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LEHMAN BROTHERS ANNUAL REPORT 2000

3 WORLD FINANCIAL CENTER, NEW YORK, NY 10285 WWW.LEHMAN.COM

Where Vision Gets Built

ANNUAL REPORT 2000

SM

1842/cover mechanical 2/13/01 7:45 AM Page 2

Lehman Brothers. The Mission. Our Firm. We are a rapidly growing global institutional investment bank with a heritage of over 150 years of success. As a growth company in a growth industry, our atmosphere is charged with entrepreneurial energy. We are a culture of “we’s”, not “I’s”, with a commitment to access and teamwork. The hallmark of our success will be our reputation as a firm that generates and supports exceptional levels of opportunity and initiative.

Our One-Firm culture allows us to team up and bring together the best of Lehman Brothers to meet our clients’ most important needs. We do this by taking the initiative to reach out to our clients; by listening carefully to understand their needs; by developing innovative and tailored solutions; and by delivering the full resources and strength of the Firm to provide superb execution of those solutions. The hallmark of our success will be that our clients look to us first as their lead investment bank.

Our People. Our success depends on the strength of our people. Our goal is to attract and develop exceptionally talented people who share our passion for individual excellence and our commitment to teamwork. We do this by attracting the best person to fill every role within the Firm; by developing everyone to reach their full potential; by fostering the mindset that finishing second is unacceptable; and by working together in an environment of integrity, respect and trust as One Firm. The hallmark of our success will be our wide recognition as a unique firm in which exceptional people build rewarding careers.

Our Shareholders. As employees, we are all shareholders of Lehman Brothers and are deeply committed to building the value of the Firm. Our goal is to deliver superior returns to all of our shareholders. We do this by committing to opportunities that offer exceptional returns; by focusing on productivity, expense discipline and profitability; by managing our risks and maintaining our financial strength; and by preserving our reputation. The hallmark of our success will be the strength of our long-term record of value creation for our shareholders.

TABLE OF CONTENTS Financial Highlights Letter to Stockholders and Clients Creating Opportunity Building Value Delivering Performance Business Review Financial Review Board Members and Officers Locations Worldwide Other Stockholder Information

1 2 6 10 22 26 36 89 92 96

Design: Russell Design Associates Photography: Shonna Valeska, Joe McNally, Neal Wilson, Patrick Lucero, Paul Hu / Liaison Agency

Our Clients.

pages 1-25 2/21/01 2:22 AM Page 1

Financial Highlights Twelve Months ended November 30

2000

(in millions, except per common share and selected data)

1999

1998

1997

1996

FINANCIAL INFORMATION Net revenues

$

7,707

$

5,340

$

4,113

$

3,873

$

3,444

Net income(1)

1,775

1,132

736

647

416

Total capital(2)

43,874

37,684

32,754

24,784

19,796

PER COMMON SHARE DATA(3) Earnings(4)

$

6.38

$

4.08

$

2.60

$

2.36

$

Dividends declared

$

0.22

$

0.18

$

0.15

$

0.12

$

1.62 0.10

Book value

$

28.78

$

22.75

$

18.53

$

16.70

$

14.42

Ending stock price

$

49.56

$

38.19

$

25.00

$

25.28

$

14.56

SELECTED DATA Return on average common equity Before redeemable preferred dividend

27.4%

21.8%

16.3%

17.0%

12.3%

After redeemable preferred dividend

26.6%

20.8%

15.2%

15.6%

12.1%

Pretax operating margin

33.5%

30.5%

25.6%

24.2%

18.5%

Adjusted leverage ratio(5)

16.6X

18.6X

20.6X

23.9X

24.8x

Weighted-average common and equivalent shares(4)

264,163,612

258,565,344

249,983,662

242,129,858

232,747,170

11,326

8,893

8,873

8,340

7,556

Employees (1) 1996 results include an after-tax special charge of $50 million.

(2) Total capital includes long-term debt, stockholders’ equity and preferred securities subject to mandatory redemption. (3) All share and per share data have been restated for the two-for-one common stock split effective October 20, 2000. (4) For the years ended November 30, 2000 and 1999, the assumed conversion of Series A and B Convertible Preferred Stock into 2,438,375 and 5,559,474 common shares had the effect of decreasing diluted earnings per share by $0.03 and $0.02, respectively. (5) Ratio of total assets excluding matched book to total stockholders’ equity and other preferred securities.

1

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Dear Stockholders and Clients Lehman Brothers had an exceptional year in 2000. We achieved the best financial performance in the history of the Firm, hitting a record level of revenues, earnings, and returns. We realized significant growth as a franchise, not only in transaction volumes, but also in terms of the breadth and depth of our global enterprise. We continued to expand our roster of global clients and attracted a large number of extraordinary people to the Firm. Our strong financial position provides a solid foundation to support our expansion and our high rate of growth. We are very proud of these results in light of last year’s market volatility, demonstrating the growing power of our franchise.

Richard S. Fuld, Jr. Chairman and Chief Executive Officer

Lehman Brothers posted outstanding results in 2000. The Firm reported net revenues of $7.7 billion and net income of $1.8 billion, increases of 44 percent and 57 percent, respectively, over last year’s results. For the past five years, the Firm has grown revenues by 22 percent per year and increased earnings at a rate of 44 percent per year. We reported earnings per share of $6.38 versus $4.08 per share in 1999. We ended the year with a return on equity of 27.4 percent before accounting for the special preferred stock dividend. In 2000, we effected a two-for-one stock split — our first ever — and early this year, we raised our common stock dividend to $0.28 per share, a 27 percent increase. These results strongly affirm our position as a preeminent institutional investment bank. Lehman Brothers has succeeded in creating a diversified, highly profitable investment bank through the growth of its higher margin businesses. In 2000, we continued to improve our revenue mix: Investment Banking fees accounted for 28 percent of our total revenues; Equities provided 34 percent; Fixed Income produced 27 percent; and Client Services provided the remaining 11 percent. From a product perspective, Lehman Brothers’ revenue base has clearly never been more diversified; but the Firm has also focused its resources on geographic diversification, responding to the higher growth potential in a number of markets outside the U.S. Our non-U.S. operations generated 42 percent of total revenues in 2000, with Europe accounting for 31 percent. Our scale and diversification make us a provider of choice among our clients, and they help to generate a more consistent base of revenues to weather difficult market conditions. BUILDING OUR CORE FRANCHISE

Lehman Brothers is strategically expanding all of its major businesses. Regionally, the Firm is concentrating its investments in Europe to capture the

2

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Net Revenues in millions of U.S. dollars $7,707

$5,340

$3,873

97

$4,113

98

99

00

Net Income in millions of U.S. dollars

$1,775

$1,132

$736 $647

97

98

99

00

dynamic evolution of that region’s capital markets. The Firm’s strategic investments continued in 2000; as the year progressed, they were increased, as we capitalized on unique opportunities created by dislocations within the industry. In 2000, we made significant strides in building our Investment Banking Division through a well-executed expansion plan. We added more than 500 bankers, growing our ranks to 2,100 professionals, and broadly expanding our client coverage in targeted industry sectors and in key products such as mergers and acquisitions and equity financing. Importantly, we also strengthened our local presence in Europe, as we made significant additions in the U.K., Germany, France, the Benelux countries, Spain, Switzerland and Sweden. We have consistently increased our share of investment banking business when and where we establish client coverage; consequently, these investments should contribute to continued revenue and market share momentum. Our results to date reaffirm our strategy: over the past five years, we have succeeded in growing our Investment Banking revenues by 27 percent per year, and in 2000, we reported revenues of $2.2 billion, a 31 percent increase over the prior year. We have also substantially expanded our Equities Division, focusing on all aspects of this business — building our capabilities in sales and trading, derivatives and financing, while ensuring full integration among these units. Over the past three years, we have doubled the size of Equity Research and dramatically increased the number of companies we evaluate. We have invested in the quality and scale of our sales force and have achieved a corresponding increase in the volume of business we transact with equity investors around the world. We have also expanded our equity derivatives capabilities and now rank as one of the world’s largest dealers. This past year, we made significant strides in enlarging our Equity Finance and Prime Brokerage capabilities through enhanced technology and the addition of seasoned professionals. All told, we have made dramatic progress: since 1996, we have grown our Equity revenues by an extraordinary 59 percent per year; our revenues in 2000 totaled $2.6 billion, an 84 percent increase versus 1999. In 2000, we continued to reinforce the diversification and dominant market position we hold in Fixed Income. We expanded our high grade and high yield capacity in Europe and bolstered our expertise in structured credit, derivatives and securitizations. Our continued investments in building this division helped us to increase our Fixed Income revenues in 2000 to $2.1 billion, a 24 percent increase versus the prior year, in an exceedingly difficult market. We also broadened the scope of our Client Services Division in 2000. Through a combination of organic growth and acquisition, we increased our total number of high net worth financial consultants to 450. With a productivity level that is among the highest in the industry, Private Client Services has been a growing contributor to Firmwide revenues. We have also grown our alternative asset

3

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“Our scale and diversification make us a provider of choice among our clients, and they help to generate a more consistent base of revenues to weather difficult market conditions.”

Return on Equity* percent

27.4%

21.8%

17.0%

management business by expanding our Private Equity capabilities. Over the course of 2000, we successfully completed the investing process for our Venture Capital fund, raised an $800 million global communications fund, and closed on $590 million in commitments for a global real estate fund. We ended the year with over $4.5 billion in Private Equity assets under management. Our Client Services Division is important to the Firm in other ways, including the sourcing of a significant number of opportunities for our Investment Banking franchise. From a geographic perspective, Lehman Brothers has focused on Europe, where the forces of deregulation, globalization, pension and taxation reform, and a single currency have established the foundation for significant growth. In Europe, we have built a strong track record: our revenues have grown at an annual rate of 43 percent per year since 1997, and revenues for 2000 rose 45 percent over the prior year. We have established a large platform throughout Europe that we continue to expand. Since 1997, we have almost doubled our European headcount from 1,500 to over 2,900, with an addition of 900 professionals this year alone. Clearly, 2000 was a year of significant achievement for Lehman Brothers. We aggressively pursued strategic investments to broaden the scope of our franchise, ultimately adding over 2,400 people to bring our total number of employees to 11,326 at year end. This expansion leaves us well-positioned for the many opportunities we see worldwide. We accomplished this growth while reporting record financial results. This achievement stems from a number of core competencies that are part of Lehman Brothers’ culture. GROWING OUR COMPETITIVE ADVANTAGE

16.3%

Expense management is one of those core competencies, and we have established ourselves as one of the most cost efficient investment banks. We focus on expenses as actively as we focus on increasing our revenue base, maintaining a significant component of variable expenses in order to weather difficult market environments. This proficiency has allowed Lehman Brothers to increase its earnings at a rate that far exceeds its overall revenue growth.

97

98

99

00

* Before redeemable preferred dividend.

We have also made significant enhancements to our risk management processes and our liquidity and funding framework, ensuring that we are best in class in these extremely important management disciplines. Our conservative approach to these activities, coupled with our $44 billion capital base, provide us with the solid financial structure to grow our business while sustaining competitive performance in market downturns. This strength was recognized by Moody’s Investors Service, when they upgraded our debt rating to single A this past November. We also regard our technology infrastructure as a major source of competitive advantage — it supports our growth, provides scale, increases productivity and gives us the capability to deliver valuable content to our clients. Our enhanced trading and risk management systems support our growing volume of business.

4

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“At Lehman Brothers, we believe that our culture creates the ultimate cornerstone for our competitive advantage. Our

In terms of electronic trading, we have positioned ourselves to capitalize on the opportunities presented by connectivity, participating in numerous consortia and alternative trading systems in major product categories and extending this liquidity to clients. Our launch of LEHMANlive provides a powerful platform to deliver product, research, and other content to our clients. In 2000, we pioneered the e-syndicate and have participated in numerous electronic bond offerings. Our objectives continue to be the facilitation of superior execution, speed, transparency and efficiency for our clients.

culture is one of trust and commitment, and we extend that commitment to our clients, employees and shareholders.”

