<Page>
================================================================================
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 FEBRUARY 28, 2002
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)
<Table>
DELAWARE 13-3216325
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
745 SEVENTH AVENUE
NEW YORK, NEW YORK 10019
(Address of princip (Zip Code)
executive offices)
</Table>
(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 MARCH 31, 2002, 244,042,186 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR
VALUE $0.10 PER SHARE, WERE OUTSTANDING.
================================================================================
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED FEBRUARY 28, 2002
INDEX
<Table>
<Caption>
PART I. FINANCIAL INFORMATION PAGE
--------------------- NUMBER
------
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Income -
Three Months Ended
February 28, 2002 and February 28, 2001.................................... 2
Consolidated Statement of Financial Condition -
February 28, 2002 and November 30, 2001.................................... 3
Consolidated Statement of Cash Flows -
Three Months Ended
February 28, 2002 and February 28, 2001.................................... 5
Notes to Consolidated Financial Statements................................. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................... 30
PART II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings............................................................... 31
Item 6. Exhibits and Reports on Form 8-K................................................ 33
SIGNATURE............................................................................................... 35
EXHIBIT INDEX........................................................................................... 36
EXHIBITS
</Table>
<Page>
LEHMAN BROTHERS HOLDINGS INC. 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)
<Table>
<Caption>
Three months ended
------------------------------
February 28 February 28
2002 2001
------------- --------------
Revenues
Principal transactions $ 569 $ 998
Investment banking 470 483
Commissions 289 278
Interest and dividends 2,886 4,981
Other 12 12
------------- --------------
Total revenues 4,226 6,752
Interest expense 2,620 4,869
------------- --------------
Net revenues 1,606 1,883
------------- --------------
Non-interest expenses
Compensation and benefits 819 960
Technology and communications 122 112
Brokerage and clearance 75 77
Occupancy 69 41
Business development 34 50
Professional fees 20 47
Other 27 23
------------- --------------
Total non-interest expenses 1,166 1,310
------------- --------------
Income from operations before taxes and dividends on
trust preferred securities 440 573
Provision for income taxes 128 172
Dividends on trust preferred securities 14 14
------------- --------------
Net income $ 298 $ 387
============= ==============
Net income applicable to common stock $ 262 $ 375
============= ==============
Earnings per common share
Basic $ 1.07 $ 1.52
============= ==============
Diluted $ 0.99 $ 1.39
============= ==============
</Table>
See notes to consolidated financial statements.
2
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(UNAUDITED)
(IN MILLIONS)
<Table>
<Caption>
February 28 November 30
2002 2001
--------------- ---------------
ASSETS
Cash and cash equivalents $ 2,523 $ 2,561
Cash and securities segregated and on deposit for regulatory and
other purposes 3,322 3,289
Securities and other financial instruments owned:
Mortgages and mortgage-backed 29,136 33,210
Governments and agencies 22,874 24,101
Derivatives and other contractual agreements 11,078 11,555
Corporate debt and other 9,394 10,918
Corporate equities 7,518 8,302
Certificates of deposit and other money market instruments 2,862 2,759
----------------------------------
Subtotal 82,862 90,845
Securities owned pledged as collateral 41,028 28,517
----------------------------------
123,890 119,362
----------------------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 91,211 83,278
Securities borrowed 19,561 17,994
Receivables:
Brokers, dealers and clearing organizations 3,071 3,455
Customers 10,595 12,123
Others 1,482 1,479
Property, equipment and leasehold improvements (net of
accumulated depreciation and amortization of $467 in 2002 and
$424 in 2001)
1,636 1,495
Other assets 2,588 2,613
Excess of cost over fair value of net assets acquired (net of
accumulated amortization of $152 in 2002 and $151 in 2001) 182 167
--------------- ----------------
Total assets $260,061 $247,816
=============== ================
</Table>
See notes to consolidated financial statements.
3
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - (CONTINUED)
(UNAUDITED)
(IN MILLIONS, EXCEPT SHARE DATA)
<Table>
<Caption>
February 28 November 30
2002 2001
---------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt $ 3,201 $ 4,865
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 35,658 25,547
Derivatives and other contractual agreements 10,129 10,324
Corporate debt and other 9,336 6,482
Corporate equities 7,367 8,977
---------------- -----------------
62,490 51,330
---------------- -----------------
Collateralized short-term financing:
Securities sold under agreements to repurchase 110,714 105,079
Securities loaned 12,324 12,541
Payables:
Brokers, dealers and clearing organizations 1,342 2,805
Customers 12,099 13,831
Accrued liabilities and other payables 10,548 9,895
Long-term debt:
Senior notes 35,274 35,373
Subordinated indebtedness 2,711 2,928
---------------- -----------------
Total liabilities 250,703 238,647
---------------- -----------------
Commitments and contingencies
Preferred securities subject to mandatory redemption 710 710
STOCKHOLDERS' EQUITY
Preferred stock 700 700
Common stock, $0.10 par value;
Shares authorized: 600,000,000 in 2002 and 2001;
Shares issued: 256,314,463 in 2002 and 256,178,907 in 2001;
Shares outstanding: 244,169,647 in 2002 and 237,534,091 in 2001 25 25
Additional paid-in capital 3,205 3,562
Accumulated other comprehensive income (net of tax) (11) (10)
Retained earnings 5,039 4,798
Other stockholders' equity, net 573 746
Common stock in treasury, at cost: 12,144,816 shares in 2002 and
18,644,816 shares in 2001 (883) (1,362)
---------------- -----------------
Total stockholders' equity 8,648 8,459
---------------- -----------------
Total liabilities and stockholders' equity $ 260,061 $ 247,816
================ =================
</Table>
See notes to consolidated financial statements.
4
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
<Table>
<Caption>
Three Months Ended
------------------------------------
February 28 February 28
2002 2001
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 298 $ 387
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 52 38
Tax benefit from issuance of stock-based awards 35 65
Amortization of deferred stock compensation 137 127
Other adjustments 23 17
Net change in:
Cash and securities segregated and on deposit (33) (854)
Securities and other financial instruments owned (5,027) (8,377)
Securities borrowed (1,567) (1,183)
Receivables from brokers, dealers and clearing organizations 384 (1,307)
Receivables from customers 1,528 (2,051)
Securities and other financial instruments sold but not yet purchased 11,160 9,471
Securities loaned (217) 2,897
Payables to brokers, dealers and clearing organizations (1,463) 204
Payables to customers (1,732) 2,600
Accrued liabilities and other payables 638 (249)
Other operating assets and liabilities, net 55 (193)
---------------- ----------------
Net cash provided by operating activities 4,271 1,592
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior notes 1,925 2,485
Principal payments of senior notes (1,545) (2,059)
Principal payments of subordinated indebtedness (221) (194)
Net payments for commercial paper and short-term debt (1,664) (929)
Resale agreements net of repurchase agreements (2,298) (2,609)
Payments for treasury stock purchases (254) (679)
Dividends paid or accrued (58) (30)
Issuances of common stock 1 26
Payments for repurchases of preferred stock -- (100)
---------------- ----------------
Net cash used in financing activities (4,114) (4,089)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and leasehold improvements, net (179) (128)
Acquisition, net of cash acquired (16) --
---------------- ----------------
Net cash used in investment activities (195) (128)
---------------- ----------------
Net change in cash and cash equivalents (38) (2,625)
---------------- ----------------
Cash and cash equivalents, beginning of period 2,561 5,160
---------------- ----------------
Cash and cash equivalents, end of period $ 2,523 $ 2,535
================ ================
</Table>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
Interest paid totaled $2,682 and $5,006 for the three months ended February 28,
2002 and February 28, 2001, respectively. Income taxes paid totaled $21 and $137
for the three months ended February 28, 2002 and February 28, 2001,
respectively.
