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 1-6817 LEHMAN BROTHERS INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

(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 |_| THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1)(a) AND (b) OF FORM 10-Q AND THEREFORE IS FILING THIS FORM WITH THE REDUCED DISCLOSURE PERMITTED THEREBY. AS OF OCTOBER 15, 2001, 1,006 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $0.10 PER SHARE, WERE OUTSTANDING. ================================================================================ LEHMAN BROTHERS INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED AUGUST 31, 2001 INDEX

2 LEHMAN BROTHERS INC. AND SUBSIDIARIES PART I - FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS LEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (IN MILLIONS)

See notes to consolidated financial statements. 3 LEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (IN MILLIONS)

See notes to consolidated financial statements. 4 LEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (UNAUDITED) (IN MILLIONS)

See notes to consolidated financial statements. 5 LEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - (CONTINUED) (UNAUDITED) (IN MILLIONS, EXCEPT SHARE DATA)

See notes to consolidated financial statements. 6 LEHMAN BROTHERS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (IN MILLIONS)

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS) Interest paid totaled $10,869 and $11,926 for the nine months ended August 31, 2001 and August 31, 2000, respectively. Income taxes paid totaled $571 and $412 for the nine months ended August 31, 2001 and August 31, 2000. See notes to consolidated financial statements. 7 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: The consolidated financial statements include the accounts of Lehman Brothers Inc., a registered broker-dealer ("LBI") and subsidiaries (collectively, the "Company"). LBI is a wholly owned subsidiary of Lehman Brothers Holdings Inc. ("Holdings"). LBI 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 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 in providing financial services. All material intercompany accounts and transactions have been eliminated in consolidation. The Company's financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q and reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Pursuant to such rules and regulations, certain footnote disclosures which are normally required under generally accepted accounting principles have been omitted. It is recommended that these consolidated financial statements be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the twelve months ended November 30, 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. CAPITAL REQUIREMENTS: As a registered broker-dealer, LBI 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. As a clearing broker-dealer, the Company has elected to compute a reserve requirement for Proprietary Accounts of Introducing Broker-Dealers ("PAIB calculation"). The PAIB calculation is completed in order for each correspondent firm that uses the Company as its clearing broker-dealer to classify its assets held by the Company as allowable assets in the correspondent's net capital calculation. At August 31, 2001, the Company had a reserve requirement for PAIB of $6 million. Additionally, the Company had $55 million of qualified securities or cash on deposit in a Special Reserve Bank Account as of August 31, 2001. 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. Repayment of subordinated indebtedness and certain advances and dividend payments by LBI are restricted by the regulations of the SEC and other regulatory agencies. In addition, certain investments governing the indebtedness of LBI contractually limit its ability to pay dividends. 8 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. 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 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.

* Amounts represent carrying value (exclusive of collateral) and do not include receivables or payables related to exchange-traded futures contracts. 9 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets included in the table above represent the Company's net receivable/ payable for derivative financial instruments before consideration of collateral. Included within the $5,949 million fair value of assets at August 31, 2001 was $5,217 million related to swaps and other OTC contracts and $732 million related to exchange-traded option and warrant contracts. Included within the $5,285 million fair value of assets at November 30, 2000 was $4,638 million related to swaps and other OTC contracts and $647 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 $4,328 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 22% 2 AA-/Aa3 or higher 27% 3 A-/A3 or higher 29% 4 BBB-/Baa3 or higher 17% 5 BB-/Ba3 or higher 3% 6 B+/B1 or lower 2% The Company is also subject to credit risk related to its exchange-traded derivative contracts. Exchange-traded contracts, including futures and certain options, are transacted directly on the exchange. To protect against the potential for a default, all exchange clearinghouses impose net capital requirements for their membership. Additionally, exchange clearinghouses require counterparties to futures contracts to post margin upon the origination of the 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 Notes 1 and 8 to the Consolidated Financial Statements included in the Form 10-K. 4. 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. 10 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. OTHER COMMITMENTS AND CONTINGENCIES: In connection with its financing activities, the Company had outstanding commitments under certain collateralized lending arrangements of approximately $2.2 billion, $3.1 billion and $3.0 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 $3.0 billion, $3.2 billion and $2.7 billion at August 31, 2001, May 31, 2001 and November 30, 2000, respectively. In addition, lending commitments to high yield borrowers totaled $1.1 billion, $918 million and $935 million 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. At August 31, 2001 and November 30, 2000, the Company had commitments to invest up to $167 million and $282 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 $150 billion. Of this collateral, approximately $145 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 10 to the Consolidated Financial Statements, included in the Form 10-K. 11 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6. 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 Division also includes the Company's risk arbitrage and secured financing businesses, as well as realized and unrealized gains and losses related to the Company's direct private equity investments. The financing 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 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 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. 12 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following are net revenues by geographic region:

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 been reclassified as international revenues using an allocation consistent with the Company's internal reporting. 13 LEHMAN BROTHERS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. RELATED PARTIES: In the normal course of business, the Company engages in various securities trading, investment banking and financial activities with Holdings and many of its subsidiaries (the "Related Parties"). Various charges, such as compensation and benefits, occupancy, administration and computer processing are allocated between the Related Parties, based upon specific identification and allocation methods. 8. 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. 14 ITEM 2 LEHMAN BROTHERS INC. AND SUBSIDIARIES MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Some of the statements contained in this Management's Analysis of 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. RECENT EVENTS 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. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 The Company reported net income of $107 million for the quarter ended August 31, 2001, a decrease of 65% from the third quarter of 2000 as a result of extremely difficult market conditions. Throughout the quarter, the Company continued to maintain its discipline toward managing expenses, risk and liquidity as well as capital deployment and utilization. For the quarter, non-personnel expenses decreased 3% from the third quarter of 2000 and 7% from the second quarter of 2001. 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.) 15 LEHMAN BROTHERS INC. AND SUBSIDIARIES MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS THREE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 (in millions) Net Revenues For the Three Months Ended ---------------------------------- August 31 August 31 2001 2000 --------------- --------------- Investment Banking $ 255 $ 437 Capital Markets 224 695 Client Services 195 171 --------------- --------------- Total $ 674 $ 1,303 =============== =============== 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 decreased 42% during the third quarter to $255 million from $437 million in the third quarter of 2000, as strong fixed income underwriting activity was more than offset by a decrease in equity origination activity and merger and acquisition fees. INVESTMENT BANKING NET REVENUES -------------------------------------------------------- (in millions) Three Months Ended August 31 August 31 2001 2000 -------------------------------- ----------- ----------- Debt Underwriting $ 182 $ 125 Equity Underwriting 29 144 Merger and Acquisition Advisory 44 168 -------------------------------- ----------- ----------- $ 255 $ 437 -------------------------------- ----------- ----------- Debt underwriting revenues totaled $182 million for the third quarter of 2001, a 46% 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 first nine calendar months of 2001 from 5.9% for calendar year 2000, according to Thompson Financial Securities Data Corp ("TFSD"). Equity origination revenues were down significantly 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 full calendar year 2000, according to TFSD. Merger and acquisition advisory fees decreased 74% compared to last year's third quarter as volume for completed deals has decreased almost 60% during that period. 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. 16 LEHMAN BROTHERS INC. AND SUBSIDIARIES MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS Capital Markets' net revenues were $224 million for the third quarter of 2001, down 68% from the third quarter of 2000 as difficult economic conditions led to lower 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 -------------------------------------------------------- (in millions) Three Months Ended August 31 August 31 2001 2000 -------------------------------- ----------- ----------- Fixed Income $ 177 $ 338 Equities 47 357 -------------------------------- ----------- ----------- $ 224 $ 695 -------------------------------- ----------- ----------- Net revenues from the fixed income and the equities component of Capital Markets decreased significantly during the third quarter of 2001, as a slowdown in the growth of the U.S. economy and a decrease in market volatility resulted in weak market conditions. 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 private equity partnerships. Client Services' net revenues were $195 million in the third quarter of 2001, up 14% 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 increased slightly compared to the third quarter of 2000, as a result of strong fixed income activity as investors adjusted their portfolios to compensate for the volatile market environment. Private equity revenues increased principally 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 -------------------------------------------------------- (in millions) Three Months Ended August 31 August 31 2001 2000 -------------------------------- ----------- ----------- Private Client $ 171 $ 168 Private Equity 24 3 -------------------------------- ----------- ----------- $ 195 $ 171 -------------------------------- ----------- ----------- Non-Interest Expenses Non-interest expenses were $550 million for the third quarter of 2001 compared to $865 million for the third quarter of 2000. Compensation and benefits expense as a percentage of net revenues was 51% for the quarter. The compensation accrual percentage is consistent with the Company's fiscal 2000 level. Non-personnel expenses were $206 million for the third quarter of 2001, relatively flat compared to the third quarter of 2000 as increased technology and brokerage and clearance costs were offset by lower management fees incurred. Income Taxes The Company's income tax provision was $17 million for the third quarter of 2001 versus $134 million for the third quarter of 2000. The decrease in the tax rate reflects a greater impact of tax preference revenues on a lower pre-tax income base. 17 LEHMAN BROTHERS INC. AND SUBSIDIARIES MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 The Company reported net income of $750 million for the nine months ended August 31, 2001, an increase of 2% from the nine months ended August 31, 2000. These results reflect the Company's continued ability to execute its strategy of growing its high margin investment banking and equities businesses while at the same time maintaining a strict discipline with regard to its expenses, all during an extremely difficult market environment. Net revenues were $3,478 million for the first nine months of 2001 compared to $3,532 million for the first nine months of 2000. 