High/Low Price Range of Common Stock* in U.S. dollars

$80.00

•

$42.50

•

•

• $31.06

•

•

$20.44

97

• $12.38

98

Our clients are the heart of our franchise — they define our purpose and, ultimately, the strength of our Firm. We regard our client relationships as partnerships, where the excellence of our ideas, advice, products, service and execution determine the quality and longevity of these relationships. As a partner, we look to help our clients achieve their vision, sharing in their success through our efforts. Our employees provide the intellectual capital that defines Lehman Brothers. As a Firm, we are committed to developing this talented group of people to reach their maximum potential. Our employees share in our success through their stock ownership, which accounts for 33 percent of our outstanding shares and equivalents. This provides a powerful incentive to ensure an atmosphere of excellence, ownership, integrity and commitment to our One Firm principle of teamwork.

$41.94

$28.06

• $14.50

At Lehman Brothers, we believe that our culture creates the ultimate cornerstone for our competitive advantage. Our culture is one of trust and commitment, and we extend that commitment to our clients, employees and shareholders. A CULTURE OF COMMITMENT

99

00

* Adjusted for 2-for-1 stock split in fiscal 2000.

Our stockholders share in our success, as the Firm’s financial performance ultimately drives our value as an enterprise. Our performance this year has improved our market capitalization to over $16 billion, a 60 percent increase versus year-end 1999 and a 45 percent annual rate of return for our shareholders since 1996. Our performance in 2000 validates our strategy and our commitment to the proposition of creating shareholder value. Given the many opportunities we see around the world, we believe this value creation has just begun. We look forward to long and successful partnerships with our clients and shareholders as we move forward.

Richard S. Fuld, Jr. Chairman and Chief Executive Officer February 14, 2001

5

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Creating Opportunity At Lehman Brothers, we build our clients’ vision, helping them extend both their reach and their grasp. Naturally, we actively collaborate Growth in Worldwide Headcount 11,326

in formulating their business goals. But we also work to turn those aspirations into tangible results.

8,893

8,873

We identify opportunities for clients, but more importantly, we create opportunities by rebuilding and realigning our capabilities to correspond with our clients’ needs and a changing marketplace. Within the last year, we substantially expanded 98

99

00

the Firm, made highly productive investments in research and technology, and fostered numerous

Ranked Research Analysts

alliances to heighten our ability to create such Equities

Fixed Income 40

31

24 19

99

00

99

00

Source: Institutional Investor U.S. poll data

6

new and rewarding opportunities for our clients.

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Expanding the Franchise Building vision and creating opportunity demand the best tools available, wherever the job needs doing. Consequently, Lehman Brothers continued its planned expansion in 2000. Overall staff increased by 27 percent, to more than 11,300, with especially significant investments in equity research, equity sales and trading, investment banking, and technology. The incoming class of analysts and associates was the largest in Firmwide history at more than 600. Beneath the sheer numbers lies an enviable resource of talent. Our standing and success attract the best quality professionals, whom we are also retaining at an extremely high rate. Industry consolidation has further deepened the talent pool. In Investment Banking, the Firm has added significant teams in technology, heathcare, media and telecom, financial institutions, chemicals, power, industrials and consumer products, among others. In research, the expanded depth and capabilities of our sector teams is one explanation for the dramatic gains we achieved in industry rankings. In our Equity business, we added capacity in the cash, derivatives and financing units to effectively address our increased volume of business and our growing client roster. In Fixed Income, we bolstered our securitization and structured credit areas, while expanding our high grade and high yield capabilities in Europe. We also acquired approximately 92 retail brokers from SG Cowen, to augment our high net worth sales force in Private Client Services. In short, our capacity to deploy uncommonly gifted professionals against the needs of our clients is growing as never before. We continue to extend our presence into local markets to enhance our client coverage. Last year, we established 11 new offices and are now located in 24 countries. Our expansion strategy has most recently targeted Europe, where the fundamentals for rapid growth and increased utilization of institutional investment banking products and services are particularly compelling. Borders and barriers to doing business continue to come down, while the single currency promotes a pan-European view and a stable platform for growth and reform. Accordingly, in 2000, we added more than 900 people to bring our total in Europe to over 2,900 professionals. We opened new offices in Rome, Stockholm, Amsterdam, and Munich, while tripling the size of our banking staff in Frankfurt. We have created a powerful presence in Europe as we continue to respond to the needs and goals of our global client base.

7

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Research During a year of severe market pressures, many investment banks scaled back their research efforts. Lehman Brothers remains committed to research excellence as a central hallmark of our client franchise. This commitment is apparent in the highly respected “All America Research Team” selections by Institutional Investor magazine. In Equity Research, we have significantly expanded our capabilities on a global basis to better serve our corporate and institutional clients. Demonstrating this success was the outstanding showing in last year’s Institutional Investor survey, where the Firm increased its number of ranked analysts in the U.S. by 63 percent to 31 — the largest increase of any competitor. In Europe, we doubled our ranked analysts from five to 11. Globally, the group has expanded to approximately 600 professionals — virtually a doubling over a three year period. Equity Research now covers 75 industries and 1600 companies, including over 90 percent of the S&P 500. Aside from quality fundamental research and stock-picking, the group has developed a strong reputation, confident that their responsibility to clients demands candor and objectivity. Lehman Brothers overwhelmingly dominated the Fixed Income Research rankings with 40 positions overall, demonstrating strength across the board — from high grade corporates to distressed securities to relative value strategies. In addition to its highly regarded qualitative, quantitative, economic and strategic analysis, Fixed Income Research produces the world’s leading bond market indices, providing comprehensive performance and risk measurements for all major bond markets. More than 90 percent of major institutional investors in the U.S. employ the Lehman Family of Indices, which are now being extensively used in Europe and are newly introduced in Asia. Index and portfolio tools once used exclusively by traders for risk management and analytics are now available to clients as the Firm continues to provide powerful website content.

8

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Technology and E-Commerce

Global Alliances

Lehman Brothers manages technology from the viewpoint of improving the level of service and efficiency for the Firm, as well as for our clients. We look to achieve rapid and reliable implementation of client solutions, quality content, superior front-end applications and execution immediacy. During 2000, we launched LEHMANlive, our new client site. This year we expect LEHMANlive to service some 10,000 clients with Lehman Brothers’ award-winning research, advanced analytical tools, market monitors, webcasts, account information, indices, clearing and execution capabilities. Over the course of 2001, we will be adding electronic trading in a wide array of products, both equity and debt. In Fixed Income, the strong movement toward electronic trading has prompted the formation of numerous dealer consortia in which we participate. The substantial savings in execution costs made possible by electronic trading is an advantage institutional clients have been quick to notice. We have developed proprietary analytics such as POINT, a valuable tool for clients to analyze and dissect their portfolios. We have also managed several e-bond offerings over the Internet, and the transparency of the process is particularly attractive to issuers. In Equities, our expertise is available through Lehman Links among other sources, an electronic connectivity service that offers clients fast, more convenient, and automated access to our trading desks worldwide, to major equities exchanges, ECNs, and other liquidity sources. Technology is, of course, not limited to e-commerce. The Firm’s equity trading volume doubled in 2000 over the previous year; systems upgrades and capacity increases have been vital to managing this increased flow. Lehman Brothers continues to implement technology solutions to address the challenges of improved information-gathering, e-trading, settlement and clearance, while striving for enhanced productivity and speed of execution.

In a testimony to Lehman Brothers’ capabilities, many firms have invited us to jointly serve their clients. Here are just some of those alliances that have broadened our global platform. Global Distribution

Lehman Brothers has extended its distribution capabilities to the retail and online investor by providing securities products and research to a number of institutions. In the U.S., we have partnered with Fidelity Investments, providing access to their 11.4 million retail customers. In Germany, we work with Consors, and in Italy we have allied with FINECO — expanding both companies’ online brokerage product offerings. We have also joined with ANZ Bank to provide their institutional customers in Australia and New Zealand with capital markets products and services. Investment Banking & Private Equity

In Investment Banking, we have partnered with Bank of Tokyo-Mitsubishi to jointly pursue advisory opportunities among their client base. In the field of municipal finance, we have formed a partnership with Cain Brothers & Co., a specialist in the healthcare field. In Private Equity, we have joined with Booz-Allen & Hamilton in an alliance to provide venture financing and strategic services for early-stage companies.

“Europe represents a unique opportunity for Lehman Brothers: the markets there have grown quickly, but they have the scope to double in size. Seizing these opportunities requires creativity, knowledge and understanding, and we see research at the core of this. Consequently, we continue to add depth and breadth to our pan-European research coverage, where we emphasize quality and focus in this highly-branded product.” Jeremy M. Isaacs Chief Executive Officer, Lehman Brothers Europe & Asia

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Building Value Lehman Brothers continues to broaden the spectrum of value it provides to clients: from creating opportunities, expanding or restructuring a business, adjusting to difficult changes that a client may experience, through the complete range of financing options, to effective, rapid and reliable execution and consistent follow-up. We foster a culture that digs deeper and works harder in pursuing our clients’ business goals. As we partner with our clients, we make their aspirations our own. Completed M&A

$340b

In the following pages, we detail a number of transactions that demonstrate our commitment to building value for our clients. We are especially

Debt Underwriting

proud of our long-term relationships with clients,

$155b

who look to us repeatedly to turn their visions into

Equity Underwriting

realities and rely on our ongoing commitment

$14b

to their interests.

Completed Transactions Calendar Year 2000 Source: Thomson Financial Securities Data Corp.

10

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Asian Restructuring / Financing Asian economic recovery continued to gather momentum last year, and Lehman Brothers played an important role with long-standing clients. The Republic of the Philippines sought to consolidate debt at the sovereign level, reduce the principal amount of its debt, and enhance liquidity with a large benchmark issue. Lehman Brothers devised a series of simultaneous transactions, including a $1.6 billion global bond offering for the Republic; an exchange of global bonds for $300 million of government-guaranteed National Power Corporation (NPC) debt; the use of $34.3 million of the offering proceeds to purchase $41.4 million of NPC bonds; and the on-lending by the Republic of $500 million in proceeds to NPC via the purchase of newly-issued NPC bonds. This was the largest Asian sovereign offering in 2000, and the first-ever third party bond tender/exchange by any sovereign borrower. The Firm has also acted as advisor to the Indonesian Bank Restructuring Agency since the summer of 1998, developing and executing programs designed to rehabilitate the banking sector and to help fund the $50 billion cost of bank restructuring. Last year, we advised IBRA on the sale of its 40 percent stake in PT Astra International Tbk, one of the country’s largest conglomerates. The $500 million transaction was the largest M&A deal ever and the first major asset sale in Indonesia. We also advised IBRA on the restructuring of over $10 billion in corporate debt and on the initial public offering of Bank Central Asia, the first bank equity sale in Indonesia since the Asian economic crisis.

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Comverse Technology, Inc. / Ulticom Inc. Comverse Technology, Inc. is the world’s leading provider of communications software and systems that enable wireless and wireline network operators to offer value-added enhanced services to their customers. Comverse has significant operations in Israel, where Lehman Brothers was the first global investment bank to open an office. Lehman Brothers has been assisting the company in building its enterprise since 1993 by utilizing our dominant franchise in both Israel and the technology sector worldwide. In 1993, Lehman Brothers lead-managed the first major financings for Comverse, with a $59 million common stock offering and a $60 million convertible debt offering. Since then, the Firm has sole-managed three additional convertible offerings for Comverse, including one for $600 million in 2000, and advised Comverse on its $461 million acquisition of Exalink Ltd. Also in 2000, Lehman Brothers advised the client on how best to realize additional value from its subsidiary, Ulticom Inc., and then led that $63.5 million IPO, one of the top 10 best performing IPOs of 2000, during an extremely difficult stock market. Six months later, we led a $213 million common stock offering for Ulticom. In 1993, Comverse was valued at $297 million. Today, with Lehman Brothers as its primary investment bank, that value is in excess of $20 billion.