See notes to consolidated financial statements.
5
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The consolidated financial statements include the accounts of Lehman Brothers
Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or
"Lehman Brothers"). Lehman Brothers is one of the leading global investment
banks serving institutional, corporate, government and high-net-worth individual
clients and customers. The Company's worldwide headquarters in New York and
regional headquarters in London and Tokyo are complemented by offices in
additional locations in North America, Europe, the Middle East, Latin America
and the Asia Pacific Region. The Company is engaged primarily in providing
financial services. The principal U.S. subsidiary of Holdings is Lehman Brothers
Inc. ("LBI"), a registered broker-dealer. All material intercompany accounts and
transactions have been eliminated in consolidation. The Company's financial
statements have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q
and reflect all normal recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods presented. Pursuant to such rules and regulations, certain footnote
disclosures which are normally required under generally accepted accounting
principles have been omitted. It is recommended that these consolidated
financial statements be read in conjunction with the audited consolidated
financial statements incorporated by reference in Holdings' Annual Report on
Form 10-K for the twelve months ended November 30, 2001 (the "Form 10-K"). The
Consolidated Statement of Financial Condition at November 30, 2001 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. EVENTS OF SEPTEMBER 11, 2001:
As a result of the September 11, 2001 terrorist attack, the Company's leased
facilities in the World Trade Center were destroyed and its leased and owned
facilities in the World Financial Center complex (including the 3 World
Financial Center building owned jointly with American Express) were
significantly damaged.
During the fourth quarter of 2001, the Company recognized a pretax special
charge of $127 million ($71 million after-tax) associated with the net losses
stemming from the events of September 11, 2001. These losses and costs included
the write-off of property damaged, destroyed or abandoned at the Company's
downtown facilities (approximately $340 million), compensation paid to employees
in lieu of utilizing external consultants for business recovery efforts and to
employees for the time they were idled (approximately $100 million), costs
incurred to maintain the facilities while they are unusable (approximately $16
million), and other costs associated with redeployment of the Company's
workforce to the temporary facilities (approximately $31 million). The losses
and costs were offset by estimated insurance recoveries of $360 million. All
expenses associated with the Company's use of temporary facilities during this
period were reflected as part of occupancy or technology and communications
expenses in the consolidated statement of income for the fiscal year ended
November 30, 2001, incorporated by reference in the Form 10-K.
In the first quarter of 2002, the Company incurred special costs resulting from
the terrorist attack of approximately $12 million related to technology
restoration and other costs associated with unusable facilities, which were
fully offset by estimated insurance recoveries. In addition, during the first
quarter of 2002, the Company incurred costs of approximately $9 million to
repair damage incurred to the core and shell of the Company's 3 World Financial
Center facility, which were fully offset by estimated insurance recoveries. The
repair of the 3 World Financial Center facility is ongoing and is expected to be
fully recoverable under the Company's building core and shell insurance policy.
6
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For further information regarding the special charge recognized during the
fourth quarter of 2001 and the effects of the terrorist attack, refer to Note 2
to the Consolidated Financial Statements incorporated by reference in the Form
10-K.
3. LONG-TERM DEBT:
During the three months ended February 28, 2002, the Company issued $1,925
million of long-term debt (all of which were senior notes). Of the total
issuances during the period, $1,038 million were U.S. dollar fixed rate, $525
million were U.S. dollar floating rate, $151 million were foreign currency
denominated fixed rate, and $211 million were foreign currency denominated
floating rate. These issuances were primarily utilized to refinance current
maturities of long-term debt in 2002 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"). All of the
Company's fixed rate new issuances were effectively converted to floating rate
obligations through the use of interest rate swaps. Of the foreign denominated
new issuances totaling $362 million, $137 million were effectively swapped to
U.S. Dollars, with the remainder match funding foreign currency denominated
capital needs.
The Company had $1,545 million of long-term debt mature during the three months
ended February 28, 2002. Long-term debt at February 28, 2002, scheduled to
mature within one year totaled $7,649 million.
4. CAPITAL REQUIREMENTS:
The Company operates globally through a network of subsidiaries, with several
subject to regulatory requirements. In the United States, LBI, as a registered
broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule, which
requires LBI to maintain net capital of not less than the greater of 2% of
aggregate debit items arising from customer transactions, as defined, or 4% of
funds required to be segregated for customers' regulated commodity accounts, as
defined. At February 28, 2002, LBI's regulatory net capital, as defined, of
$1,662 million exceeded the minimum requirement by $1,549 million.
Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered
broker-dealer and subsidiary of Holdings, is subject to the capital requirements
of the Financial Services Authority ("FSA") of the United Kingdom. Financial
resources, as defined, must exceed the total financial resources requirement of
the FSA. At February 28, 2002, LBIE's financial resources of approximately
$2,340 million exceeded the minimum requirement by approximately $650 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 February 28,
2002, had net capital of approximately $259 million which was approximately $90
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 February 28,
2002, these other subsidiaries were in compliance with their applicable local
capital adequacy requirements. In addition, the Company's "AAA" rated
derivatives subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and
Lehman Brothers Derivative Products Inc. ("LBDP"), have established certain
capital and operating restrictions which are reviewed by various rating
agencies. At February 28, 2002, LBFP and LBDP each had capital which exceeded
the requirement of the most stringent rating agency by approximately $76 million
and $28 million, respectively.
7
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
5. 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 did not
have a material effect on the Company's Consolidated Statement of Financial
Condition or its 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
accounting 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
immaterial for the three months ended February 28, 2002 and 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.
8
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
FAIR VALUE* FAIR VALUE*
FEBRUARY 28, 2002 NOVEMBER 30, 2001
-------------------------------------------------------------------
(IN MILLIONS) ASSETS LIABILITIES ASSETS LIABILITIES
- -------------------------------------------------------------------------------------------------------------------------
Interest rate, currency and credit default
swaps, and options (including caps, collars
and floors) $5,714 $5,156 $ 6,482 $ 6,485
Foreign exchange forward contracts and
options 860 1,132 740 1,111
Other fixed income securities contracts
(including futures contracts, options and
TBAs) 768 1,163 747 226
Equity contracts (including equity swaps,
warrants and options) 3,736 2,678 3,586 2,502
-------------------------------------------------------------------
TOTAL $11,078 $10,129 $11,555 $10,324
-------------------------------------------------------------------
</Table>
* Amounts represent carrying value (exclusive of collateral) and do not
include receivables or payables related to exchange-traded futures
contracts. In addition, includes end-user derivative activity on a
mark-to-market basis in accordance with SFAS No. 133.
