. ------------------------------------------------------ CLIENT SERVICES NET REVENUES ------------------------------------------------------ Three Months Ended Aug. 31 Aug. 31 (in millions) 2001 2000 ------------------------------------------------------ Private Client $171 $186 Private Equity 32 13 ------------------------------------------------------ $203 $199 ------------------------------------------------------ Non-Interest Expenses Non-interest expenses were $1,193 million for the third quarter of 2001 compared to $1,379 million for the third quarter of 2000. Compensation and benefits expense, as a percentage of net revenues was 51% for the quarter, consistent with the Company's fiscal 2000 level. Non-personnel expenses were $363 million for the third quarter of 2001 compared to $312 million for the third quarter of 2000 and flat compared to the second quarter of 2001. The increase in non-personnel expenses is less than the 26% increase in headcount from the third quarter of 2000 and reflects the Company's continued investment in technology and increased occupancy costs offset by firmwide savings initiatives. Income Taxes The Company's income tax provision was $112 million for the third quarter of 2001 versus $202 million for the third quarter of 2000. The effective tax rate was 25.8% for the third quarter of 2001 compared to the third quarter of 2000 tax rate of 30.0%. The decrease in the tax rate reflects a greater impact of tax preference revenues on a lower pre-tax income base. 20 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 The Company reported net income of $1,125 million for the nine months ended August 31, 2001, a decrease of 18% from the nine months ended August 31, 2000. Earnings per common share (diluted) were $3.91 for the nine months of 2001 compared to $4.91 for the comparable period in 2000. Earnings per share computations for both periods include the impact of the annual $50 million dividend on the Company's Redeemable Voting Preferred Stock paid in the second quarter. (The last such dividend will be payable in 2002, prorated for the partial year from December 2001 through May 2002.) These results reflect the Company's continued ability to execute its strategy of growing its high margin investment banking and equities businesses; increasing its presence in certain strategic businesses in Europe; and, at the same time, maintaining a strict discipline with regard to its expenses, all during a very difficult market environment. Net revenues were $5,533 million for the first nine months of 2001 compared to $6,009 million for the first nine months of 2000. Pre-tax operating margin was approximately 30% through the end of the third quarter of 2001 and return on equity (excluding the impact of the $50 million in dividends on the Company's Redeemable Voting Preferred Stock) was 20% for the same period. Non-interest expenses decreased 2% in the first nine months of 2001 compared to the first nine months of 2000, and the Company's compensation and benefits ratio decreased to 51% of net revenues from 52% for the comparable period a year ago. 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.) ------------------------------------------------------------------- Net Revenues for the (in millions) Nine Months Ended ------------------------------------ August 31 August 31 2001 2000 ----------------- --------------- Investment Banking $ 1,482 $ 1,635 Capital Markets 3,447 3,703 Client Services 604 671 ----------------- --------------- Total $ 5,533 $ 6,009 ================= =============== ------------------------------------------------------------------- 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 and advising clients on merger and acquisition activities and other services. Investment Banking's net revenues of $1,482 million decreased 9% in the first nine months of 2001 when compared to $1,635 million for the first nine months of 2000. The decrease was primarily due to a decrease in equity underwriting and merger and acquisition advisory revenues partially offset by strong results in debt underwriting. 21 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Debt underwriting revenues increased 61% to $676 million in the first nine months of 2001 from $419 million for the first nine months of 2000. The increase was primarily due to an increase in fixed income issuances combined with a increase in the Company's market share to 6.7% for the first nine months of fiscal 2001 compared to 5.9% for calendar year 2000, according to TFSD. ------------------------------------------------------ INVESTMENT BANKING NET REVENUES ------------------------------------------------------ Nine Months Ended Aug. 31 Aug. 31 (in millions) 2001 2000 ------------------------------------------------------ Debt Underwriting $ 676 $ 419 Equity Underwriting 364 682 Merger and Acquisition Advisory 442 534 ------------------------------------------------------ $1,482 $1,635 ------------------------------------------------------ Equity underwriting revenues were $364 million for the first nine months of 2001 compared to $682 million for the first nine months of 2000. Although the Company's market share for