12

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BellSouth Corporation / Cingular Wireless Communications and Media is an industry specialization where Lehman Brothers’ professionals have achieved recognized leadership for many years. For one of our clients, BellSouth Corporation, Lehman Brothers has completed five advisory and financing transactions since 1998, including advising on the sale of its wireless towers and the issuance of a total of $2.5 billion in debt securities. In 2000, we were joint-lead manager for a $2 billion offering of BellSouth term debt. As one of the leading experts on corporate restructurings, the Firm also advised the company on the creation of its Latin American tracking stock. Also in 2000, BellSouth wanted to review its strategic alternatives for its wireless communications business and turned to Lehman Brothers for advice. The result was the creation of Cingular Wireless in October, a joint venture that combined BellSouth’s domestic wireless voice and data operations with those of SBC Communications Inc. Cingular Wireless has been a major force in the wireless communications industry from its inception, and is today the second largest wireless company in the United States.

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Global Natural Resources In the rapidly consolidating oil and gas sector, Lehman Brothers’ understanding of industry forces and command of a broad range of financial issues was critical for two clients. For Lehman Brothers, the announcement of Chevron’s $43 billion merger with Texaco was the culmination of several years of relationship building. In early 1999, when Chevron began negotiations with Texaco, they turned to Lehman Brothers — having worked across the negotiating table from us in a number of transactions. While those early negotiations did not lead to a transaction, in late 1999, we advised Chevron on two significant fixed income financings. And in 2000, we advised the company on the formation of a landmark $6 billion petrochemicals joint venture with Phillips Petroleum. In 2000, Chevron and Texaco began a fresh round of negotiations; Lehman Brothers advised Chevron on the full range of structural, financial and accounting issues surrounding the transaction with a merger agreement announced in October. Lehman Brothers also maintains an extensive long-standing relationship with Kerr-McGee, an Oklahoma-based energy company. Hearing that Repsol-YPF, the Spanish energy firm, was considering a divestiture of its North Sea properties, our bankers in the U.S. and Madrid arranged discussions between the two companies. Once the $550 million acquisition was completed, Lehman Brothers arranged the financing — a concurrent offering of 7.5 million common shares and $600 million in convertible subordinated debentures. Kerr-McGee raised $1 billion in proceeds in the largest exploration and production financing of 2000.

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KirchGroup Until 1998, KirchGroup, Germany’s second largest media company, was privately owned by Dr. Leo Kirch and consisted of numerous media businesses. KirchGroup needed a more rational and effective structure to give the company a solid foundation for growth, the penetration of international media markets, and the potential to raise outside capital. The company chose Lehman Brothers to advise it based on our media expertise and our ability to resolve complex structuring issues. Lehman Brothers identified three reorganizational objectives: (i) streamlining the group by realigning the corporate structure along principal business lines to create “pure-play” formations; (ii) raising capital through the entry of strategic private equity investors while enhancing the Group’s overall valuation; and, (iii) preparing the company for a future IPO. Lehman’s assistance in restructuring the company in early 1999 resulted in three separate holding companies: KirchMedia (programming rights and commercial television), KirchPayTV, and KirchBeteiligung (other media assets). Later that year, we raised DM1.6 billion for KirchMedia from a core group of strategic shareholders, including our own Merchant Banking group, while advising on a subsidiary's DM2.0 billion TV joint venture with Mediaset. In 2000, Lehman Brothers advised the group on a number of transactions, including a DM1.2 billion investment in KirchPayTV by core shareholders, including Lehman Brothers’ Merchant Banking; a $375 million block trade of BSkyB shares for KirchPayTV; and, KirchMedia’s acquisition of shares in ProSieben Media and SAT.1 and their subsequent merger to create Germany’s leading family of broadcasters.

Alteon WebSystems, Inc. Lehman Brothers’ recognized standing in the technology sector prompted Alteon WebSystems to appoint the Firm as its sole bookrunning lead manager in 1999. Alteon is a pioneer in the design of “content switches” — intelligent Web switches used to manage and route Internet traffic — and controls approximately 40 percent of that market. Lehman Brothers explored with Alteon the company’s strategic vision, defining its goals and the means by which these could be turned into reality. The first step of Alteon’s growth plan was Alteon’s $87 million initial public offering in late 1999, in which the Firm served as sole bookrunning lead manager. Four months later in early 2000, Lehman Brothers again served as sole bookrunning lead manager for a $569 million follow-on equity offering, providing the company with the capital to expand its business. In the course of 2000, our strategic explorations with Alteon began to focus on how the company might benefit most from a long-term strategic partnership with a large telecommunications equipment company. This past October, we served as Alteon’s sole financial advisor in its acquisition by Nortel Networks for $7.8 billion, one of the largest M&A transactions among communications equipment makers ever.

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Qwest Communications International Inc. As a result of the Firm’s strength in the communications industry and long-term relationship with U S WEST, Lehman Brothers was retained by the company in 1999 to evaluate two competing merger proposals. Viewing the combination with broadband communications provider Qwest as a tremendous strategic transaction, we served as advisor to U S WEST on that $56 billion deal, the largest merger transaction in the Firm’s history. The combination created a leading growth company in the communications sector, with a state-of-the-art fiber optic network for Internet-based communications around the world and core local and wireless operations in 14 states. Shortly after the merger, the “new” Qwest turned its sights on the bond market in order to re-finance its short-term debt. Recognizing the value that Lehman had created in facilitating the merger and our leading role in underwriting telecommunications debt, Qwest retained Lehman Brothers as joint bookrunner. In its inaugural post-merger financing, Qwest raised $3 billion – up from the original target of $2 billion. This offering, cited as “Runner-Up” for 144A Bond Deal of the Year by Corporate Finance, was a strong statement about the “new” Qwest, and it underscored our Firm’s strength in providing new credits with efficient access to the capital markets.

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Convertible Securities Lehman Brothers excels in underwriting conventional and highly structured convertible securities. These securities offer issuers vast corporate finance flexibility and are an increasingly important part of the capital markets. We were bookrunner on more than $7.8 billion of convertibles in calendar year 2000. The Firm continued its tradition of creative financing by introducing a premium puttable convertible structure into the U.S. market with a $550 million transaction for Teva Pharmaceutical Finance LLC. We also underwrote one of the largest-ever euro-denominated exchangeables, a €2.5 billion issue for Tecnost, allowing this Olivetti subsidiary to monetize its stake in Telecom Italia while efficiently financing its corporate needs. For the fourth time, we were bookrunner for a convertible offering by communications equipment provider Comverse Technology, Inc. in a $600 million sole-managed overnight transaction, maximizing the client’s proceeds while minimizing its stock price risk. Lehman also sole-managed a $300 million overnight convertible offering for L-3 Communications Holdings, taking advantage of favorable conditions to eliminate market risk. For Vitesse Semiconductor Corporation, we successfully priced a $720 million convertible with a two-day accelerated “book-build” marketing period, despite volatile market conditions. This was the largest convertible issuance by a U.S. semiconductor company at the time. The $357 million convertible we joint lead-managed for International Power was the lowest yielding sub-investment grade issue in Europe in 2000, in the client’s inaugural financing after its demerger from National Power plc.

Capital Securities Lehman Brothers is an undisputed leader in devising bank capital solutions: we are able to structure bank capital transactions across a wide variety of regulatory jurisdictions and tax regimes in a range of currencies to meet the specific strategic needs of our clients. In 2000, we managed 42 of these transactions, raising over $19 billion for our clients. Notable among these transactions is the U.S. $1 billion offering we arranged for the Abbey National plc, which was the first Yankee hybrid Tier 1 preferred issue by a U.K. bank, as well as the first e-preferred, with web-based marketing, distribution, and execution. We acted as joint bookrunner in a $2.0 billion (equivalent) multi-tranche, multi-currency subordinated issue for AXA, one of the world’s largest insurers, helping that company to strengthen its capital base and refinance the recent acquisition of certain minority interests in AXA Financial. This transaction was the largest-ever subordinated issue from the insurance sector and AXA’s inaugural issue in the U.S. market. We also served as sole manager on a $500 million flexible Money Market Cumulative Preferred offering for Zurich Capital Markets. Later in the year, we followed with an additional $500 million offering of 1, 2 and 3 year flexible Money Market Preferred, after our successful performance in the inaugural issue. In addition, through our leadership in the traditional preferred stock market, we were able to successfully execute a tax-efficient preferred stock offering for ABN Amro, resulting in the largest such transaction in the past several years at $860 million.

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Structured Finance As a dominant underwriter of asset-backed securities, Lehman Brothers applies securitization technology across asset types. The Firm is a market leader in all structured finance categories — asset-backed and mortgaged-backed securities, collateralized debt obligations (CDOs), collateralized loan obligations (CLOs), synthetics and asset-backed commercial paper. Lehman Brothers also is a leader in developing cutting edge technologies for the asset-backed market. The cash flow or arbitrage “CDO” has been successful among clients seeking to increase their assets under management. Thanks to our leadership in the CDO market, we have been able to work with some of the most sophisticated investment managers and achieve their objectives through a variety of CDO structures. We managed a landmark $350 million transaction for Metropolitan Life Insurance Company, applying their expertise to manage a diversified portfolio of high yield bonds and syndicated bank loans. We also arranged $500 million CDOs for Teachers Insurance and Annuity Association and for Westdeutsche Landesbank Gironzentrale, N.Y. branch, both backed by portfolios of asset-backed securities. Lehman Brothers has also been a leader in the synthetics market — instruments that transfer the risk from a pool of assets to allow for the redeployment of firmwide capital. In 2000, we organized a €4.3 billion synthetic CLO for Cygnus Finance (KBC Bank) of Belgium, referenced to a portfolio of European and U.S. commercial and industrial loans, in the largest CLO in European history.

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SEAT Pagine Gialle After several years of working closely with SEAT, including advising the Italian Treasury on the company’s privatization, Lehman Brothers assisted the company in its primary objective: to evolve from being the leading publisher of white and yellow pages in Italy into a company combining this business with a prominent online presence. The key was to exploit the online opportunities generated by SEAT’s client base of 3 million businesses, with access to end-users and consumers through the yellow and white pages. Progress toward that ambitious goal began in March 2000 with Lehman advising SEAT on its €30 billion acquisition of Telecom Italia’s Internet service provider, TIN.IT, in the largest Internet M&A transaction in Europe. Lehman Brothers also advised the company on two other transactions which advanced its pan-European acquisition strategy: SEAT’s €760 million acquisition of TDL Infomedia, the second largest publisher of directories in the U.K., and its $150 million acquisition of a 40.7 percent stake in Mondus, the first global web-based business-to-business marketplace for the procurement needs of small and mid-sized companies. Also in 2000, we were joint bookrunner for the inaugural €1.0 billion Eurobond offering for the company, and we have advised SEAT in the €1.1 billion voluntary conversion of savings shares into ordinary shares, which simplifies the company’s capital structure. This, combined with the Eurobond offering, provides SEAT with significant cash resources and increased flexibility for growth. Lehman Brothers has committed its efforts to assist SEAT Pagine Gialle in becoming the leading Italian integrated multimedia player, with broadly expanded pan-European business-to-consumer and business-to-business platforms.