Assets included in the table above represent the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral. Included within the $11,078 million fair value of assets at February
28, 2002 was $10,112 million related to swaps and other over-the-counter ("OTC")
contracts and $966 million related to exchange-traded option and warrant
contracts. Included within the $11,555 million fair value of assets at November
30, 2001 was $10,555 million related to swaps and other OTC contracts and $1,000
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 $6,144 million at February 28, 2002, representing the fair value
of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral. Presented below is an analysis of the Company's net
credit exposure at February 28, 2002 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.
<Table>
<Caption>
COUNTERPARTY S&P/MOODY'S NET CREDIT
RISK RATING EQUIVALENT EXPOSURE
----------- ---------- --------
1 AAA/Aaa 14%
2 AA-/Aa3 or higher 26%
3 A-/A3 or higher 34%
4 BBB-/Baa3 or higher 22%
5 BB-/Ba3 or higher 3%
6 B+/B1 or lower 1%
</Table>
9
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's OTC contracts credit exposure by weighted-average maturity is set
forth below:
<Table>
<Caption>
Less Greater
Counterparty Than 2-5 5-10 than
Risk Rating 1 Year Years Years 10 Years Total
---------------------------------------------------------------------------------
1 2% 5% 4% 3% 14%
2 5% 11% 5% 5% 26%
3 9% 15% 4% 6% 34%
4 6% 6% 3% 7% 22%
5 1% 1% - 1% 3%
6 1% - - - 1%
---------------------------------------------------------------------------------
Total 24% 38% 16% 22% 100%
=================================================================================
</Table>
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 "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Off-Balance Sheet Financial Instruments and Derivatives" and the
Notes to the Consolidated Financial Statements, incorporated by reference in the
Form 10-K.
6. SECURITIZATIONS:
The Company is a market leader in mortgage- and asset-backed securitizations and
other structured financing arrangements. In connection with these activities,
the Company utilizes special purpose entities principally for (but not limited
to) the securitization of commercial and residential mortgages, home equity
loans, government and corporate bonds, and lease and trade receivables. The
Company derecognizes financial assets transferred in securitizations provided
that the Company has relinquished control over such assets. The Company may
retain an interest in the financial assets it securitizes ("Retained Interests")
which may include assets in the form of residual interests in the special
purpose entities established to facilitate the securitization. Any Retained
Interests are included in Securities and Other Financial Instruments Owned
within the Company's Statement of Financial Condition. 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. When 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. During the first quarter of fiscal
2002, the Company securitized approximately $26 billion of financial assets.
As of February 28, 2002, the Company had approximately $1.1 billion of
non-investment grade retained interests from its securitization activities. The
Company records its Retained Interests at fair value and actively monitors the
market risk exposures associated with Retained Interests.
10
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. SECURITIES PLEDGED AS COLLATERAL:
The Company enters into secured borrowing and lending transactions to finance
trading inventory positions, obtain securities for settlement, and meet
customers' needs. The Company primarily receives collateral in connection with
resale agreements, securities borrowed transactions, customer margin loans and
other loans. The Company is generally permitted to sell or repledge these
securities held as collateral and use the securities to secure repurchase
agreements, enter into securities lending transactions or deliver to
counterparties to cover short positions. The Company carries secured financing
agreements for financial reporting purposes on a net basis when permitted under
the provision of Financial Accounting Standards Board Interpretations No. 41
("FIN 41"). At February 28, 2002 and November 30, 2001, the fair value of
securities received as collateral and securities owned that have not been sold,
repledged or otherwise encumbered totaled approximately $43 billion and $38
billion, respectively. At February 28, 2002 and November 30, 2001, the gross
fair value of securities received as collateral where the Company was permitted
to sell or repledge the securities was approximately $263 billion and $245
billion, respectively. Of this collateral, approximately $251 billion and $234
billion at February 28, 2002 and November 30, 2001, respectively, has been sold
or repledged, generally as collateral under repurchase agreements or to cover
securities and other financial instruments sold but not yet purchased.
Securities owned pledged as collateral at February 28, 2002 and November 30,
2001 for which the counterparty has the right to sell or repledge are comprised
of the following amounts:
<Table>
<Caption>
FEBRUARY 28, NOVEMBER 30,
(IN MILLIONS) 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Securities and other financial instruments owned:
Corporate equities $15,246 $15,178
Governments and agencies 10,281 2,596
Corporate debt and other 9,235 10,051
Mortgages and mortgage-backed 5,531 -
Certificates of deposit and other money market instruments 735 692
- --------------------------------------------------------------------------------------------------------------------
Total $41,028 $28,517
====================================================================================================================
</Table>
The carrying value of securities and other financial instruments owned that have
been pledged to counterparties where those counterparties do not have the right
to sell or repledge are as follows:
<Table>
<Caption>
FEBRUARY 28, NOVEMBER 30,
(IN MILLIONS) 2002 2001
- --------------------------------------------------------------------------------------------------------------------
Securities and other financial instruments owned:
Governments and agencies $17,703 $17,672
Mortgages and mortgage-backed 15,096 20,776
Corporate debt and other 4,196 7,199
Certificates of deposit and other money market instruments 2,015 2,173
Corporate equities 1,807 4,098
- --------------------------------------------------------------------------------------------------------------------
Total $40,817 $51,918
====================================================================================================================
</Table>
11
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. OTHER COMMITMENTS AND CONTINGENCIES:
As of February 28, 2002 and November 30, 2001, the Company was contingently
liable for $1.0 billion and $1.1 billion, respectively, of letters of credit,
primarily used to provide collateral for securities and commodities borrowed and
to satisfy margin deposits at option and commodity exchanges, and other
guarantees.
In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $2.0 billion and
$2.1 billion at February 28, 2002 and November 30, 2001, 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, at February 28, 2002 the Company had commitments
to enter into forward starting secured resale and repurchase agreements of $60.0
billon and $23.7 billion, respectively, as compared to $52.3 billion and $26.5
billion, respectively, at November 30, 2001.
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. The Company utilizes various hedging and funding
strategies to actively manage its market, credit and liquidity conditions
exposures on these commitments. In addition, total commitments are not
indicative of actual risk or funding requirements, as the commitments may not be
drawn or fully utilized. These commitments and any related draw downs of these
facilities typically have fixed maturity dates and are contingent upon certain
representations, warranties and contractual conditions applicable to the
borrower.
At February 28, 2002 and November 30, 2001, the Company had net lending
commitments to investment grade borrowers of $3.3 billion (gross commitments of
$5.3 billion less $2.0 billion of associated hedges) and $4.1 (gross commitments
of $5.9 billion less $1.8 billion of associated hedges), respectively. Lending
commitments to non-investment grade borrowers totaled $1.4 billion at both
February 28, 2002 and November 30, 2001, respectively. In addition, the Company
has pre-arranged funding facilities with third party lenders of $4.9 billion at
both February 28, 2002 and November 30, 2001, available against these
commitments. These funding facilities contain limits for certain concentrations
of counterparty, industry or credit ratings of the underlying loans.
At February 28, 2002 and November 30, 2001, the Company had commitments to
invest up to $787 million and $555 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. After considering all relevant
facts, available insurance coverage and the advice of counsel, in the opinion of
the Company such litigation will not, in the aggregate, have a material adverse
effect on the Company's consolidated financial position, but may be material to
the Company's operating results for any particular period, depending on the
level of income for such period.
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, credit or counterparty, liquidity, legal and operational risks.