the first nine months of 2001 was up over 12% from the year-ago period, according to TFSD, results decreased as industry-wide equity underwriting activities were down over 25%. Merger and acquisition advisory revenues for the first nine months of 2001 decreased 17% when compared to the first nine months of 2000 driven by a 32% industry-wide decrease in completed market volume. CAPITAL MARKETS This segment's net revenues reflect institutional flow activities and secondary trading and financing activities related to fixed income and equity products. These products include a wide range of cash, derivative, secured financing and structured instruments. Capital Markets' net revenues were $3,447 million for the first nine months of 2001, down 7% from the first nine months of 2000, as an extremely weak market environment was partially offset by strong institutional customer flow activity. ------------------------------------------------------ CAPITAL MARKETS NET REVENUES ------------------------------------------------------ Nine Months Ended Aug. 31 Aug. 31 (in millions) 2001 2000 ------------------------------------------------------ Fixed Income $1,849 $1,403 Equities 1,598 2,300 ------------------------------------------------------ $3,447 $3,703 ------------------------------------------------------ Net revenues from the fixed income component of Capital Markets increased to $1,849 million for the first nine months of 2001 compared to $1,403 million for the first nine months of 2000. These record results were driven by strong institutional customer flow activity as clients moved into interest-rate based products. Net revenues from the equity component of Capital Markets decreased 31% to $1,598 million for the first nine months of 2001 compared to $2,300 million for the first nine months of 2000. This decrease was driven by reduced volatility levels versus the same period last year, spread compression beginning in the second quarter of 2001 from NASDAQ decimalization and declines in revenues from both private equity and risk arbitrage investments from year-ago levels, partially offset by stronger results in institutional customer flow activity and convertible securities. 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 in its private equity partnerships. 22 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Client Services' net revenues were $604 million for the first nine months of 2001 compared to $671 million for the first nine months of 2000. Excluding a special performance-based asset management fee of $73 million in the year-ago period, Client Services' results improved slightly as the Company's high-net-worth retail sales force continued to produce strong results despite the weak equity market environment. In addition, private equity revenues increased from the year-ago period primarily due to a $20 million incentive fee recognized from the Company's general partner interest in a single Merchant Banking investment. ------------------------------------------------------ CLIENT SERVICES NET REVENUES ------------------------------------------------------ Nine Months Ended Aug. 31 Aug. 31 (in millions) 2001 2000 ------------------------------------------------------ Private Client $546 $638 Private Equity 58 33 ------------------------------------------------------ $604 $671 ------------------------------------------------------ Non-Interest Expenses Non-interest expenses were $3,900 million for the first nine months of 2001 and $3,984 million for the comparable period of 2000. Compensation and benefits expense as a percentage of net revenues decreased to 51%, which is consistent with the Company's fiscal 2000 level. Non-personnel expenses were $1,078 million for the first nine months of 2001 and $859 million for the first nine months of 2000, an increase of approximately 25% reflecting the Company's strategic growth plan and the 26% increase in headcount. Income Taxes The Company's income tax provision was $466 million for the nine months of 2001 compared to $607 million for the nine months of 2000. The effective tax rate was 28.5% for the first nine months of 2001 compared to 30.0% for the first nine months of 2000. The decrease in the effective tax rate relates to an increase in tax preference revenues on a lower level of pre-tax income. 23 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY, FUNDING AND CAPITAL RESOURCES Liquidity Risk Management Liquidity risk management is of critical importance to the Company, providing a framework which seeks to ensure that the Company maintains sufficient liquid financial resources to continually fund its balance sheet and meet all of its funding obligations in all market environments. The Company's liquidity framework has been structured so that even in a severe liquidity event the balance sheet does not have to be reduced purely for liquidity reasons (although we may choose to do so for risk reasons). This allows the Company to continue to maintain its customer franchise and debt ratings during a liquidity event. The Company's liquidity management philosophy incorporates the following principles: o Liquidity providers are credit and market