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Biotechnology Benefiting from cutting-edge equity research and recognized biotechnology expertise, Lehman Brothers has assisted some exciting firms in raising their profiles and pursuing their goals. Oxford GlycoSciences Plc needed capital to exploit its proteomics platform for internal development. With our detailed knowledge of the biotech markets in Europe and in the U.S., Lehman Brothers lead-managed Oxford’s three equity offerings in 2000, raising £315 million and significantly expanding its global shareholder base. Our listing of OGSI on Nasdaq provides the company additional flexibility for international growth. In December 1999, Lehman shook off a weak biotech capital market to lead-manage a record-breaking IPO for Tularik Inc., which creates drugs that regulate genes. The success of this $112 million IPO opened the U.S. biotech financing window and, three months later, we led Tularik’s $101 million follow-on equity offering. Our relationship with CuraGen Corporation began with their IPO in 1998. In 2000, we lead-managed a $150 million convertible senior debt offering, advised on a private placement for its newly-formed genomic technologies subsidiary, and co-led a $197 million common stock offering — all to allow CuraGen to maximize the value of its genomics business.

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Baltimore Technologies Lehman Brothers’ dedication to the One Firm principal has countless practical examples. For instance, when a Private Client Services representative ascertains that an individual whose assets they are helping to manage also has needs in their capacity as a business executive, he introduces the appropriate teams of banking, research, sales and trading professionals. Lehman Brothers’ relationship with Baltimore Technologies, a Dublin-based global leader in e-security solutions, was initiated following an introduction by our Private Client Services area. Since that time, we have been actively engaged in strategic value creation on behalf of the company. In 1999, Lehman Brothers jointly lead-managed a $188 million common stock offering and concurrent listing on Nasdaq for the company. Thereafter, and during the course of 2000, we lead-managed several block trades on behalf of Baltimore’s shareholders for an aggregate amount of $171 million. Last year, we also served as advisor to Baltimore when it announced its $990 million acquisition of Content Technologies, the worldwide market leader in content security solutions. The acquisition added complementary technology and broadened Baltimore’s product portfolios. The transaction, which was executed on the London Stock Exchange by our teams in New York and London, was accompanied by a subsequent $253 million equity offering, where we served as joint-lead manager. Baltimore Technologies is only one of many clients that has benefited from our ability to deliver the full resources of a global investment bank.

PEMSTAR Inc. Lehman Brothers’ relationship with PEMSTAR Inc. demonstrates how we combine capital investment and financial expertise to achieve a client’s vision. In 1994, PEMSTAR was founded with the objective of building a world-class, global provider of electronics manufacturing services (EMS). PEMSTAR recognized that strong institutional support was required to expand both organically and through acquisition. In 1998, our Venture Capital Group invested approximately $10 million in PEMSTAR, fueling the company’s expansion in Mexico and China. In 1999, we provided both strategic and structuring advice with respect to bank financing, allowing the company to proceed with acquisitions of significant manufacturing capabilities in Europe and Silicon Valley. Our Venture Capital Group also invested an additional $18 million, providing the long-term capital necessary for the company to complete the transactions. Taking full advantage of its global capabilities, PEMSTAR again partnered with Lehman Brothers, drawing on our equity research and capital markets expertise, to leadmanage a successful $100 million IPO in August 2000. Utilizing the full scope of our resources, PEMSTAR has created a solid foundation to emerge as a global EMS industry leader.

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Delivering Performance At Lehman Brothers, we apply creativity and foresight when we think about growing our own Measures of Profitability percent

business and about strategies to maximize our opportunities in an ever-changing, ever-expanding

33.5% 30.5% 27.4% 25.6%

Pretax Operating Margin

24.2%

industry. As a Firm, we have demonstrated a constancy of vision, a consistency of purpose,

21.8%

and a clear commitment to our clients, our Return on Equity

17.0%

16.3%

employees and our shareholders. Our results are the ultimate testament to our success as a premier global institutional investment bank.

97

98

99

00

Revenue Growth in Key Businesses in millions of U.S. dollars

Ours is a business of client relationships and ideas: we must continue to deliver superior performance on behalf of our clients to grow

$4,689

and to thrive as a franchise. Ultimately, it is our ability to build our clients’ vision that defines our success.

$3,093

$2,179

$1,664

$839 $583

99

00

Investment Banking

22

99

00

Capital Markets

99

00

Client Services

pages 1-25 2/21/01 8:16 PM Page 23

Delivering Profitability Lehman Brothers’ financial performance was at the top of the range for its industry in 2000. Given that the investment banking industry has recorded profitability growth well above the market averages, this was a strong performance indeed for the Firm as a whole. In volatile and often treacherous markets, Lehman Brothers’ revenues of $7.7 billion grew by 44 percent in 2000, while the Firm’s net income hit a record of $1.78 billion, an increase of 57 percent for the year. We accomplished this through the diligent execution of our strategic plan: building a diversified set of high margin, global businesses, including the expansion of our Investment Banking franchise, our global Equities business, our Private Client unit, Private Equity and our businesses broadly in Europe. In the meantime, we have balanced our strategic investments with the objective of meeting certain financial targets. Consequently, our careful control over expense levels and our prudent management of risk have helped to produce exceptional bottom-line results. Over the past five years, this disciplined approach has allowed the Firm to generate net income that has grown at a compounded rate of 44 percent per year. For 2000, Lehman Brothers realized a pretax operating margin of 33.5 percent and a return on equity of 27.4 percent (before a special preferred dividend), representing significant increases over the prior year’s results and an extraordinary level of performance. These measures are the ultimate determinants of value for our shareholders. We remain committed to enhancing the performance of our franchise to realize the full value potential for them.

“Lehman Brothers has continued to build its equity and investment banking franchise and now generates profit margins that are comparable with the industry leaders. Lehman’s expanding European operations also contribute a significant and growing share of the Firm’s overall profitability. This has improved the geographic diversification of Lehman’s earnings, and Moody’s thinks the Firm should be able to remain profitable over a wide range of market conditions.” Moody’s Investors Service (On its upgrade of Lehman Brothers’ credit ratings, November 3, 2000)

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Delivering Growth Lehman Brothers achieved record revenues and significant growth in each of its major businesses and every region of the world in 2000. By any measure — revenues, earnings, headcount, transactions closed, trading volume, clients covered — the Firm continued on its upward trajectory of growth. In 2000, our Investment Banking revenues jumped 31 percent to $2.2 billion, as the value of our merger and acquisition completions rose by 88 percent and our fees from equity offerings increased by 79 percent. We supported this expansion and positioned ourselves for future growth by raising our investment banking ranks 25 percent to 2,050 during the year. Our revenues in Capital Markets rose by 52 percent in 2000, bolstered by an 84 percent increase in Equities, as we continued to grow and integrate our sales, trading, research and derivatives expertise. In terms of Fixed Income, despite weaker market conditions, the Firm was able to increase revenues by 24 percent. Our Client Services division grew 44 percent in 2000, as we increased our high net worth sales force and grew transaction volumes with clients. Lehman Brothers continued to build its franchise in Europe and Asia, keeping pace with the rapid growth in these regions. In 2000, our revenues in Europe increased by 45 percent and our Asian revenues rose by 58 percent. The Firm’s activities outside the U.S. accounted for 42 percent of our total revenues last year, demonstrating that we remain exceedingly well-positioned to serve our global client base with the full array of capital markets solutions.

“Lehman Brothers has advised Williams over the years on many aspects of our corporate strategy. Most recently, that advice has centered on the development and the proposed separation of Williams Communications. They have provided industry insight and execution expertise in both the energy and communications sectors and have been instrumental in helping our management construct solutions to meet our business objectives.” Keith E. Bailey Chairman, President and Chief Executive Officer The Williams Companies, Inc.

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“I would characterize our relationship with Lehman Brothers as a total relationship — they touch on every aspect of our business and we touch on theirs, respectively. We use all of their products and services, from investment banking to fixed income and equities, and they are also a great client of ours, widely using our funds and money management services.” James F. Getz President, Federated Securities Corp.

Delivering the Franchise Our business is one of innovation and ideas, where our clients demand comprehensive advice, tailored solutions and flawless execution. We pride ourselves on our ongoing dialogue with our clients, providing them with the intelligence and the tools they need for their next stage of evolution. For our banking clients, we organize extensive team coverage that is meant to address all of the client’s issues: this begins with our industry, product and research specialists; it often includes experts in tax issues, derivatives, securitization and structured credit, among other disciplines. This level of focus and expertise has allowed the Firm to garner a substantial portion of repeat business from satisfied clients. In 2000, we participated in investment banking transactions for 1,072 clients, of which 601 had engaged the Firm for other transactions in the prior two years. In our Equity business, we leverage our product expertise, our geographic reach and fundamental and technical research to deliver the full range of cash products, financing and derivatives to our clients. We work across product groups to provide our clients with efficient and optimal solutions; and, we organize our product specialists by industry sector to provide broader expertise to our clients. In Fixed Income, we utilize our extensive product capabilities, our quality research, our skills in derivatives, securitization and structured credit to source, create or finance tailored products for our clients. Often, we work with our clients on both sides of their balance sheet to create value. Our commitment to state-of-the-art technology platforms also enhances the efficiency and content we provide to our clients.

25

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Investment Banking Composition of Investment Banking Fees in millions of U.S. dollars

$2,179 777

$1,664 504 $1,401 817

511

456

$1,050 328 309 342

704 585

581 380

97

98

99

00

Merger & Acquisition Advisory Fees Equity Underwriting Fees Debt Underwriting Fees

Dollar Value of Completed Worldwide Mergers and Acquisitions in billions of U.S. dollars $340

$189

$69

98

99

Lehman Brothers’ global industry groups — Chemicals, Communications & Media, Consumer/Retailing, Financial Institutions, Financial Sponsors, Healthcare, Industrial, Natural Resources, Power, Real Estate and Technology — deliver senior bankers with superior industry knowledge and the resources to meet all of their clients’ objectives. Specialized product groups in Mergers and Acquisitions, Equity Capital Markets, Debt Capital Markets, Leveraged Finance and Private Placements are partnered with global relationship managers to provide comprehensive solutions for clients. The Firm’s specialists in new product development, tax, and derivatives also offer the expertise to tailor specific structures for clients. During the past year, Lehman Brothers dedicated significant resources to expanding Investment Banking, and this expansion was complimented by significant growth in the Firm’s research presence in both the United States and Europe. We enlarged virtually all of our global industry groups over the course of 2000, and we emerged notably strengthened. All told, we added close to 500 professionals to Investment Banking in 2000, ending the year with well over 2,050 bankers, including 174 managing directors. Much of this expansion took place in Europe, where, in addition to augmenting our industry and product groups, we added significant local presences in the U.K., Germany, France, Italy, Spain, the Benelux countries, Switzerland and Sweden.

$277

97

Clients do not lightly grant the opportunity to build their vision: they require creativity, sound advice, extensive understanding of their industry and their special needs, access to the full array of capital markets-based solutions, and reliable execution. If an investment bank falls short of client expectations, the chances of repeat business are scant. We are proud that, in the year 2000, over 56 percent of Lehman Brothers’ investment banking transactions were performed for existing clients; recurring assignments and long-term client relationships are a cornerstone of our Firm. During the past year, we also continued to build new client relationships, and these new partnerships contributed to our growing base of business worldwide. The Firm’s fees from advisory and financing activities increased 31 percent in 2000, to total $2.2 billion. We have emerged as a preeminent provider of investment banking services globally, and we have done so by earning the trust and respect of our clients over many years.

00

MERGERS AND ACQUISITIONS / STRATEGIC ADVISORY Lehman Brothers advised on a total of 223 completed mergers and acquisitions in 2000, totaling $340 billion and generating fees of $777 million. Fifty-three of these transactions were valued in excess of a billion dollars, including a total of 22 such transactions in Europe.