Management has developed a control infrastructure throughout the Company to
monitor
12
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and manage these risks on a global basis. For further discussion of these
matters, refer to the Risk Management section of Management's Discussion and
Analysis of Financial Condition and Results of Operations incorporated by
reference in the Form 10-K and the Risk Management section of Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in this Report.
9. 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. Through the Division, the Company is a global market-maker
in numerous equity and fixed income products, including U.S., European and Asian
equities, government and agency securities, money market products, corporate
high grade, high yield and emerging market securities, mortgage- and
asset-backed securities, municipal securities, bank loans, foreign exchange and
derivatives products. The Division also includes the Company's risk arbitrage
and secured financing businesses, as well as realized and unrealized gains and
losses related to the Company's direct private equity investments. The financing
business manages the Company's equity and fixed income matched book activities,
supplies secured financing to institutional clients and customers, and provides
secured funding for the Company's inventory of equity and fixed income products.
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 thirty-three
private equity partnerships. In addition, these revenues also include the
appreciation of its general partnership interests.
The Company's segment information for the first quarter of 2002 and 2001 is
presented below and was developed consistent with the accounting policies used
to prepare the Company's consolidated financial statements.
<Table>
<Caption>
INVESTMENT CAPITAL CLIENT
(IN MILLIONS) BANKING MARKETS SERVICES TOTAL
---------------- ------------- ------------- ------------
FEBRUARY 28, 2002
Net Revenue $ 459 $ 945 $ 202 $ 1,606
================ ============= ============= ============
Earnings before taxes (1) $ 118 $ 276 $ 46 $ 440
================ ============= ============= ============
Segment assets (billions) $1.6 $ 252.8 $ 5.7 $ 260.1
================ ============= ============= ============
FEBRUARY 28, 2001
Net Revenue $ 471 $ 1,208 $ 204 $ 1,883
================ ============= ============= ============
Earnings before taxes (1) $ 75 $ 451 $ 47 $ 573
================ ============= ============= ============
Segment assets (billions) $1.4 $ 229.2 $ 5.7 $ 236.3
================ ============= ============= ============
</Table>
(1) And before dividends on preferred securities.
13
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following are net revenues by geographic region:
<Table>
<Caption>
February 28 February 28
(IN MILLIONS) 2002 2001
------------------- -------------------
U.S. $ 1,057 $ 1,232
Europe 417 519
Asia Pacific and other 132 132
------------------- -------------------
Total $ 1,606 $ 1,883
=================== ===================
</Table>
10. INCENTIVE PLANS:
In February of 2002, the Company transferred 9.3 million shares of its common
stock held in treasury into the Company's irrevocable grantor trust for
restricted stock units (the "RSU Trust") awarded to current and former
employees. The RSU Trust is included in the Consolidated Statement of Financial
Condition as a component of other stockholders' equity. The transfer had no
impact on the total stockholders' equity of the Company, as the decrease in
treasury stock was offset by a corresponding decrease in additional paid-in
capital and other stockholders' equity. At February 28, 2002 and November 30,
2001, 49.7 million and 45.7 million outstanding shares, respectively, were held
in the RSU Trust.
11. EARNINGS PER COMMON SHARE:
Earnings per share was calculated as follows (in millions, except for per share
data):
<Table>
<Caption>
THREE MONTHS ENDED
-------------------------------------
FEBRUARY 28 FEBRUARY 28
2002 2001
---------------- ----------------
NUMERATOR:
Net income $298 $387
Preferred stock dividends (36) (12)
---------------- ----------------
Numerator for basic and diluted earnings per share-income available to
common stockholders $262 $375
================ ================
DENOMINATOR:
Denominator for basic earnings per share - weighted-average shares 245.3 246.2
Effect of dilutive securities:
Employee stock options 15.1 17.3
Employee restricted stock units 4.8 7.2
---------------- ----------------
Dilutive potential common shares 19.9 24.5
---------------- ----------------
Denominator for diluted earnings per share - adjusted weighted-
average shares 265.2 270.7
================ ================
BASIC EARNINGS PER SHARE $1.07 $1.52
================ ================
DILUTED EARNINGS PER SHARE $0.99 $1.39
================ ================
</Table>
14
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. SUBSEQUENT EVENT:
Subsequent to quarter-end, Holdings issued $575 million in 20-year convertible
floating-rate senior notes. The proceeds from the issuance of the notes will be
used to refinance current maturities of long-term debt and increase total
capital.
The notes carry an initial coupon of 0.9% below three-month LIBOR, subject to
adjustment in certain events. The notes are redeemable by Holdings at par after
April 1, 2004. The holders of notes may cause Holdings to repurchase the notes
at par on April 1, 2004, 2007, 2012 or 2017, or upon a change of control of
Holdings. The notes are convertible in certain circumstances (including upon the
trading price of the common stock or of the notes reaching certain levels, a
downgrade of the ratings of the notes and certain other events) into common
stock of Holdings at $96.10 per share, subject to adjustment for certain events.
The description of the notes herein is only a summary; a complete description of
the notes is contained in Exhibit 4.01 to Holdings' Current Report on Form 8-K
dated March 26, 2002, which is incorporated herein by reference.
15
<Page>
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 sales and trading, 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.
Marketplace uncertainties experienced throughout 2001 continued into the first
quarter of 2002. In response to these conditions and to stimulate growth, the
Federal Reserve lowered interest rates 25 basis points in mid-December, the
eleventh reduction in the Federal Funds rate since January of 2001. As of
February 28, 2002, the Federal Funds rate was 1.75%, its lowest level in nearly
40 years.
These economic conditions, combined with a number of high-profile defaults and
concerns over accounting and corporate governance issues, produced lower returns
in all major equity markets during the fiscal first quarter of 2002, when
compared to the same period a year ago. The Standard & Poor's 500 Index declined
by 11% from the end of the fiscal first quarter of 2001 and 3% from the end of
fiscal year 2001. The NASDAQ experienced even greater deterioration, closing the
fiscal first quarter of 2002 with decreases of 20% from a year ago and 10% from
November 30, 2001.
Globally, other world markets experienced the same slowing of growth and
declines in equity market valuations. The FTSE 100 decreased 14% from the end of
the fiscal first quarter of 2001, while the DAX decreased 19%. In Asia, the
Nikkei was down 18% from the end of the fiscal first quarter of 2001, resulting
in its lowest level in the past two decades.
Equity origination markets improved during the quarter as economic data released
towards the end of the fiscal quarter pointed to the early stages of a possible
cyclical recovery. As a result, global equity origination market volume was up
17% when compared to the fiscal first quarter of 2001, according to Thomson
Financial Securities Data Corp. ("TFSD").
Fixed income markets, which benefited from declining interest rates during 2001,
continued to be strong during the fiscal first quarter of 2002, as lower
interest rates resulted in very attractive borrowing rates. The volume of global
debt origination was up approximately 7% when compared to the fiscal first
quarter of 2001, according to TFSD.