sensitive. Consequently, firms must be in a state of constant liquidity readiness. o Firms should not rely on asset sales to generate cash or believe that they can increase unsecured borrowings or funding efficiencies in a liquidity crisis. o During a liquidity event, certain secured lenders may require higher quality collateral. Firms must therefore not over-estimate the availability of secured financing, and must fully integrate their secured and unsecured funding strategies. o The firm's legal entity structure may constrain liquidity. Regulatory requirements can restrict the flow of funds between regulated and unregulated group entities and this must be accounted for in liquidity planning. The Company's Funding Framework incorporates these principles and mitigates liquidity risk whenever possible. This Framework comprises four major components: (1) The Cash Capital Model - which evaluates the amount of long-term liabilities - with remaining maturities of over one year - that are required to fund the Company. (2) The Reliable Secured Funding Model - which forecasts the reliable sources of overnight secured funding available to the Company. (3) The Maximum Cumulative Outflow - which estimates the size of the added liquidity requirement necessary to fund contingent cash outflows expected from a stress environment. (4) The Contingency Funding Plan - which represents a detailed action plan to manage a stress liquidity event within the Company. For further discussion of these principles refer to the Liquidity, Funding and Capital Resources section of Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in the Form 10-K. As a consequence of implementing its Funding Framework, the Company has generally shifted to longer term funding over the past several years. As a result, the Company has reduced its reliance on short-term unsecured debt, which represents only 3% of adjusted total assets and 10% of total debt. 24 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Total Capital Total Capital (defined as long-term debt, preferred securities subject to mandatory redemption and stockholders' equity) was $48.2 billion at August 31, 2001 compared to $43.9 billion at November 30, 2000. The net increase in Total Capital resulted from a net increase in long-term debt, the retention of earnings and amortization associated with RSU awards. These were partially offset by repurchases of common stock (to fund employee share awards) and the redemption of the Cumulative Convertible Voting Preferred Stock for $150 million. Aug. 31 Nov. 30 (in millions) 2001 2000 ------------------------------------------------------------------ LONG-TERM DEBT Senior Notes $ 36,402 $ 32,106 Subordinated Indebtedness 2,934 3,127 ------------ ------------- 39,336 35,233 PREFERRED SECURITIES 710 860 STOCKHOLDERS' EQUITY Preferred Equity 700 700 Common Equity 7,411 7,081 ------------ ------------- 8,111 7,781 ------------------------------------------------------------------ TOTAL CAPITAL $ 48,157 $ 43,874 ------------------------------------------------------------------ As a result of the favorable interest rate and credit spread environment, the Company issued $8.8 billion in long-term debt, which was $3.2 million in excess of maturing debt, during the first nine months of 2001. Long-term debt increased to $39.3 billion at August 31, 2001 from $35.2 billion at November 30, 2000, with a weighted-average maturity of 3.8 years at both August 31, 2001 and November 30, 2000. 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 $1 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. During the second quarter of 2001, the Company elected to reduce the committed amount under the Credit Agreement to $1 billion from $2 billion. The reduction reflects the Company's belief that its liquidity position is stronger as a result of the implementation of the Funding Framework, and the Company's desire to utilize its credit in forms that are more suitable to its needs. In July 2000, the Company entered into a $1 billion Committed Securities Repurchase Facility (the "Facility") for LBIE, the Company's major operating entity in Europe. The Facility provides secured multicurrency 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 25 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 $243.3 billion at August 31, 2001 from $224.7 billion at November 30, 2000. 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 $156.4 billion at August 31, 2001 compared to $143.5 billion at November 30, 2000. 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 fixed income securities, particularly mortgages and corporate debt, associated with increased customer flow activities within the Capital Markets business. 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. 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 preferred securities subject to mandatory redemption. 