Lehman Brothers advised on some of the largest transactions completed in 2000. Of special note were the formation of a joint venture of the wireless operations of BellSouth Corporation and SBC Communications to create Cingular Wireless; MediaOne Group Inc.’s acquisition by AT&T Corp. for $51.9

26

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“In 2000, the Investment Banking Division significantly increased the size and scope of Lehman Brothers’ franchise globally. We also made tremendous progress in building broader and deeper relationships with many of our key clients by partnering with them

billion; R.J. Reynolds Tobacco Holdings Inc.’s $15.2 billion acquisition of Nabisco Group Holdings; Seagate Technology’s $19.7 billion acquisition by VERITAS Software and a buyout group led by Silver Lake Partners. In Europe, Lehman Brothers served as lead advisor to Teleglobe Inc. in its $6.5 billion acquisition by BCE Inc.; to VIAG AG in its $16.3 billion acquisition by VEBA AG., and to Abbey National plc on its agreement to acquire Scottish Provident for $2.5 billion. We advised a number of clients on multiple transactions: Chevron Corporation on its $43.3 billion pending acquisition of Texaco, after advising the client on the formation of a $6.1 billion chemical business joint venture with Phillips Petroleum earlier in the year; QUALCOMM Incorporated on the $1.0 billion sale of its cellular handset manufacturing business to Kyocera Corp. and its $1.1 billion acquisition of SnapTrack Inc.; SEAT Pagine Gialle on its €30.4 billion merger with TIN.IT, its $712 million acquisition of TDL Infomedia Ltd., and two other transactions totaling $194 million; and KirchGroup on four separate transactions totaling $4.1 billion.

in the development and execution of their strategic vision. The bringing together of a multi-disciplined team of bankers from across the Firm globally, alongside our research and capital markets expertise, is the essence of that partnership.” Bradley H. Jack Head of Investment Banking

In Asia, the Firm advised our alliance partner, the Bank of Tokyo-Mitsubishi, on its integration with the Mitsubishi Trust and Banking Corporation and Nippon Trust Bank to form Mitsubishi Tokyo Financial Group in a ¥1.2 trillion transaction. We also advised Newbridge in its $417 million acquisition of Korea First Bank and AsiaNetCorp. in its $1.3 billion acquisition by Littauer Technologies. Our work with the Indonesian Bank Restructuring Agency (IBRA) resulted in the sale of a $500 million stake it held in PT Astra International Tbk, voted “Indonesian Deal of the Year” by AsiaMoney magazine; and we continue to advise IBRA on their $11 billion debt restructuring and loan sale program. Turbulence and extreme volatility characterized the global equity markets last year. Even so, Lehman Brothers engaged in a record level of equity issuance on behalf of our clients: we managed a total of 191 transactions worth $88 billion. We were lead manager on 89 separate offerings totaling $14.4 billion, an 11 percent increase over our 1999 volumes. Of this total, the Firm served as lead manager for 32 IPOs, raising a total of $3.0 billion in transactions such as the $550 million offering for Dobson Communications, a $617 million offering for Tele1 Europe — the largest IPO ever from a Nordic country — and a $178 million IPO for Hongkong.com. Over the course of 2000, we received repeat equity mandates from 22 clients — another tribute to the strength of our service and execution on behalf of clients. Among the most notable were a $411 million series of three transactions for Oxford GlycoSciences Plc, three transactions totaling $290 million for Baltimore Technologies, and two separate offerings for SBA Communications that raised a total of $527 million.

EQUITY FINANCING

Lehman Brothers continued to demonstrate its global capabilities in 2000, leading large transactions across all product lines throughout the world. In one of

27

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“QUALCOMM has worked closely with Lehman Brothers for the past ten years as QUALCOMM, through its leadership in advanced CDMA technology, has been building the wireless world and leading the way for advanced 3G wireless networks that are now in the process of being developed. Lehman, as lead advisor to QUALCOMM throughout this period, has provided senior strategic judgment and advice along with aggressive capital raising for QUALCOMM every step of the way. Lehman has raised over $2.5 billion of equity related securities for QUALCOMM and has provided strategic advice in a series of acquisitions, divestitures and spin-offs.” Richard Sulpizio President and Chief Operating Officer QUALCOMM Incorporated

28

the largest-ever euro-denominated exchangeables, we led Teconost’s €2.5 billion transaction. We also led offerings for Alteon WebSystems, in a $569 million underwriting; and our $150 million offering of zero yield puttable securities for CMC Magnetics marked the first Asian equity-linked transaction outside Japan. DEBT FINANCING Despite extremely difficult conditions in the Fixed Income markets in 2000, Lehman Brothers retained its premier position, lead-managing $155.0 billion in global debt offerings. During the course of the year, we served as lead manager for a number of landmark transactions around the world: we were joint bookrunner on two offerings raising £1.25 billion and U.S. $1.0 billion for Abbey National plc; we were sole bookrunner for Vodafone’s floating rate note issue of $3.75 billion; and we raised a total of $2.0 billion for AXA in a 3-tranche dollar, euro and sterling-denominated transaction. In Asia, we were lead manager on the $1.6 billion series of bond offerings for the Republic of Philippines. In the U.S., we raised over $6.0 billion for General Electric Capital Corp. in a series of 12 transactions. We also served as lead manager for Qwest Capital Funding in their $3.0 billion inaugural financing after the merger with U S WEST Inc., a runner up for Corporate Finance’s “144 A Deal of the Year.”

The year 2000 was particularly difficult in the leveraged finance markets. Nevertheless, Lehman Brothers completed a number of notable transactions, including a $1.0 billion lead-managed transaction for Williams Communications Group and a $450 million transaction for Telecorp PCS, Inc. The Firm continued to engage in comprehensive financing solutions for clients, including advisory and financing transactions for Penn National Gaming and Time Warner Telecom. In the syndicated loan market, where we organize and syndicate loan facilities for both high grade and high yield borrowers, we arranged a $3.0 billion credit facility for Cingular Wireless and a $615 senior secured credit facility for Vought Aircraft. Lehman Brothers’ tradition of innovation in the fixed income markets continued in 2000. Early in the year, Lehman Brothers arranged the first-ever corporate e-bond offering and raised $1.2 billion for Ford Motor Credit Company. We also continued to apply our skills in securitization and structured finance to benefit our clients, arranging a $2.0 billion collateralized loan obligation for Fleet and a €4.3 billion collateralized loan obligation for Cygnus Finance (KBC Bank of Belgium).

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Capital Markets Volume of Lead-Managed Equity and Equity-Related Underwriting in billions of U.S. dollars $14 $13

$9

97

$9

98

99

00

Volume of Lead-Managed Worldwide Fixed Income Underwriting in billions of U.S. dollars $192

$192

$155

$150

97

98

99

00

Lehman Brothers has built a dominant Capital Markets franchise of global standing and scale over many years, investing heavily in technology and outstanding professionals, constantly refining the structure and its working details. One point of constant attention: the integration of traders, investment bankers, sales professionals and research specialists, since the effective functioning of the whole requires the equally effective functioning of all the parts. To enhance the high degree of integration needed in serving the sophisticated global investor, Lehman Brothers made an important organizational change in 2000, joining its Equities and Fixed Income Divisions under the umbrella of Capital Markets. This structure allows for superior alignment with investors, enhanced opportunities in research and in our Prime Broker operations, as well as improved risk management and capital allocation processes. Preeminent capital markets businesses require a large technology component. Lehman Brothers has developed trading and risk management systems that effectively support the Firm’s growing volume of business, while improving productivity and ease of execution. In terms of electronic trading, the Firm has positioned itself as an owner or member of numerous consortia and alternative trading systems in every major product market, extending liquidity flows to our clients through various connectivity initiatives. Additionally, the launch of LEHMANlive provides a proprietary platform to deliver product, research, portfolio tools and other powerful content to our institutional clients. All of these efforts have a single target — superior execution for our clients, performed with transparency and cost efficiency. EQUITIES Lehman Brothers’ net revenues from Equities grew to $2.6 billion in 2000, an 84 percent increase over the prior year’s results. Significant growth in the Firm’s global cash, derivatives and financing businesses contributed to this increase. These impressive results were achieved while we expanded the division significantly, growing to 1,740 professionals, a 44 percent increase over 1999.

Lehman Brothers has established itself as a leading global underwriter of equity securities. In calendar year 2000, the Firm lead-managed a total of $14.4 billion in equity and related issuance, including 32 initial public offerings which raised $3.0 billion for clients. Lehman Brothers served as lead manager on a number of notable initial public offerings, including a $106 million lead-managed offering for PEMSTAR and a $64 million initial public offering for Ulticom, one of the 10 best-performing IPOs of 2000. Lehman Brothers was one of the largest underwriters of offerings in the healthcare field, highlighting the Firm’s capabilities in biotechnology with such transactions as a $550 million convertible offering for Teva Pharmaceuticals, a $53 million initial public offering for Sangamo Biosciences, and a $116 million IPO for Rosetta Inpharmatics. In 2000, Lehman Brothers lead-managed numerous secondary offerings for clients, including Dynegy’s $514 million offering, Kerr-McGee’s $975 million concurrent common and convertible transactions and a $412 million convertible

29

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“In a year of industry consolidation and high market volatility, Lehman Brothers’ Equity Division had another record year in terms of revenues and investment in our global footprint. In Equity Research, we achieved enormous recognition in public and private surveys for our breakout progress, while Europe continued to be an enormous focus. Best ideas and best execution remain at a premium, and this is something our clients will always receive from us. Our priorities are simple: superior service to our clients and excellent returns for our shareholders.” Roger B. Nagioff Robert S. Shafir Co-Heads of Equities

30

offering for Dominion Resources. Other notable secondary transactions where we served as lead manager included a $450 million transaction for Time Warner Telecom and $837 million in common and convertible offerings for Versatel Telecom International. Lehman Brothers demonstrated its superior marketing ability in 2000 through its execution on accelerated book building, including a $564 million transaction for American Tower and a $516 million trade for Bank Hapoalim. The Firm also offered its clients quality execution and exceptional service in difficult markets, completing a $720 million transaction on an accelerated basis for Vitesse Semiconductor and raising a total of $1.5 billion in six separate offerings for clients such as L-3 Communications Holdings Inc., Comverse Technology and Cross Timbers Oil Company in one week in November, 2000. In terms of market-making activities, Lehman Brothers remains one of the leading investment banks for U.S. and pan-European listed trading volume, and the Firm maintains a major presence in over-the-counter stocks, all major European and Asian large capitalization stocks, warrants, convertible debentures and preferred issues. We currently make markets in over 2000 listed stocks and 500 Nasdaq stocks worldwide. In order to improve client information and execution, we have increasingly structured our trading units by industry sector; this process is well-developed in our U.S. operations and is now being applied in Europe. Lehman Brothers has developed comprehensive equity derivatives capabilities that allow the Firm to apply sophisticated financial engineering techniques in serving the needs of clients. In 2000, Lehman Brothers again witnessed significant growth in its two major equity derivatives product areas — its volatility business, encompassing options-related products, and its portfolio trading business, specializing in agency/risk baskets, index rebalancing and other structured products — reflecting the Firm’s growing client base and the expansion of derivatives sales and research. The condition of the markets in 2000 unquestionably enlarged the global appetite for options-based volatility trading products and for the structured products we offer through our portfolio trading business. We have created a series of joint ventures between derivatives and each of our Equity businesses to better meet our clients’ demands, combining program trading flows, options flows and Nasdaq and listed flows to maximize liquidity and trading efficiency. Lehman Brother’s Equity Finance and Prime Brokerage business engages in two primary functions: providing liquidity to the Firm’s customers and supplying secured financing for the Firm. Prime Brokerage provides margin financing and securities lending services to alternative investment managers on a collateralized basis across a wide variety of investment strategies. Additional services are provided to help these investors manage their daily business activities, including trade clearance and settlement and the delivery of information products and

pages 26-35, 89-96 2/21/01 8:40 PM Page 31

“We have an important relationship with Lehman Brothers. In Equities, they are one of our largest suppliers, and they also

analytics over LEHMANlive. In 2000, we expanded our overall coverage of the hedge fund market, where we see significant opportunities to cross-sell a variety of our capital markets products, while delivering a comprehensive package of financing, securities lending and structured products to finance a client’s portfolio in the most optimal, cost-effective manner. In 2000, Prime Brokerage introduced a series of new value-added products, including our Capital Introductions Program, enhanced financing products, such as Lehman Brothers’ Prime PLUSsm and our new PrimeWEB hedge fund portal.

provide us with significant value through quality research, sales and trading services.” Bruce W. Calvert Chief Executive Officer Alliance Capital Management

“I think execution has played a big role in Lehman Brothers’ success in Equities. They have a very focused sales effort. More importantly, they have product to call with, and they have something of value to say about it. Across the board they seem to be clicking.” Bill Riegel Equity Portfolio Manager TIAA-CREF

Excellence in research, execution, and distribution comprise the foundations of Lehman Brothers’ powerful Fixed Income franchise. Although a rising interest rate environment, widening credit spreads and deteriorating credit quality made for a challenging year in 2000, our Fixed Income Division recorded total revenues of $2.1 billion, up 24 percent over the prior year, reflecting the broad diversification within this division.