- --------------------------------------------------------------------------------
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 AND LIQUIDITY RISKS INCLUDE
CHANGES IN INTEREST AND FOREIGN EXCHANGE RATES AND SECURITIES AND COMMODITIES
VALUATIONS, THE AVAILABILITY AND COST OF CAPITAL AND CREDIT, CHANGES IN INVESTOR
SENTIMENT, GLOBAL ECONOMIC AND POLITICAL TRENDS AND INDUSTRY COMPETITION. LEGAL
RISKS INCLUDE LEGISLATIVE AND REGULATORY DEVELOPMENTS IN THE U.S. AND THROUGHOUT
THE WORLD. 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 AND, ACCORDINGLY, READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON SUCH STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION,
FUTURE EVENTS OR OTHERWISE.
16
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Merger and acquisition advisory activity, which slowed considerably in 2001,
continued to be weak during the fiscal first quarter of 2002. Quarterly merger
and acquisition advisory volume reached its lowest level since 1997, as the
combination of accounting concerns and weak global equity markets led to a
significant reduction in activity. Worldwide completed mergers and acquisitions
for the fiscal first quarter of 2002 decreased almost 75% from the fiscal first
quarter of 2001, according to TFSD. In addition, announced transaction volumes
industry-wide decreased approximately 45% when compared to the fiscal first
quarter of 2001.
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED FEBRUARY 28, 2002 AND FEBRUARY 28, 2001
The Company reported net income of $298 million for the quarter ended February
28, 2002, a decrease of 23% from the first quarter of 2001. Net revenues for the
first quarter of 2002 were $1,606 million and earnings per common share
(diluted) were $0.99. During the quarter, the Company accrued a $25 million
special preferred dividend on its Redeemable Voting Preferred Stock, the final
payment required. The Company's pre-tax operating margin for the first quarter
was 27.4%, and its return on equity was 14.6% (excluding the impact of the
special preferred dividend). These relatively strong results in a very difficult
market environment demonstrate the growing breadth and depth of the Company's
franchise.
The Company continued to maintain strict discipline with regard to expense
management, risk management and capital deployment. For the quarter,
non-personnel expenses decreased slightly from the first quarter of 2001 and
remained relatively flat when compared to the fourth quarter of 2001.
The Company is segregated into 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 all
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 FEBRUARY 28, 2002 AND FEBRUARY 28, 2001
<Table>
<Caption>
(IN MILLIONS) Net Revenues
----------------------------------
for the
Three Months Ended
-----------------------------------
Feb 28 Feb 28
2002 2001
---------------- ---------------
Investment Banking $ 459 $ 471
Capital Markets 945 1,208
Client Services 202 204
---------------- ---------------
Total $ 1,606 $ 1,883
================ ===============
</Table>
The following discussion provides an analysis of the Company's net revenues.
17
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 3% during the first quarter of 2002
to $459 million from $471 million in the first quarter of 2001, as strong fixed
income and improved equity underwriting activity was more than offset by a
decrease in merger and acquisition ("M&A") advisory activity.
<Table>
<Caption>
- --------------------------------------------------------
INVESTMENT BANKING NET REVENUES
- --------------------------------------------------------
(IN MILLIONS) Three Months Ended
February 28 February 28
2002 2001
- --------------------------------------------------------
Debt Underwriting $ 205 $ 183
Equity Underwriting 163 105
M&A Advisory 91 183
- --------------------------------------------------------
$ 459 $ 471
- --------------------------------------------------------
</Table>
Debt underwriting revenues totaled $205 million for the first quarter of 2002, a
12% increase over last year's first quarter. Fixed income origination benefited
this quarter as issuers continued to take advantage of lower interest rates to
raise long-term debt and replace short-term financing. Contributing to these
results was a 40% increase from the year-ago period in the Company's global debt
origination market volume, compared to a 7% increase industry-wide, according to
TFSD.
Equity origination revenues for the first quarter of 2002 were $163 million, up
55% compared to the year-ago period, as an improved outlook for the U.S. economy
led to increased activity. Driving the increase in revenues was a significant
increase in secondary offering volume, as the value of transactions completed by
the Company increased almost 30% compared to the year-ago period, according to
TFSD.
M&A advisory fees for the first quarter of 2002 were $91 million, down 50%
versus the first quarter of 2001 as industry-wide volumes for completed
transactions decreased almost 75% during the same time period, according to
TFSD.
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 $945 million for the first quarter of 2002,
down 22% from the first quarter of 2001 as record fixed income results were more
than offset by lower revenues from equity products. Overall, the Company
continued to experience strong institutional customer flow activity across a
wide range of products.
<Table>
<Caption>
- --------------------------------------------------------
CAPITAL MARKETS NET REVENUES
- --------------------------------------------------------
(IN MILLIONS) Three Months Ended
February 28 February 28
2002 2001
- --------------------------------------------------------
Fixed Income $ 681 $ 523
Equities 264 685
- --------------------------------------------------------
$ 945 $ 1,208
- --------------------------------------------------------
</Table>
This customer flow business provides the Company with a recurring 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.
Net revenues from the fixed income component of Capital Markets increased 30% to
$681 million from the first quarter of 2001, principally driven by strong
institutional customer flow in credit products, such as high grade bonds and
municipals. Favorable interest rates led to higher volumes across almost all
fixed income
18
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
products, particularly residential mortgages, which was driven by the continued
high levels of refinancings and new home sales. In addition, a combination of
periods of high volatility and increased corporate debt issuance during the
quarter drove increased investor demand for interest rate derivatives.
Net revenues from the equity component of Capital Markets were $264 million in
the first quarter of 2002, down 61% from the first quarter of 2001. This
year-over-year decrease was driven by a decline in market volatility, which
reduced customer activity in derivative-related products, and declines in
revenues from both private equity investments and risk arbitrage activity 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 thirty-three
private equity banking partnerships.
Client Services net revenues were $202 million in the first quarter of 2002,
down slightly from the first quarter of 2001. Despite weak equity markets,
high-net-worth sales remained relatively unchanged as the decline in equities
was partially offset by record fixed income activity, as investors continued to
adjust their portfolios to compensate for the volatile equity market
environment.
<Table>
<Caption>
- --------------------------------------------------------
CLIENT SERVICES NET REVENUES
- --------------------------------------------------------
(IN MILLIONS) Three Months Ended
February 28 February 28
2002 2001
- --------------------------------------------------------
Private Client $ 191 $ 192
Private Equity 11 12
- --------------------------------------------------------
$ 202 $ 204
- --------------------------------------------------------
</Table>
Private equity net revenues were virtually unchanged from the first quarter of
2001 as an increase in management fees was offset by lower incentive fee
revenue.
NON-INTEREST EXPENSES Non-interest expenses were $1,166 million for the first
quarter of 2002 compared to $1,310 million for the first quarter of 2001.
Compensation and benefits expense of $819 million decreased 15% from the first
quarter of 2001 due to the decrease in revenues. Compensation and benefit
expense, as a percentage of net revenues however, remained at 51% for the
quarter, consistent with the Company's fiscal 2001 level. Nonpersonnel expenses
were $347 million for the first quarter of 2002, down slightly compared to the
first quarter of 2001, as increases in occupancy and technology were offset by
decreased business development activity and savings initiatives in other areas.
INCOME TAXES The Company's income tax provision was $128 million for the first
quarter of 2002 versus $172 million for the first quarter of 2001. The effective
tax rate was 29% for the first quarter of 2002 versus 30% for the first quarter
of 2001.
19
<Page>
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 A 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 is comprised of 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 2% of adjusted total assets and less than 8% of total debt.