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 was 17.7x and 16.6x as of August 31, 2001 and November 30, 2000, respectively. Consistent with maintaining a single A credit rating, the Company targets an adjusted leverage ratio of under 20x. The Company continued to operate below this targeted level. Due to the nature of the Company's Capital Markets sales and trading activities, the overall size of the Company's balance sheet fluctuates from time to time, and at specific points in time may be higher than the fiscal quarter ends. CREDIT RATINGS The Company, like other companies in the securities industry, relies on external sources to finance a significant portion of its day-to-day operations. The Company's access to and cost of funding is generally dependent upon its short- and long-term debt ratings. On June 20, 2001, Fitch IBCA, Inc. upgraded Holdings long-term senior debt from A to A+. Fitch also upgraded LBI's senior debt from A to A+ and its subordinated debt from A- to A. As of August 31, 2001 the short- and long-term debt ratings of Holdings and LBI were as follows: Holdings LBI ----------------------- ------------------------- Short-term Long-term Short-term Long-term** ------------------------------------------------- ------------------------- Fitch IBCA, Inc. F-1 A+ F-1 A+/A Moody's P-1 A2 P-1 A1*/A2 Standard & Poor's Corp. A-1 A A-1 A+*/A * Provisional ratings on shelf registration ** Senior/subordinated 26 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OTHER The Company underwrites, trades, invests and makes markets in high yield corporate debt securities. The Company also syndicates, trades and invests in loans to below investment grade-rated companies. For purposes of this discussion, high yield debt instruments are defined as securities or loans to companies rated BB+ or lower, or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans which, in the opinion of management, are non-investment grade. Non-investment grade securities generally involve greater risks than investment grade securities due to the issuer's creditworthiness and the liquidity of the market for such securities. In addition, these issuers have higher levels of indebtedness, resulting in an increased sensitivity to adverse economic conditions. The Company recognizes these risks and aims to reduce market and credit risk through the diversification of its products and counterparties. High yield debt instruments are carried at fair value, and unrealized gains or losses for these securities are recognized in the Company's Consolidated Statement of Income. Such instruments at August 31, 2001 and November 30, 2000 included long positions exposure with an aggregate market value of approximately $3.4 billion and $3.5 billion, respectively, and short positions with an aggregate market value of approximately $993 million and $745 million, respectively. The Company mitigates its aggregate and single-issuer net exposure through the use of derivatives, sole-recourse securitization financing and other financial instruments. Additional information about the Company's high yield securities and lending activities, including related commitments, can be found in Note 6 to the Consolidated Financial Statements (Other Commitments and Contingencies). The Company has investments in twenty-five private equity partnerships, for which the Company acts as general partner, as well as related direct investments. At August 31, 2001, the Company's private equity related investments were $811 million. The Company's policy is to carry its investments, including the appreciation of its general partnership interests, at fair value based upon the Company's assessment of the underlying investments. Additional information about the Company's private equity activities, including related commitments, can be found in Note 6 to the Consolidated Financial Statements (Other Commitments and Contingencies). For a discussion of the Company's use of derivative instruments and the risks related thereto, see Note 4 to the Consolidated Financial Statements (Derivative Financial Instruments) and the Off-Balance Sheet Financial Instruments and Derivatives section of Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in the Form 10-K. RISK MANAGEMENT As a leading global investment banking company, risk is an inherent part of the Company's businesses. Global markets, by their nature, are prone to uncertainty and subject participants to a variety of risks. The Company has developed policies and procedures to identify, measure and monitor each of the risks involved in its trading, brokerage and investment banking activities on a global basis. The principal risks of Lehman Brothers are market, credit, liquidity, legal and operational risks. Risk Management is considered to be of paramount importance. Consequently, the Company devotes significant resources across all of its worldwide trading operations to the measurement, management and analysis of risk, including investments in personnel and technology. 