FIXED INCOME

In calendar year 2000, the Firm completed over $155 billion in lead-managed debt transactions for its global clients. Notable assignments included a $2.0 billion offering for BellSouth Capital Funding, two $1.3 billion global note transactions for The CIT Group, a $1.0 billion offering for Liberty Media Group and two lead-managed offerings totaling $825 million for Enron Corp. In Europe, the Firm lead-managed a €300 million offering for AB Electrolux, a €1.1 billion offering for UniCredito Italiano, a €1.0 billion debut Eurobond for SEAT Pagine Gialle, and a €600 million floating rate note issue for the Republic of Turkey. Lehman Brothers emerged as a leader in the placement of capital securities for global banks, completing 42 transactions totaling $19 billion for clients such as Lloyds TSB, DG Bank and AXA. Market conditions and economic circumstances were especially challenging in high yield securities over the course of 2000. Even so, Lehman Brothers leadmanaged a total of $2.4 billion in high yield securities, and the Firm’s default rates remained among the lowest of any underwriter. Highlights included a $1.0 billion two-tranche offering for Williams Communications Group, a $600 million offering for Globix Corp., and a $200 million offering for Grant Prideco. In the non-dollar high yield market, the Firm executed lead-managed transactions for Versatel and for Clondalkin. In the syndicated loan market, Lehman Brothers continued to expand its client base of high grade and high yield borrowers, arranging a $3.0 billion facility for Cingular Wireless, a $700 million facility for AES EDC, and a $340 million facility for Buffets, Inc. Our leadership in mortgage-backed and asset-backed securities is demonstrated through our research strength and our consistent standing as a top underwriter. In calendar year 2000, we served as lead-manager for over $27.0 billion of mortgagebacked issuance and $30.0 billion of asset-backed placements. We executed the largest residential mortgage transaction ever, a $7.0 billion securitization for

31

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“In 2000, when volatility was commonplace, Lehman Brothers’ Fixed Income franchise continued to propel forward. Our core strategy of providing superior advice with robust content — research — to a core

Washington Mutual. Through Lehman Brothers Bank, FSB, the Firm is expanding its funding sources and creating new mortgage origination pipelines for securitization, including a joint venture with Sotheby’s International Realty, Inc. and a partnership with Freddie Mac, EDS and Microsoft. In Korea, we formed a joint venture with Korea Asset Management Corporation to invest in loan portfolios and accelerate the restructuring process in that country. In the asset-backed business in 2000, we successfully completed Embarcadero Aircraft’s $793 million securitization and lead-managed auto loan securitizations totaling $5.1 billion for Ford Motor Credit. We established ASAP Funding Ltd., a $1.5 billion conduit to finance an investment portfolio through the issuance of secured liquidity notes, and placed a $1.3 billion transaction to finance Avis Rent-A-Car System’s car fleet. Lehman Brothers also acquired a stake in properties owned by Telecom Italia in conjunction with Beni Stabili S.p.A. and announced that we were assisting Burford Holdings plc in its £920 million management buyout.

client constituency, was again validated. Both dealer consolidation and a general aversion to risk by market participants pushed to the forefront those service providers, such as Lehman Brothers, who are capable of providing intellectual capital. Our research credentials were again recognized by Institutional Investor magazine. In addition, the growing use of our bond indices continued unabated.” Theodore P. Janulis Herbert H. McDade, III Co-Heads of Fixed Income

32

Complimenting our expertise in securitization, high yield debt and syndicated lending, structured credit trading occupies an increasingly important role for both institutional investors and dealers, through its ability to control credit risk, manage regulatory capital, and enhance investment returns. We have developed industry-leading capabilities in credit derivatives, structured products and collateralized loan and debt obligations. In 2000, we were sole arranger for a $1.5 billion two-tranche transaction for Zurich Capital Markets issued by our proprietary structured trust program — the largest of its kind. We also lead-managed a $750 million synthetic collateralized bond obligation for Rabobank International, the first synthetic resecuritization of CDOs. In Municipal and Public Finance, Lehman Brothers has fully integrated its investment banking, sales, trading and derivative functions, and introduced asset-backed and reinsurance expertise, to generate comprehensive client solutions. For the past five years, the Firm has consistently ranked as one of the top dealers in municipal derivatives, consistent with this focus. In 2000, Lehman Brothers lead-managed $17.7 billion in offerings, including an $800 million financing for the Metropolitan Transportation Authority of New York. We are the ranking institution in higher education finance, and in 2000, we executed more than $1.5 billion in senior managed financings for clients such as Harvard University. The Firm also ranks as one of the top housing groups, where we make frequent use of derivatives to provide savings to clients such as California, New York and Alaska. In 2000, we acquired an interest in Cain Brothers to enhance our heathcare practice. Lehman Brothers remains a preeminent global market-maker in numerous fixed income products, including U.S., European and Asian government and agency securities, money market products, corporate high grade, high yield and emerging markets securities, mortgage-and asset-backed securities, preferred stock, municipal securities, bank loans, foreign exchange, financing and derivatives products. The Firm has effectively integrated derivatives specialists into all areas of

pages 26-35, 89-96 2/21/01 6:39 PM Page 33

“We have a solid relationship with Lehman Brothers across all fixed income products. At our firm, we acknowledge that portfolio managers, research and trading must

Fixed Income in response to the continued convergence of the cash and derivatives markets worldwide. Lehman Brothers ranks as one of the top providers of interest rate derivatives: this market has grown rapidly, and Lehman Brothers’ volume has increased at a higher rate. The Firm has developed a Special Client Services unit for its active derivatives clients to provide risk and scenario analysis as well as middle and back office functions. GLOBAL DISTRIBUTION AND RESEARCH Even in the challenging market conditions of 2000, Lehman Brothers invested to reinforce its status as a premier client franchise: worldwide, our sales force grew to 822 and our research staff increased to over 900.

work together as a team, and Lehman is set up the same way. As a result, they are great communi-

Equity Sales is devoted to understanding the investment objectives of its institutional investor client base and delivering market-leading execution and liquidity throughout the equity product spectrum. Their success is increasingly defined by their ability to cut across geographies and offer the full array of cash, financing, derivatives and research products to provide maximum value for their clients.

cators: between our two firms, research talks, the traders talk, the analysts talk, and the relationship extends right up to senior management. Last year, they structured our first high grade collateralized debt obligation, easing the process by acting as a single team from the structuring and trading sides of their business. They get the balance right.” Brad Tank Director of Fixed Income Office of the CEO Strong Capital Management

Similarly, Fixed Income Sales specialists concentrate on partnering with their clients, not only knowing their investment parameters, but also providing quality research, resources and the willingness to work across the Firm to develop customized solutions. Globally, fixed income performance is increasingly benchmarked, and the Lehman Brothers’ Bond Indices are the most reliable and widely-used tools in the fixed income market. Recently, we have established advisory councils to refine the global indices; these panels include some of the most high-profile investors in the bond market. Our sales effort has been augmented by our strategic alliance with Fidelity Investments, who provides our products and research to their retail brokerage and on-line customers. In 2000, Lehman Brothers joined with Fidelity in the $1.0 billion directed share program for AT&T’s spin-off of its wireless business. With Fidelity, we now have the capabilities to manage both directed share and employee stock option programs. In 2000, we forged similar alliances with Consors in Germany and Fineco in Italy; we also formed an alliance with ANZ Investment Bank to provide capital markets’ access to their institutional clients. Research extends into every corner of our business, supplying invaluable analysis, information, and advice for our clients. Equity Research now incorporates over 450 professionals worldwide, while our Fixed Income Research group numbers 342 professionals. In addition to broad-based fundamental, quantitative, strategic, and tactical research, these groups have developed specialized products such as “10 Uncommon Values,” “10 Uncommon Euro Values” and the Lehman Bond Indices to provide investing clients with unique valued-added products.

33

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Client Services “Private Client Services is a natural complement to our institutional business, since these clients require the highest standard of service. As a Lehman Brothers’ client, they get direct access to all parts of the Firm, as well as a trusted advisor that stands ready to assist in the management of both their assets and liabilities. That is why, over the last two years, we have raised or invested over $10 billion for our private clients, in transactions ranging from IPOs to acquisitions to sourcing private equity.” Stephen M. Lessing Senior Client Relationship Manager & Head of Private Client Group

Lehman Brothers’ Client Services Division incorporates both our Private Client Services group, a retail-based organization involved in managing assets for wealthy individuals, and our Private Equity Division, which offers alternative asset management through a series of private equity funds. Private client banking is customarily a matter of investment advice. Lehman Brothers has a different vision: adding value for our client base of high net-worth individuals, families, corporations and mid-sized institutional investors through innovative financial solutions, global access to capital, research excellence, global product depth and personal service and advice. Unique in this business, we provide our clients with direct access to the same capabilities, knowledge and resources that are used by our largest institutional clients.

PRIVATE CLIENT SERVICES

We do provide investment advice, of course, along with fast and reliable execution and the sophisticated analysis of Lehman Brothers’ proprietary research. As a leading investment bank and member of every major stock exchange in the world, we offer access to an exceptionally broad range of securities. Additionally, we provide our clients with investment alternatives such as private equity investments and structured products to manage risk, diversify or leverage current investments or enhance returns. Our ability to monetize client investments can provide an attractive alternative to an outright sale. Our 450 Private Client professionals are alert to investing opportunities as well as to their clients’ special needs. But people who have accumulated substantial assets have frequently done so in their capacity as business owners or executives. They are, more often than not, already sophisticated investors. Their responsibilities require a higher level of investment banking services, and we are expert in introducing them to the appropriate capital commitment specialists and other global banking resources of our institution: from M&A to derivatives, from debt transactions to foreign exchange, from IPOs to private equity capital. In 2000, Private Client Services recorded average commissions of $2.1 million per investment representative, a level that is among the highest in the industry. The group’s net revenues for the year were $795 million, a 39 percent increase over 1999. We remain committed to expanding our Private Client activities: in 2000, we recruited our largest-ever class of entry-level associates; we continued to attract seasoned professionals; and we also added 92 investment representatives through the acquisition of the retail brokerage operations of SG Cowen. When Lehman Brothers entered the Private Equity business in 1984, it was one of the first investment banks to do so. Currently, the Firm manages a number of private equity funds with committed capital in excess of $4.5 billion. Investment performance over the last 16 years has been exceptional, with net returns to investors significantly exceeding relevant performance benchmarks. These results are attributable not only to our private equity professionals, whom PRIVATE EQUITY