20
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
TOTAL CAPITAL The Company's Total Capital (defined as long-term debt, preferred
securities subject to mandatory redemption and stockholders' equity) was $47.3
billion at February 28, 2002 compared to $47.5 billion at November 30, 2001. The
slight decrease in Total Capital resulted from a net decrease in long-term debt,
principally due to redemptions, offset by an increase in total equity,
principally due to net income.
<Table>
<Caption>
FEBRUARY 28 NOVEMBER 30
(IN MILLIONS) 2002 2001
- -------------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT
Senior Notes $ 35,274 $ 35,373
Subordinated Indebtedness 2,711 2,928
-------- --------
37,985 38,301
PREFERRED SECURITIES 710 710
STOCKHOLDERS' EQUITY
Preferred Equity 700 700
Common Equity 7,948 7,759
-------- --------
8,648 8,459
- -------------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL $ 47,343 $ 47,470
- -------------------------------------------------------------------------------------------------------------------
</Table>
During the first quarter of 2002, the Company issued $1.9 billion in long-term
debt securities, which was $380 million in excess of maturing debt securities.
Long-term debt decreased to $38.0 billion at February 28, 2002 from $38.3
billion at November 30, 2001, with a weighted-average maturity of 3.7 years at
February 28, 2002 and 3.8 years at November 30, 2001.
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 (at quarter end) for up to
364 days. In April 2002, the Company renegotiated the Credit Agreement; under
the new terms, the banks have committed to provide up to $1 billion for three
years with a final maturity in April 2005. The Credit Agreement contains
covenants that require, among other things, that the Company maintain a
specified level of tangible net worth.
In October 2001, the Company renegotiated its $1 billion Committed Securities
Repurchase Facility (the "Facility") for LBIE, the Company's major operating
entity in Europe. The Facility provides secured multi-currency financing for a
broad range of collateral types. Under the terms of the Facility, the bank group
has agreed 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. This commitment expires in October 2002, but the Company anticipates
obtaining a new $1 billion commitment on substantially similar terms.
There were no borrowings outstanding under either the Credit Agreement or the
Facility at February 28, 2002. Although the Company has not previously actively
used the Credit Agreement, it now intends to do so and to use the proceeds for
general corporate purposes. The Company has maintained compliance with the
applicable covenants for both the Credit Agreement and the Facility at all
times.
21
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
BALANCE SHEET The Company's total assets increased to $260.1 billion at February
28, 2002 from $247.8 billion at November 30, 2001. 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
$168.9 billion at February 28, 2002 compared to $164.5 billion at November 30,
2001. 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 associated with increased customer flow activities within the
Company's 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 net leverage ratios based on adjusted total assets were 18.0x and
17.9x as of February 28, 2002 and November 30, 2001, respectively. Consistent
with maintaining a single A credit rating, the Company targets an adjusted
leverage ratio of under 20x. The Company continues to operate below this level.
Due to the nature of the Company's 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 cost
and availability of unsecured financing generally are dependent on the Company's
short-term and long-term credit ratings. Factors that may be significant to the
determination of the Company's credit ratings or otherwise affect the ability of
the Company to raise short-term and long-term financing include its profit
margin, its earnings trend and volatility, its cash liquidity and liquidity
management, its capital structure, its risk level and risk management, its
geographic and business diversification, and its relative positions in the
markets in which it operates. A deterioration in any of the previously mentioned
factors or combination of these factors may lead rating agencies to downgrade
the credit ratings of the Company, thereby increasing the cost to the Company
of, or possibly limiting the access of the Company to, certain types of
unsecured financings. In addition, the Company's debt ratings can impact certain
capital markets revenues, particularly in those businesses where longer-term
counterparty performance is critical, such as over-the-counter derivative
transactions, including credit derivatives and interest rate swaps. As of
February 28, 2002 the short- and long-term debt ratings of Holdings and LBI were
as follows:
<Table>
<Caption>
Holdings LBI
----------------------------------- ------------------------------------
Short-term Long-term Short-term Long-term**
- ------------------------------------------ ---------------- ------------------ -- ---------------- -------------------
Fitch IBCA, Inc. F-1 A+ F-1 A+/A
Moody's P-1 A2 P-1 A1*/A2
Standard & Poor's Corp. AA-1 A A-1 A+*/A
</Table>
* Provisional ratings on shelf registration
** Senior/subordinated
22
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
HIGH YIELD
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 relatively 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 February 28, 2002 and November 30, 2001 included long positions
with an aggregate market value of approximately $3.8 billion and $3.5 billion,
respectively, and short positions with an aggregate market value of
approximately $1.4 billion and $1.0 billion, respectively. The Company mitigates
its aggregate and single-issuer net exposure through the use of derivatives,
non-recourse securitization financing and other financial instruments.
PRIVATE EQUITY
The Company has investments in thirty-three private equity partnerships, for
which the Company acts as general partner, as well as related direct
investments. At February 28, 2002, the Company's private equity related
investments were $927 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 8 to the Consolidated Financial Statements
(Other Commitments and Contingencies).
SUMMARY OF CONTRACTUAL OBLIGATIONS
As of February 28, 2002 and November 30, 2001, the Company was contingently
liable for $1.0 billion and $1.1 billion, respectively, of letters of credit,
primarily used to provide collateral for securities and commodities borrowed and
to satisfy margin deposits at option and commodity exchanges, and other
guarantees.
In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $2.0 billion and
$2.1 billion at February 28, 2002 and November 30, 2001, 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, at February 28, 2002 the Company had commitments
to enter into forward starting secured resale and repurchase agreements of $60.0
billon and $23.7 billion, respectively, as compared to $52.3 billion and $26.5
billion, respectively, at November 30, 2001.
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. The Company utilizes various hedging and funding
strategies to actively manage its market, credit and liquidity conditions
exposures on these commitments. In addition, total commitments are not
indicative of actual risk or funding requirements, as the commitments may not be
drawn or fully utilized. These commitments and any related draw downs of
23
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
these facilities typically have fixed maturity dates and are contingent upon
certain representations, warranties and contractual conditions applicable to the
borrower.
At February 28, 2002 and November 30, 2001, the Company had net lending
commitments to investment grade borrowers of $3.3 billion (gross commitments of
$5.3 billion less $2.0 billion of associated hedges) and $4.1 (gross commitments
of $5.9 billion less $1.8 billion of associated hedges), respectively. Lending
commitments to non-investment grade borrowers totaled $1.4 billion at both
February 28, 2002 and November 30, 2001, respectively. In addition, the Company
has pre-arranged funding facilities with third party lenders of $4.9 billion at
both February 28, 2002 and November 30, 2001, available against these
commitments. These funding facilities contain limits for certain concentrations
of counterparty, industry or credit ratings of the underlying loans.
As of February 28, 2002 and November 30, 2001, the Company had commitments to
invest up to $787 million and $555 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.