27 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company seeks to reduce risk through the diversification of its businesses, counterparties and activities in geographic regions. The Company accomplishes this objective by allocating the usage of capital to each of its businesses, establishing trading limits for individual products and traders and setting credit limits for individual counterparties, including regional concentrations. The Company seeks to achieve adequate returns from each of its businesses commensurate with the risks that they assume. Overall risk management policy is established by a Risk Management Committee (the "Committee") comprised of the Chief Executive Officer, the Global Risk Manager, the Chief Financial Officer, the Chief Administrative Officer, and the Heads of Capital Markets and Investment Banking. The Committee brings together senior management with the sole intent of discussing risk-related issues and provides an effective forum for managing risk at the highest levels within the Company. The Committee meets on a monthly basis, or more frequently if required, to discuss, among other matters, significant market exposures, concentrations of positions (e.g., counterparty, market risk), potential new transactions or positions and risk limit exceptions. The Global Risk Management Group (the "Group") supports the Committee, is independent of the trading areas and reports directly to the Chief Executive Officer. The Group combines two departments, credit risk management and market risk management, into one unit. This facilitates the analysis of counterparty credit and market risk exposures and leverages personnel and information technology resources in a cost-efficient manner. The Group maintains staff in each of the Company's regional trading centers and has daily contact with trading staff at all levels within the Company. These discussions include a review of trading positions and risk exposures. Credit Risk Credit risk represents the possibility that a counterparty will be unable to honor its contractual obligations to the Company. Credit risk management is therefore an integral component of the Company's overall risk management framework. The Credit Risk Management Department ("CRM Department") has global responsibility for implementing the Company's overall credit risk management framework. The CRM Department manages the credit exposure related to trading activities by giving initial credit approval for counterparties, establishing credit limits by counterparty, country and industry group and by requiring collateral in appropriate circumstances. In addition, the CRM Department strives to ensure that master netting agreements are obtained whenever possible. The CRM Department also considers the duration of transactions in making its credit decisions, along with the potential credit exposure for complex derivative transactions. The CRM Department is responsible for the continuous monitoring and review of counterparty credit exposure and creditworthiness and recommending valuation adjustments where appropriate. Credit limits are reviewed periodically to ensure that they remain appropriate in light of market events or the counterparty's financial condition. Market Risk Market risk represents the potential change in value of a portfolio of financial instruments due to changes in market rates, prices and volatilities. Market risk management also is an essential component of the Company's overall risk management framework. The Market Risk Management Department ("MRM Department") has global responsibility for implementing the Company's overall market risk management framework. It is responsible for the preparation and dissemination of risk reports, developing and implementing the firmwide Risk Management Guidelines and evaluating adherence to these guidelines. These guidelines provide a clear framework for risk management decision-making. To that end the MRM Department identifies and quantifies risk exposures, develops limits, and reports and monitors these risks with respect to the approved limits. The identification of material market risks inherent in positions includes, but is not limited to, interest rate, equity and foreign exchange risk 28 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. 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 and liquidity that may adversely impact market valuation. Equity market risk is actively managed through the use of index futures, exchange-traded and OTC options, swaps and cash instruments. The Company enters into foreign exchange transactions in order to facilitate the purchase and sale of non-dollar instruments, including equity and interest rate securities. The Company is exposed to foreign exchange risk on its holdings of non-dollar assets and liabilities. The Company is active in many foreign exchange markets and has exposure to the euro, Japanese yen, British pound, Swiss franc, and Canadian 29 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 for virtually all of its trading activities. In general, value-at-risk measures the potential loss of revenues at a given confidence level over a specified time horizon. Value-at-risk over a one-day holding period measured at a 95% confidence level implies that potential loss of daily trading revenue will be at least as large as the value-at-risk amount on one out of every 20 trading days. The Company's methodology estimates a reporting day value-at-risk using actual daily trading revenues over the previous 250 trading days. This estimate is measured as the loss, relative to the median daily trading revenue. The Company also estimates an