34

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“Our Private Equity Division continues to build on Lehman Brothers’ success in identifying and investing in extraordinary opportunities for the Firm, our employees and outside investors. We are focused on increasing our assets under management by introducing new funds in areas where Lehman Brothers’ expertise and market position gives us a competitive edge. During 2000, we significantly expanded our business with the addition of a Communications fund and a Real Estate fund to our established Merchant Banking and Venture Capital funds. We now have a terrific platform in place to grow significantly our funds under management.” Michael J. Odrich Head of Private Equity

we increased to 92 from 39 last year, and our global presence, which gives us access to worldwide proprietary deal flow, but also to a disciplined selection and investment review process, which places special emphasis upon management strength, business fundamentals, market opportunities and clearly-defined exit strategies. Our objectives in Private Equity are threefold: first, to provide a wide range of attractive alternative investment products to clients; second, to realize significant capital appreciation on these investments; and, third, to launch a diversified series of funds, thereby providing a more significant and stable source of Private Equity earnings to the Firm. Private Equity currently operates in four asset classes: • Merchant Banking partners with established, well-managed operating companies in the U.S. and Europe to achieve an objective of long-term capital appreciation. Currently, $1.3 billion of its $2.0 billion institutional fund is invested in five portfolio companies. We expect that the U.S. will continue to provide attractive investment opportunities, and that Europe, where the Firm has deep roots and a strong local presence, will emerge as a large opportunity in 2001 and the foreseeable future • Venture Capital provides growth-oriented equity investments in privatelyheld companies. Specifically, we focus on investing in companies capable of turning innovative technology and management solutions into successful businesses. The Venture Capital Fund currently has $302 million under management; it has invested in 46 portfolio companies across a significant range of industries. Venture Capital opened a London office last year, which manages investments in both Europe and Israel, and we intend to launch a healthcare venture capital initiative in 2001. To leverage further our extensive expertise and client relationships with developing portfolio companies, we announced a new venture, Innovate@Lehman Brothers/Booz-Allen, in late 2000. This global alliance provides start-up and spin-out ventures with funding as well as a wide range of strategic, technical, executive and financial services that are typically unavailable to early-stage companies. • The Communications Fund is the first industry-specific fund sponsored by Lehman Brothers. With capital commitments of $800 million, the Communications Fund invests in early-stage communications service providers, predominantly in the U.S. and Europe. There are presently five companies in this portfolio. Lehman Brothers frequently acts as a lead investor in these companies and takes an active role in managing their growth. • Our newest fund, Lehman Brothers Real Estate Partners, L.P. closed on commitments of $590 million during 2000. Its objective is to invest in a variety of properties, real estate companies, service businesses ancillary to the real estate industry, mortgage interests, and equity and debt instruments in North America and Europe.

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TABLE OF CONTENTS Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Summary—Fiscal 2000 Business Environment Results of Operations Geographic Diversification Non-Interest Expenses Income Taxes Liquidity, Funding and Capital Resources Managing Liquidity, Funding and Capital Resources Total Capital Back-Up Credit Facilities Balance Sheet Financial Leverage Credit Ratings High Yield Securities Private Equity Off-Balance Sheet Financial Instruments and Derivatives Overview Lehman Brothers’ Use of Derivative Instruments Risk Management Credit Risk Market Risk Value-at-Risk New Accounting Developments Effects of Inflation Report of Independent Auditors Consolidated Financial Statements Notes to Consolidated Financial Statements Selected Financial Data

37 37 39 42 43 43 43 45 45 46 46 46 47 47 47 47 47 48 49 49 49 50 51 52 53 54 61 88

LEHMAN MD&A (36-53) 2/20/01 11:41 PM Page 37

MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

MD&A FINANCIAL SUMMARY— FISCAL 2000 • Net revenue growth of 44%

For 2000, Lehman Brothers Holdings Inc. (“Holdings”) and subsidiaries (collectively, the “Company” or “Lehman Brothers”) reported its 6th consecutive year of record financial performance.

• Net income increased 57%

Net income of $1,775 million increased 57% over 1999 while earnings per share of $6.38 grew approximately 56% over last year. These results reflect the continued successful execution of the Company’s strategy to grow its • ROE of 27.4%(1) high margin investment banking and equities businesses; increase its presence in certain businesses in Europe; and, at the same time, maintain a (1) Before redeemable preferred dividend strict discipline with regard to its expenses and risk management. Net revenues increased to a record $7,707 million from $5,340 million in 1999 as the Company achieved record revenues in each major business segment and region in which it operates. The Company’s emphasis on high margin businesses and disciplined approach to expense management supported an increase in the Company’s pretax operating margin to 33.5% in 2000 from 30.5% in 1999. Revenues in each of the Company’s three segments grew by over 30% compared to last year and return on equity increased to 27.4% from 21.8% a year ago. As a result of the Company’s continued emphasis on expense discipline, non-personnel expenses increased only 19%, compared with an overall increase of 44% in net revenues. The Company’s compensation and benefits ratio increased slightly to 51.0% of net revenues from 50.7% in 1999 as the Company continued to increase headcount, making significant additions in areas where the Company is focusing its growth. • Pretax margin of 33.5%

The Company reported net income of $1,132 million and earnings per share of $4.08 for 1999. Net revenues increased 30% from 1998 to $5.3 billion. The Company’s pretax operating margin was 30.5% for 1999 and 25.6% for 1998. The compensation and benefits ratio was 50.7% of net revenues and non-personnel expenses as a percentage of revenues was 18.8% compared to 23.7% in 1998. These results reflected the continued implementation of the strategy to grow high margin businesses while managing expenses carefully. For 1998, the Company reported net income of $736 million and earnings per share of $2.60. BUSINESS ENVIRONMENT The principal business activities of the Company are investment banking and securities trading and sales, which by their nature are subject to volatility, primarily due to changes in interest and foreign exchange rates and security valuations, global economic and political trends and industry competition. As a result, revenues and earnings may vary significantly from quarter to quarter and from year to year. The favorable market and economic conditions experienced during 1999 continued into the first half of 2000, boosted by a wealth effect stemming from previous gains in the stock market and strong consumer spending. In response to strong growth and rising inflation fears, the Federal Reserve raised the Federal Funds rate by a total of 100 basis points to 6.50% over the first half of 2000, with the last increase occurring on May 16, 2000. In the second half of the year, marketplace uncertainties combined with slower consumer spending, higher borrowing costs and recessionary fears resulted in weaker market conditions, prompting the Federal Reserve to adopt an easing bias by year-end. Some of the statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, including those relating to the Company’s strategy and other statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” and similar expressions are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements are not historical facts but instead represent only the Company’s expectations, estimates and projections regarding future events. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict, which may include market, credit or counterparty, liquidity, legal and operational risks. Market risks include changes in interest and foreign exchange rates and securities valuations, global economic and political trends and industry competition. The Company’s actual results and financial condition may differ, perhaps materially, from the anticipated results and financial condition in any such forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

37

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As a result of this changing economic climate, the U.S. equity markets were very volatile during the year, posting lower returns when compared to the previous several years. By the middle of January 2000, in anticipation of further Federal Reserve Board rate hikes, the Dow Jones Industrial Average (“DJIA”) started to decline, falling briefly below the 10,000 level before recovering through the end of August. Following the Federal Reserve Board’s fifty basis point tightening in May, equity analysts started to lower their forecasts for the late 2000 and early 2001 quarters, a pattern that would continue through the end of the fiscal year. In October, the DJIA again slipped below the 10,000 level before recovering to 10,415 at November 30, 2000, a 4% decrease from fiscal year-end 1999. The NASDAQ Composite experienced even greater volatility, climbing 40% to an all-time high of 5,049 in early March, before slipping almost 50% during the second half of the year. The NASDAQ close of 2,598, represented a 22% decline for the year-ended November 30, 2000, the worst full year performance since its inception in the early 1970s. The S&P 500 also closed lower, marking the first time in a decade that all three major indexes would finish the year with losses. Europe was the only major region to register positive returns on equities for the twelve months ended November 30, 2000. However, the 6% return in local currency terms (FTSE World Europe Index) disguised a sharp sectoral divide. The technology and telecommunications sectors had wide swings, rising 50% in value during the three months ended February 2000, before losing 40% of their value in the next three-quarters. Meanwhile, the rest of the market recorded a much steadier performance, although the fourth quarter was weak across all sectors as regional growth expectations began to deteriorate. Trading volumes were very strong in the early months of the year, but dropped off significantly during the second half of the year. Asian Pacific markets were particularly weak for the year-ended November 30, 2000. The capital-weighted index of all shares listed on the Tokyo Stock Exchange (“TOPIX index”) lost 17% of its value during the year as the cyclical recovery in Japan began losing momentum. Outside of Japan, Asian markets also fell sharply during the year as the FTSE World Pacific Basin index was down 10% for the year. Equity new issuances reached record levels during the year with volumes up 23% over the same period last year. Fueling the growth in the U.S. equity market was increased IPO volume and continued equity raising in the technology, telecommunication and new media sectors. Fourth quarter origination volumes, however, were off significantly from the first nine months of the year as the equity markets began to feel the affects of the market’s downturn. Overall, the fixed income market environment was sub-optimal in 2000. The U.S. Treasury market was the lone exception, as it benefitted from many factors, including the turbulence in the equity markets, increased U.S. Treasury buybacks, lower volume of U.S. corporate debt issuance and revised forecasts for higher future U.S. budget surpluses. This led to a strong performance in the government bond sector during the second half of 2000. The credit market environment was very difficult for virtually the entire year. Interest rates were rising, the yield curve was inverted and credit spreads widened significantly toward the end of the year due to uncertainty over the interest rate environment and increased concerns over corporate credit quality and defaults. This was most prominently seen in the high yield market, where spreads widened to their highest levels since 1991. European corporate bond market activity slowed significantly during the second half of the year, primarily as a result of continued concerns around corporate credit quality. Credit spreads widened moderately by year-end, leading to underperformance of corporate bonds compared to government securities. Trading activities also slowed, affected by volatile trading conditions in high profile sectors such as telecommunications. Global debt new issuances were dampened by the inversion of the yield curve and the anticipation of future interest rate hikes by the Federal Reserve. However, as it became apparent that the Federal Reserve was no longer aggressively raising interest rates, market fundamentals improved in the second half of the year. Overall, debt new issuances for the year were down approximately 15% from 1999. However, the high yield new issue market was down significantly, approximately 50% from 1999, due to the spread widening in this sector. Merger and acquisition advisory activities on a global basis reached record levels in 2000, although fourth quarter results were significantly slower than the rest of the year as volatility in equity markets affected the pace of announced transactions. Overall, the volume of completed transactions for the year soared to a record $3.4 trillion in 2000, which included the completion of the highest ever number of deals greater than $1 billion. The increase was influenced by activity involving European

38

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

companies and cross-border mergers and acquisitions as the forces of consolidation, deregulation and globalization across industry sectors continued to drive strategic combinations. RESULTS OF OPERATIONS The Company is segregated into the following three business segments (each of which are described below): Investment Banking, Capital Markets and Client Services. Each segment represents a grouping of activities and products with similar characteristics. These business activities result in revenues from both institutional and high-net-worth retail clients which are recognized across the different revenue categories contained in the Company’s Consolidated Statement of Income. (Net revenues by segment also contain certain internal allocations, including funding costs, which are centrally managed.)

Net Revenue Diversity by Division

11% 28% 27% 62% 34%

TWELVE MONTHS ENDED NOVEMBER 30, 2000 Investment Banking

Principal Transactions, Commissions and Net Interest

(in millions)

Capital Markets: Equities Fixed Income

Investment Banking

Investment Banking

Client Services

Other

$2,179

Capital Markets

$2,179

$4,660

$ 29

4,689

697

37

105

839

$5,357

$2,216

$134

$7,707

Investment Banking

Other

Client Services Total

Total

Investment Banking and Equities generated 62% of net revenues in 2000 compared with 39% in 1997.