<Table>
<Caption>
IN MILLIONS Amount of Commitment Expiration Per Period
---------------------------------------------------------
Total
Contractual Remaining
FEBRUARY 28, 2002 Amount 2002 2002-2005 2005-2007 2008-Thereafter
- ------------------------------------------------------------------------------------------------- ----------------------
Lending commitments
High grade $3,285 $2,310 $ 481 $ 424 $ 70
High yield 1,386 93 676 438 179
Secured lending transactions 85,726 29,955 22,058 9,070 24,643
Standby letters of credit 990 990
Private equity investments 787 787
</Table>
For additional information on contractual obligations see Summary of Contractual
Obligations section of Management's Discussion and Analysis of Financial
Condition and Results of Operations incorporated by reference in the Form 10-K.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
For a discussion of the Company's use of derivative instruments and the risks
related thereto, see Note 5 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 in the Company's day-to-day operations. Consequently, the Company
devotes
24
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
significant resources (including investment in personnel and technology) across
all of its worldwide trading operations to the measurement, management and
analysis of risk.
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. Nonetheless, the effectiveness of
the Company's policies and procedures for managing risk exposure can never be
completely or accurately predicted or fully assured. For example, unexpectedly
large or rapid movements or disruptions in one or more markets or other
unforeseen developments can have an adverse effect on the Company's results of
operations and financial condition. The consequences of these developments can
include losses due to adverse changes in inventory values, decreases in the
liquidity of trading positions, higher volatility in the Company's earnings,
increases in the Company's credit exposure to customers and counterparties and
increase in general systemic risk.
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 weekly 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, but
remains 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 combination facilitates the
analysis of counterparty credit and market risk exposures, while leveraging
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
25
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
of the Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for implementing the
Company's overall market risk management framework. It is responsible for the
preparation and dissemination of risk reports, developing and implementing the
firmwide Risk Management Guidelines, and evaluating adherence to these
guidelines. These guidelines provide a clear framework for risk management
decision-making. To that end, the MRM Department identifies and quantifies risk
exposures, develops limits, and reports and monitors these risks with respect to
the approved limits. The identification of material market risks inherent in
positions includes, but is not limited to, interest rate, equity and foreign
exchange risk exposures. In addition to these risks, the MRM Department also
evaluates liquidity risks, credit and sovereign concentrations.
The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.
Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client-driven market-making transactions, the size of the Company's
proprietary and arbitrage positions, and the volatility of financial instruments
traded. The Company seeks to mitigate, whenever possible, excess market risk
exposures through the use of futures and option contracts and offsetting cash
market instruments.
The Company participates globally in interest rate, equity, 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.
26
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar, as well as a variety of developed and emerging
market currencies. The Company hedges its risk exposures primarily through the
use of currency forwards, swaps, futures and options.
If any of the strategies utilized to hedge or otherwise mitigate exposures to
the various types of risks described above are not effective, the Company could
incur losses.
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
following table sets forth the daily value-at-risk for each component of market
risk as well as total value-at-risk:
<Table>
<Caption>
Three Months Ended
As of February 2002
-------------------------- ------------------------------------------
Feb. 28 Nov. 30
(IN MILLIONS) 2002 2001 Average High Low
---------- ------------ ----------- ------------ -----------
Interest rate risk $15.4 $14.6 $11.1 $15.4 $14.5
Equity price risk 12.5 15.1 13.7 15.1 12.4
Foreign exchange risk 1.8 1.9 1.8 1.9 1.8
Diversification benefit (9.8) (8.3) (4.2) (9.0) (8.8)
---------- ------------ ----------- ------------ -----------
Total Company $19.9 $23.3 $22.4 $23.4 $19.9
========== ============ =========== ============ ===========
</Table>
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.
27
<Page>
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 the Company's 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 February 28, 2002:
[Graphic omitted--bar graph showing: ]
Weekly trading net revenues:
Less than $0 0 weeks
$ 0-50 million 0 weeks
$ 50-100 million 8 weeks
$100-150 million 4 weeks
$150-200 million 0 weeks
$200+ million 1 week
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.
SIGNIFICANT ACCOUNTING POLICIES
The Company's financial statements are prepared in conformity with generally
accepted accounting principles, many of which require the use of management
estimates and assumptions. Management believes that the estimates utilized in
preparing its financial statements are reasonable and prudent. Actual results
could differ from these estimates.
FAIR VALUE The Company records its inventory positions, including Securities and
Other Financial Instruments Owned and Securities Sold but not yet Purchased, at
fair value, with unrealized gains and losses reflected in Principal transactions
in the Consolidated Statement of Income. Market value is generally based on
listed prices. If listed market prices are not available, or if liquidating the
Company's position is reasonably expected to affect market prices, fair value is
determined based on either internal valuation pricing models, which take into
account time value and volatility factors underlying the financial instruments,
or management's estimate of the amounts that could be realized under current
market conditions, assuming an orderly liquidation over a reasonable period of
time. The determination of fair value is fundamental to the Company's financial
condition and results of operations and, in certain circumstances, it requires
the use of complex judgments. The use of different pricing models or assumptions
could produce different estimates of fair value.
TRANSFERS OF FINANCIAL ASSETS The Company accounts for the transfer of financial
assets in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities--a replacement of FASB No. 125" ("SFAS No.
28
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
140"). This statement requires that the transfer of financial assets be
accounted for as a sale when control over the asset has been relinquished.
Control is deemed to be relinquished when the following conditions are met: (i)
the assets have been isolated from the transferor (even in bankruptcy or other
receivership), (ii) the transferee has the right to pledge or exchange the
assets received and (iii) the transferor has not maintained effective control
over the transferred assets. The Company is a market leader in mortgage- and
asset-backed securitizations and other structured financing arrangements. In
connection with these activities, the Company utilizes special purposes entities
principally for (but not limited to) the securitization of commercial and
residential mortgages, home equity loans, government and corporate bonds, and
lease and trade receivables. The Company derecognizes financial assets
transferred in securitizations provided that the Company has relinquished
control over such assets.
The Company may retain an interest in the financial assets it securitizes
("Retained Interests"), which may include assets in the form of residual
interests in the special purpose entities established to facilitate the
securitization. Any Retained Interests are included in Securities and Other
Financial Instruments Owned within the Company's Statement of Financial
Condition. The Company records its Securities and Other Financial Instruments
Owned, including Retained Interests, at fair value, with changes in fair value
reported in earnings.
For additional information on the Company's significant accounting policies see
Note 1 to the Consolidated Financial Statements (Summary of Significant
Accounting Policies) incorporated by reference in the Form 10-K.
NEW ACCOUNTING DEVELOPMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS 141 requires all business combinations initiated after June 30,
2001 to be accounted for using the purchase method. Under SFAS 142, intangible
assets with indefinite lives and goodwill will no longer be amortized. Instead,
these assets will be evaluated annually for impairment. The Company adopted the
provisions of SFAS 142 at the beginning of fiscal year 2002. The adoption of
SFAS 142 had an immaterial effect on the Company's financial position and
results of operations.
29
<Page>
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.
30
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in a number of judicial, regulatory and
arbitration proceedings concerning matters arising in connection with the
conduct of its business. Such proceedings include actions brought against the
Company and others with respect to transactions in which the Company acted as an
underwriter or financial advisor, actions arising out of the Company's
activities as a broker or dealer in securities and commodities and actions
brought on behalf of various classes of claimants against many securities and
commodities firms, including the Company.
Although there can be no assurance as to the ultimate outcome, the
Company generally 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 it intends to defend vigorously each such case.
Based on information currently available and established reserves, the Company
believes that the eventual outcome of the actions against it, including the
matters described below, will not, in the aggregate, have a material adverse
effect on the consolidated financial position of the Company but may be material
to the Company's operating results for any particular period, depending on the
level of the Company's income for such period.