average value-at-risk measure over 250 rolling reporting days, thus looking back a total 500 trading days. The following table sets forth the daily value-at-risk for each component of market risk and in total (in millions): Three Months Ended As of August 2001 -------------------- -------------------------------- Aug. 31 Nov. 30 2001 2000 Average High Low --------- ---------- ---------- ---------- ---------- Interest rate risk $ 12.9 $ 12.6 $ 12.1 $ 13.7 $ 10.5 Equity price risk 15.9 15.1 15.6 17.0 12.0 Foreign exchange risk 1.8 1.5 1.7 1.9 1.5 Diversification benefit (6.8) (5.5) (6.0) (7.5) (3.5) --------- ---------- ---------- ---------- ---------- Total Company $ 23.8 $ 23.7 $ 23.4 $ 25.1 $ 20.5 ========= ========== ========== ========== ========== Value-at-risk is one measurement of potential loss in trading revenues that may result from adverse market movements over a specified period of time with a selected likelihood of occurrence. As with all measures of value-at-risk, the Company's estimate has substantial limitations due to its reliance on historical performance, which is not necessarily a predictor of the future. Consequently, this value-at-risk estimate is only one of a number of tools the Company utilizes in its daily risk management activities. 30 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Trading Net Revenues Distribution Substantially all of our inventory positions are marked-to-market on a daily basis and changes are recorded in net revenues. The following chart sets forth the frequency distribution for substantially all of the Company's trading net revenues on a weekly basis for the three months ended August 31, 2001: N | O. 10 | 9 | O 8 | F 7 | 6 | W 5 | E 4 | E 3 | X X X K 2 | X X X X X S 1 | X X X X X X ------------------------------------------------------------ <$0 $0-60 $60-90 $90-120 $120-150 $150+ WEEKLY TRADING NET REVENUES ($ IN MILLIONS) 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. NEW ACCOUNTING DEVELOPMENTS In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB No. 125" ("SFAS 140"). SFAS 140 carries over the fundamental control premise of SFAS No. 125, which requires an entity to recognize only assets it controls and to derecognize assets only when control has been surrendered. SFAS 140 amends the control framework of SFAS 125 by revising the criteria to be used for evaluating whether a financial asset is controlled and providing new criteria necessary to meet the definition of a Qualifying Special Purpose Entity ("QSPE"). A QSPE is a limited-purpose vehicle often used for asset securitizations. SFAS 140 will also change the accounting for collateral. SFAS 140 will no longer require entities to recognize controlled collateral as an asset on the balance sheet. Rather, SFAS 140 will require entities to separately classify financial assets owned and pledged. SFAS 140 also requires new disclosures for collateral and retained interests in securitizations. SFAS 140 has multiple effective dates. The accounting for new transfers of financial assets began on March 31, 2001 and the collateral disclosure rules began during the second quarter. The collateral accounting rules will be effective for the Company's year-end financial statements. The adoption of 31 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SFAS 140 is not expected to have a material impact to the Company's financial position or results of operations. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangibles Assets". SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS No. 142, intangible assets with indefinite lives and goodwill will no longer be required to be amortized. Instead, these assets will be evaluated annually for impairment. The Company will adopt the provisions of SFAS No. 142 at the beginning of fiscal year 2002 and does not expect the adoption to have a material impact to the Company's financial position or results of operations. 32 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART I - FINANCIAL INFORMATION ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information under the caption "Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Management" above in this Report is incorporated herein by reference. 33 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising in connection with the conduct of its business. Such proceedings include actions brought against the Company and others with respect to transactions in which the Company acted as an underwriter or financial advisor, actions arising out of the Company's activities as a broker or dealer in securities and commodities and actions brought on behalf of various classes of claimants against many securities and commodities firms, including the Company. Although there can be no assurance as to the ultimate outcome, the Company has denied, or believes it has a meritorious defense and will deny, liability in all significant cases pending against it including the matters described below, and intends to defend vigorously each such case, and, based on information currently available, the Company believes that the eventual outcome of the actions against it, including the matters described below, will not, in the aggregate, have a material adverse effect on the consolidated financial position or results of operations of the Company. Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing Inc. v. Minmetals International Non-Ferrous Metals Trading Company (Reported in Holdings' 2000 Annual Report on Form 10-K and Quarterly Report on Form 10-Q for the quarter ended May 31, 2001) The trial date has been postponed to December 10, 2001. 34 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS: The following exhibits are filed as part of this Quarterly Report, or where indicated, were theretofore filed and are hereby incorporated by reference: 3.1 Restated Certificate of Incorporation of the Registrant dated May 27, 1994 (Incorporated by reference to Exhibit 3.1 to the Registrant's Transition Report on Form 10-K for the eleven months ended November 30, 1994) 3.2 Certificate of Designations with respect to the Registrant's 5.94% Cumulative Preferred Stock, Series C (Incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed with the Commission on May 13, 1998) 3.3 Certificate of Designations with respect to the Registrant's 5.67% Cumulative Preferred Stock, Series D (Incorporated by reference to Exhibit 4.2 to the Registrant's Current Report on Form 8-K filed with the Commission on July 23, 1998) 3.4 Certificate of Designations with respect to the Registrant's Fixed/Adjustable Rate Cumulative Preferred Stock, Series E (Incorporated by reference to Exhibit 4.2 to the Registrant's Current Report on Form 8-K filed with the Commission on March 30, 2000) 3.5 Certificate of Amendment of the Restated Certificate of Incorporation of the Registrant, dated April 9, 2001 (Incorporated by reference to Exhibit 3.5 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended February 28, 2001) 3.6 By-Laws of the Registrant, amended as of March 26, 1997 (Incorporated by reference to Exhibit 3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended February 28, 1997) 11.1 Computation of Per Share Earnings (Omitted in accordance with section (b)(11) of Item 601 of Regulation S-K. The calculation of per share earnings is set forth in Part I, Item 1, in Note 10 to the Consolidated Financial Statements (Earnings Per Common Share).) 12.1 Computation of Ratios of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends (Filed herewith) 35 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART II - OTHER INFORMATION (B) REPORTS ON FORM 8-K: The following reports on Form 8-K were filed during the quarter for which this Quarterly Report is filed: 1. Form 8-K dated August 21, 2001, Item 7 2. Form 8-K dated August 14, 2001, Item 7. 3. Form 8-K dated July 26, 2001, Item 7. 4. Form 8-K dated July 3, 2001, Item 7. 5. Form 8-K dated June 29, 2001, Item 7. 6. Form 8-K dated June 19, 2001, Items 5 and 7. Financial Statements: Exhibit 99.2 Consolidated Statement of Income (Three Months Ended May 31, 2001) (Preliminary and Unaudited) Exhibit 99.3 Consolidated Statement of Income (Six Months Ended May 31, 2001) (Preliminary and Unaudited) Exhibit 99.4 Segment Net Revenue Information (Three and Six Months Ended May 31, 2001) (Preliminary and Unaudited) Exhibit 99.5 Selected Statistical Information (Preliminary and Unaudited) 7. Form 8-K dated June 14, 2001, Item 7. 8. Form 8-K dated June 1, 2001, Item 7. 36 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LEHMAN BROTHERS HOLDINGS INC. (Registrant) Date: October 15, 2001 By: /s/ David Goldfarb -------------------------------------------------- Chief Financial Officer (principal financial and accounting officer) 37 EXHIBIT INDEX EXHIBIT NO. EXHIBIT Exhibit 12.1 Computation of Ratios of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends EX-12.1 3 file002.txt COMPUTATION OF RATIOS OF EARNINGS EXHIBIT 12.1 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (DOLLARS IN MILLIONS) (UNAUDITED)
For the Nine Months Ended For the Twelve Months Ended November 30 Aug. 31 ------------------------------------------------------ ----------- 1996 1997 1998 1999 2000 2001 ---------- ---------- ---------- ---------- ---------- ----------- Pre-tax earnings from continuing operations $ 637 $ 937 $ 1,052 $ 1,631 $ 2,579 $ 1,633 Add: Fixed charges (excluding capitalized interest) 10,852 13,043 15,813 13,681 18,778 12,606 ------ ------ ------ ------ ------ ------ Pre-tax earnings before fixed charges 11,489 13,980 16,865 15,312 21,357 14,239 ====== ====== ====== ====== ====== ====== Fixed charges: Interest 10,816 13,010 15,781 13,649 18,740 12,560 Other (a) 50 41 47 71 57 57 ------ ------ ------ ------ ------ ------ Total fixed charges 10,866 13,051 15,828 13,720 18,797 12,617 ------ ------ ------ ------ ------ ------ Preferred stock dividend requirements 58 109 124 174 195 164 ------ ------ ------ ------ ------ ------ Total combined fixed charges and preferred stock dividends $ 10,924 $ 13,160 $ 15,952 $ 13,894 $ 18,992 $ 12,781 ======== ======== ======== ======== ======== ======== RATION OF EARNINGS TO FIXED CHARGES 1.06 1.07 1.07 1.12 1.14 1.13 RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS 1.05 1.06 1.06 1.10 1.12 1.11
(a) Other fixed charges consist of the interest factor in rentals and capitalized interest.