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.) NINE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000 ---------------------------------------------------------------------------- (in millions) Net Revenues for the Nine Months Ended ---------------------------------- August 31 August 31 2001 2000 --------------- --------------- Investment Banking $ 1,029 $ 1,102 Capital Markets 1,882 1,912 Client Services 567 518 --------------- --------------- Total $ 3,478 $ 3,532 =============== =============== ---------------------------------------------------------------------------- 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 $1,029 million decreased 7% in the first nine months of 2001 when compared to $1,102 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. Debt underwriting revenues increased 75% to $582 million in the first nine months of 2001 from $332 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 nine months ended August 31, 2001 compared to 5.9% for calendar year 2000, according to TFSD. -------------------------------------------------------- INVESTMENT BANKING NET REVENUES -------------------------------------------------------- (in millions) Nine Months Ended August 31 August 31 2001 2000 -------------------------------- ----------- ----------- Debt Underwriting $ 582 $ 332 Equity Underwriting 224 422 Merger and Acquisition Advisory 223 348 -------------------------------- ----------- ----------- $1,029 $1,102 -------------------------------- ----------- ----------- 18 LEHMAN BROTHERS INC. AND SUBSIDIARIES MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS Equity underwriting revenues were $224 million for the first nine months of 2001 compared to $422 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 first nine months of 2001, 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 36% 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 $1,882 million for the first nine months of 2001, down 2% 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 --------------------------------------------------------- (in millions) Nine Months Ended August 31 August 31 2001 2000 -------------------------------- ------------ ----------- Fixed Income $ 1,124 $ 909 Equities 758 1,003 -------------------------------- ------------ ----------- $ 1,882 $ 1,912 -------------------------------- ------------ ----------- Net revenues from the fixed income component of Capital Markets increased to $1,124 million for the first nine months of 2001 compared to $909 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 24% to $758 million for the first nine months of 2001 compared to $1,003 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. Client Services' net revenues were $567 million for the first nine months of 2001 compared to $518 million for the first nine months of 2000. Client Services' results improved primarily due to strong fixed income activity as the Company's high-net-worth investors adjusted their portfolios to compensate for volatile equity market environment. In addition, private equity revenues increased from the year-ago period 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 -------------------------------------------------------- (in millions) Nine Months Ended August 31 August 31 2001 2000 ------------------------------- ----------- ------------ Private Client $ 541 $ 512 Private Equity 26 6 ------------------------------- ----------- ------------ $ 567 $ 518 ------------------------------- ----------- ------------ 19 LEHMAN BROTHERS INC. AND SUBSIDIARIES MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS Non-Interest Expenses Non-interest expenses were $2,414 million for the first nine months of 2001 and $2,432 million for the comparable period of 2000. Compensation and benefits expense as a percentage of net revenues were 51%, which is consistent with the Company's fiscal 2000 level. Non-personnel expenses were $641 million for the first nine months of 2001 and $613 million for the first nine months of 2000, an increase of approximately 5% reflecting the Company's strategic growth plan. Income Taxes The Company's income tax provision was $314 million for the nine months of 2001 compared to $362 million for the nine months of 2000. The effective tax rate was 29.5% for the first nine months of 2001 compared to 32.9% for the first nine months of 2000. The decrease in the tax rate reflects a greater impact of tax preference revenues on a lower pre-tax income base. 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 this quarter. The collateral accounting rules will be effective for the Company's year-end financial statements. The adoption of 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 tested 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. 20 LEHMAN BROTHERS 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 LBI's 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. 21 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 heretofore filed and are hereby incorporated by reference: 3.1 Restated Certificate of Incorporation of the Registrant dated September 3, 1981 (Incorporated by reference to Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987) 3.2 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant dated May 11, 1984 (Incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988) 3.3 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant, dated March 6, 1985 (Incorporated by reference to Exhibit 3.3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985) 3.4 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant, dated August 31, 1987 (Incorporated by reference to Exhibit 3.4 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987) 3.5 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant, dated January 28, 1988 (Incorporated by reference to Exhibit 3.5 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987) 3.6 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant, dated July 19, 1990. (Incorporated by reference to Exhibit 3.6 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990) 3.7 Certificate of Amendment to Restated Certificate of Incorporation of the Registrant, dated August 2, 1993 (Incorporated by reference to Exhibit 3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993) 3.8 Certificate of Designations of Floating Rate Preferred Stock, filed April 30, 1996 (Incorporated by reference to Exhibit 3.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996) 3.9 By-Laws of the Registrant, amended as of January 30, 1997 (Incorporated by reference to Exhibit 3.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996) 12.1 Computation of Ratio of Earnings to Fixed Charges (Filed herewith) 22 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: None 23 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 INC. (Registrant) Date: October 15, 2001 By: /s/ David Goldfarb ----------------------------- Chief Financial Officer (Principal Financial Officer) 24 EXHIBIT INDEX EXHIBIT NO. EXHIBIT ----------- ------- Exhibit 12.1 Computation of Ratio of Earnings to Fixed Charges 25

LEHMAN BROTHERS INC// 10-Q