IN RE ENRON CORPORATION SECURITIES LITIGATION
In April 2002 a Consolidated Complaint for Violation of the Securities
Laws was filed in the United States District Court for the Southern District of
Texas in IN RE ENRON CORPORATION SECURITIES LITIGATION, adding as defendants
Holdings along with eight other commercial or investment banks. The case is
purportedly brought on behalf of purchasers of Enron Corporation's publicly
traded equity and debt securities between October 19, 1998 and November 27,
2001, and, in addition to the banks, names 38 current or former Enron officers
and directors, Enron's accountants, Arthur Anderson and affiliated entities and
partners, and two law firms. The complaint seeks unspecified compensatory and
injunctive relief for purported violations of federal and state securities laws
based on the theory that defendants engaged or participated in manipulative
devices to inflate Enron's reported profits and financial condition, made false
or misleading statements and participated in a scheme or course of business to
defraud Enron's shareholders. Against Holdings, the complaint alleges violations
of Sections 11 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934 (the "Exchange Act") and the Texas
Securities Act.
IPO ALLOCATION CASES (reported in Holdings' 2001 Annual Report on Form 10-K)
A new suit was filed in April 2002 in Delaware Chancery Court by
Breakaway Solutions Inc. ("Breakaway"), which names LBI and two other
underwriters as defendants. The complaint purports to be brought on behalf of a
class of issuers who issued securities in initial public offerings ("IPOs")
through at least one of the defendants during the period of January 1998 through
October 2000 and whose securities increased in value 15% or more above the
original price within 30 days after the IPO. It alleges that defendants
underpriced IPO securities and allocated those underpriced securities to certain
favored customers in return for alleged arrangements with the customers for
increased commissions on other transactions and alleged tie-in arrangements. The
complaint asserts claims for breaches of contract, of the implied covenant of
good faith and fair dealing and of fiduciary duty, and for indemnification or
contribution and unjust enrichment or restitution. Breakaway seeks, among other
relief, certification of a
31
<Page>
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
class, a permanent injunction preventing defendants from engaging in the alleged
practices, an accounting of all defendants' commissions, profits and
compensation in connection with the IPOs, declarations requiring defendants to
indemnify Breakaway in the pending consolidated IPO securities class actions and
determining that Breakaway has no indemnification obligation to defendants in
those actions, and compensatory damages.
ACTIONS REGARDING FRANK GRUTTADAURIA (reported in Holdings' 2001 Annual Report
on Form 10-K)
The following additional actions have been filed relating to the
alleged conduct of Frank Gruttadauria, the former branch manager of the
Company's Cleveland office:
DOMINIC A. VISCONSI, SR. AND DOMINIC A. VISCONSI, JR. AND
JAMES V. STANTON V. LEHMAN BROTHERS, INC. AND S.G. COWEN SECURITIES
CORP. In March 2002, LBI was served with a complaint in the United
States District Court for the Northern District of Ohio. The complaint
alleges breach of fiduciary duty, fraud, aiding and abetting,
promissory estoppel, negligent misrepresentation, breach of contract,
conversion, negligent hiring, negligent supervision and violations of
the Investment Advisers Act of 1940 (the "Advisers Act"). Plaintiffs
seek unspecified compensatory and punitive damages, a full accounting
of all account activity, attorneys fees and costs and prejudgment and
postjudgment interest.
GEORGIA SARANTAKIS AND CAROL ANN COYLE V. FRANK DOMINIC
GRUTTADAURIA, LEHMAN BROTHERS, INC., LEHMAN BROTHERS HOLDINGS, INC. ET
AL. In March 2002, LBI and Holdings were served with a complaint in the
United States District Court for the Northern District of Illinois. The
complaint alleges violations of Sections 10(b) and 20(a) of the
Exchange Act, of Illinois securities laws and of various NASD and New
York Stock Exchange rules, breach of fiduciary duty, fraud, negligent
hiring and supervision and negligent misrepresentation. Plaintiffs seek
unspecified compensatory and punitive damages, prejudgment and
postjudgment interest and attorneys fees and costs.
SAMUEL GLAZER V. LEHMAN BROTHERS, INC. AND S.G. COWEN
SECURITIES CORPORATION. In March 2002, LBI was served with a complaint
in the United States District Court for the Northern District of Ohio.
The complaint alleges breach of fiduciary duty, fraud and deceit,
negligent retention, hiring and supervision, negligent and reckless
misrepresentation, breach of implied contract, conversion, violations
of Sections 10(b) and 20(a) of the Exchange Act, civil conspiracy,
aiding and abetting and promissory estoppel. Plaintiff seeks the
amounts in his accounts from various times, alleged to be in excess of
$24 million, the value of income tax paid on non-existent transactions
and expense to correct tax returns, fair compensation for value
converted from his accounts including interest, punitive damages in the
amount of $500 million and attorneys fees and costs.
ALAN YALE AND JUDITH YALE V. S.G. COWEN SECURITIES CORPORATION
AND LEHMAN BROTHERS INC. In April 2002, LBI was served with a complaint
in the United States District Court for the Northern District of
Illinois. The complaint alleges violations of Sections 10(b) and 20(a)
of the Exchange Act, of the Advisers Act and of Illinois laws,
conversion, fraud, civil conspiracy, aiding and abetting, breach of
fiduciary duty, negligent misrepresentation, negligence, promissory
estoppel and breach of contract. Plaintiffs seek "benefit of the
bargain damages", compensatory damages in an amount substantially
exceeding $12 million, treble compensatory damages under the Illinois
Consumer Fraud Act, punitive damages in the amount of five times
compensatory damages, a full accounting of all account activity,
attorneys fees and costs and prejudgment and postjudgment interest.
32
<Page>
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:
3.01 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)
3.02 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)
3.03 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)
3.04 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)
3.05 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)
3.06 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)
11.01 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 11 TO
THE CONSOLIDATED FINANCIAL STATEMENTS (EARNINGS PER COMMON SHARE))
12.01 Computation of Ratios of Earnings to Fixed Charges and to Combined
Fixed Charges and Preferred Stock Dividends (FILED HEREWITH)
33
<Page>
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 February 5, 2002, Item 7.
2. Form 8-K dated February 1, 2002, Item 7.
3. Form 8-K dated December 26, 2001, Item 7.
4. Form 8-K dated December 20, 2001, Items 5 and 7.
Financial Statements:
Exhibit 99.2 Selected Statistical Information
(Preliminary and Unaudited)
Exhibit 99.3 Consolidated Statement of Income
(Three Months Ended November 30, 2001)
(Preliminary and Unaudited)
Exhibit 99.4 Consolidated Statement of Income
(Twelve Months Ended November 30, 2001)
(Preliminary and Unaudited)
Exhibit 99.5 Segment Net Revenue Information
(Three and Twelve Months Ended
November 30, 2001)
(Preliminary and Unaudited)
34
<Page>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEHMAN BROTHERS HOLDINGS INC.
(Registrant)
Date: April 15, 2002 By: /s/ DAVID GOLDFARB
--------------------------------------
Chief Financial Officer
(principal financial and accounting officer)
35
<Page>
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT
- ----------- -------
Exhibit 12.01 Computation of Ratios of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends
36