TWELVE MONTHS ENDED NOVEMBER 30, 1999

Principal Transactions, Commissions and Net Interest

(in millions)

Investment Banking Capital Markets

$1,664 $3,071

Client Services Total

Total $1,664

$22

3,093

523

18

42

583

$3,594

$1,682

$64

$5,340

Investment Banking

Other

TWELVE MONTHS ENDED NOVEMBER 30, 1998

(in millions)

Principal Transactions, Commissions and Net Interest

Investment Banking Capital Markets Client Services Total

$1,401 $2,175

Total $1,401

$(62)

2,113

472

40

87

599

$2,647

$1,441

$ 25

$4,113

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LEHMAN MD&A (36-53) 2/21/01 6:22 AM Page 40

Lehman Brothers provides a full array of capital market products and advisory services worldwide. Through the Company’s banking, research, trading, structuring and distribution capabilities of equity and fixed income products the Company continues its focus of building its client/customer business model. These “customer flow” activities represent a majority of the Company’s revenues. In addition to its customer flow activities, the Company also takes proprietary positions, the success of which is dependent upon its ability to anticipate economic and market trends. The Company believes its customer flow orientation mitigates its overall revenue volatility. The Company, through its subsidiaries, is a market-maker in all major equity and fixed income products in both the domestic and international markets. In order to facilitate its trading activities, the Company is a member of all principal securities and commodities exchanges in the United States and holds memberships or associate memberships on several principal international securities and commodities exchanges, including the London, Tokyo, Hong Kong, Frankfurt, Milan and Paris stock exchanges. As part of its market-making customer flow activities, the Company maintains inventory positions of varying amounts across a broad range of financial instruments, which are marked-to-market on a daily basis and, along with any proprietary trading positions, give rise to principal transactions revenues. Net revenues from the Company’s market-making, sales and trading activities in the capital markets are recognized as either principal transactions, commissions or net interest revenues, depending upon the method of execution, financing and/or hedging related to specific inventory positions. The Company evaluates its sales and trading strategies on an overall profitability basis, which combines principal transactions revenues, commissions and net interest. INVESTMENT BANKING

Investment Banking—Net Revenues in millions $2,250

• Net revenues increased 31% for the year

GR

25

%

$2,000

CA

• Record merger and acquisition advisory fees of $777 million, up over 50% from a year ago

$1,750

• Record equity underwriting revenues of $817 million, up 79% from 1999 on record lead managed underwriting volume of $14 billion

$1,500

$1,250

98

99

00

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 increased 31% in 2000 to $2,179 million from $1,664 million in 1999 and $1,401 million in 1998, due principally to an increase in equity underwriting and merger and acquisition advisory activities. This increase in net revenues reflects the progress the Company has made in its strategy to build its global investment banking franchise.

INVESTMENT BANKING NET REVENUES: (in millions)

Equity Underwriting Debt Underwriting

2000

1999

1998

$ 817

$ 456

$ 309

585

704

581

777

504

511

$2,179

$1,664

$1,401

Merger and Acquisition Advisory

40

Equity underwriting revenues increased 79% to $817 million driven by increased issuances as well as the Company’s improvement in lead-managed global equity issuances and corresponding improvement in the competitive rankings per Thomson Financial Securities Data Corp. (“TFSD”). Merger and acquisition advisory revenues increased 54% to a record $777 million. These record results were driven by an increase in the Company’s market share for completed mergers and acquisition transactions from 7.6% in 1999 to 9.8% in 2000, per TFSD.

LEHMAN MD&A (36-53) 2/21/01 6:31 AM Page 41

MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Debt underwriting revenues decreased 17% to $585 million as a result of challenging market conditions as rising interest rates led to decreased underwriting volume across most fixed income products, most notably in the high yield market where spreads were at their widest levels since 1991. Overall market volumes for global debt underwriting and high yield issuances were down 14% and 52%, respectively, according to TFSD. The increase in net revenues in Investment Banking in 1999 from 1998 reflected the ongoing success in building-out this segment, as evidenced by the Company’s ability to execute several significant multiple product transactions for key clients in equity and investment grade debt underwriting. In addition, the Company also met a key strategic initiative in improving its ranking in lead-managed initial public offerings and European-related transactions during the year. CAPITAL MARKETS

Fixed Income—Net Revenues

Equities —Net Revenues

in millions

in millions $2,250

$3,000

• Net revenues up 52% for the year $2,500

GR

$2,000

CA

91

GR

%

21

%

$2,000

$1,750

CA

• Equities revenues increased 84% over 1999 results • Fixed income revenues up 24% from a year ago

$1,500 $1,500 $1,000

$1,250 $500

98

99

00

98

99

00

This segment’s net revenues reflect institutional flow activities and secondary trading and financing activities related to a broad spectrum of equity and fixed income products. These products include a wide range of cash, derivative, secured financing and structured instruments. Capital Markets’ net revenues were $4,689 million for 2000, $3,093 million for 1999 and $2,113 million for 1998. The 52% increase in net revenues in 2000 is primarily attributable to a significant increase in customer flow activities as overall transaction volumes almost doubled 1999 levels. Net revenues from the equity component of Capital Markets increased 84% to $2,629 million from $1,425 million in 1999. (in millions) 2000 1999 1998 This performance reflects the success of the continued developEquities $2,629 $1,425 $ 717 ment of the Company’s equity franchise, a key component of Fixed Income 2,060 1,668 1,396 the Company’s strategic focus on building high margin busi$4,689 $3,093 $2,113 nesses. Revenues benefited from strong customer flow activity across all equity products and regions, in particular equity derivative and cash products. Also contributing to the increase were higher revenues related to the Company’s Private Equity Investments. CAPITAL MARKETS NET REVENUES:

Net revenues from the fixed income component of Capital Markets increased 24% to $2,060 million from $1,668 million in 1999. The Company generated this year-over-year increase in an extremely difficult market environment due to strong activity across most fixed income instruments, especially in higher margin structured products. Certain products, particularly high yield instruments, experienced reduce flow activity due to the widening of spreads resulting from ongoing credit concerns. These concerns led many institutional investors toward more liquid types of fixed income products, such as government and mortgage-backed securities.

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The increase in net revenues in Capital Markets from 1998 to 1999 was primarily due to significantly increased institutional customer flow activity across most equity and fixed income products as the Company continued to invest in high margin product areas. Private Equity Assets Under Management

CLIENT SERVICES

Number of Investment Representatives

in billions

$4.5

$5.0

500

450

• Net revenues up 44% for the year • Private equity assets under management grew 51% in 2000 • Private Client’s investment representatives increased over 40% during the year

$4.0

400

308

$3.0 $2.8

284

$3.0

300

$2.0

200

$1.0

100

98

99

00

98

99

00

Client Services net revenues reflect earnings from the Company’s private client and private equity businesses. Private client net revenues reflect the Company’s high-net-worth retail customer flow activities as well as asset management fees. Private equity net revenues include the management and incentive fees earned in the Company’s role as general partner for twenty private equity banking partnerships. Client Services’ net revenues for 2000 were $839 million compared to $583 million for 1999 and $599 million for 1998. The (in millions) 2000 1999 1998 44% increase in 2000 was driven by record customer activity as Private Client $795 $573 $523 the Company successfully increased the headcount and proPrivate Equity 44 10 76 ductivity of its investment representatives. In October of 2000, $839 $583 $599 the Company acquired SG Cowen’s high-net-worth group of 92 investment representatives. This, combined with the Company’s own hiring initiatives, increased the number of investment representatives to 450 as of November 30, 2000. In addition, Private Equity management fees increased significantly as the Company’s assets under management increased 51% to $4.5 billion. This growth is part of the Company’s strategic expansion of its high margin businesses. CLIENT SERVICES NET REVENUES:

In 1999, Private Client revenues increased 10% to a record $573 million due to increased productivity of its sales force which offset a reduction in realized gains and incentive fees from the liquidation of private equity investments. GEOGRAPHIC DIVERSIFICATION In fiscal 2000, the Company continued to strategically expand its international franchise, with a particular focus in Europe. This expansion enabled the Company to benefit from the continued globalization of financial markets driven by the increase in cross-border transactions and client demand for global investment products. International net revenues represented 42% of total net revenues in 2000, compared with only 28% in 1997. During the year, the Company continued to invest significant resources in expanding its European franchise as it expanded headcount by approximately 40%. Since 1997, European headcount has nearly doubled. This growth is based on the Company’s belief that the European economy will continue the transformation toward a more capital markets driven environment. Overall European revenues increased 45% versus 1999 to approximately $2.4 billion, as the region experienced significant growth in all business lines, particularly equity cash and derivative products and the growth of investment banking. The Company also saw increased revenues in the Asian Pacific region across most equity and fixed income products.

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NON-INTEREST EXPENSES Twelve months ended November 30 (in millions)

Compensation and benefits Nonpersonnel Total non-interest expenses Compensation and benefits/ Net revenues Nonpersonnel expenses/ Net revenues

2000

1999

1998

$3,931

$2,707

$2,086

1,197

1,002

975

$5,128

$3,709

$3,061

Non-Interest Expense As a Percentage of Net Revenues

Nonpersonnel Expense As a Percentage of Net Revenues 24%

80%

22% 70% 20%

18%

60%

51.0%

50.7%

50.7%

16% 50% 14%

15.5%

18.8%

23.7% 98

99

00

98

99

00

Non-interest expenses in 2000 totaled $5,128 million, up 38% over 1999’s non-interest expenses of $3,709 million. The increase in non-interest expenses was more than offset by the 44% increase in net revenues, highlighting the Company’s continued disciplined approach to expense management. This ongoing focus on expenses is a key attribute of the Company’s strategic objective of increasing pretax operating margins. Nonpersonel expenses as a percentage of net revenues decreased from 18.8% in 1999 to 15.5% in fiscal 2000. Compensation and benefits expense as a percentage of net revenues increased slightly to 51.0% compared to 50.7% in 1999. The increase reflects the Company’s continued expansion of its investment banking, equities and European franchises as well as its investment in technology and e-commerce capabilities. Compensation and benefits expense includes the cost of salaries, incentive compensation and employee benefit plans as well as the amortization of deferred stock compensation awards. INCOME TAXES Lehman Brothers 2000 income tax provision of $748 million represented a 29% effective tax rate. In 1999 and 1998, income tax provisions were $457 million and $316 million, respectively, resulting in effective tax rates of 28% in 1999 and 30% in 1998. The effective tax rate increased in 2000 due to an overall increase in the level of pretax income, which lessened the relative impact of certain tax preference items. The increase was partially offset by a decrease in the state and local effective tax rate. Additional information about the Company’s income taxes can be found in Note 11 to the Consolidated Financial Statements.

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: • Liquidity providers are credit and market sensitive. Consequently, firms must be in a state of constant liquidity readiness. • 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. • During a liquidity event, certain secured lenders may require higher quality collateral. Firms must therefore not overestimate the availability of secured financing, and must fully integrate their secured and unsecured funding strategies. • 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.

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The Company’s Funding Framework incorporates these principles and mitigates liquidity risk wherever possible. This Framework comprises four major components: 1. The Cash Capital Model—which evaluates the amount of long-term liabilities—with remaining maturities of over one year—that are required to fund the Company. The model incorporates that the following must be funded with cash capital: • Secured funding “haircuts,” to reflect the estimated value of cash that would be advanced to the Company by counterparties during a stress environment. • Fixed assets and goodwill. • Operational cash at banks and unpledged assets independent of collateral quality; the Company assumes that it will not be able to operate with lower requirements in a stress environment than the Company currently operates with in a normal environment. The Company operates with a surplus of cash capital sources over cash capital uses. To ensure that the Company is always operating “within its means,” the businesses operate within strict cash capital limits. This limit culture has been institutionalized and this policy engages the entire Company in managing liquidity. 2. The Reliable Secured Funding Model (“RSFM”)—which forecasts the reliable sources of overnight secured funding available to the Company. The RSFM represents our assessment of the reliable secured funding capacity, by asset class, that we would anticipate in a liquidity event. The Company pays careful attention to validating this capacity through a periodic counterparty by counterparty, product by product review which draws upon the Company’s understanding of the financing franchise and experience. In cases where a business has inventory at a level above its RSFM, the Company requires the excess to be funded on a term basis with a maturity in excess of three months. If this is not feasible, the Company will then provide for this in its liquidity cushion—a cash amount with a remaining term in excess of 90 days. The cost of maintaining the liquidity cushion is borne by the business and encourages the development of secured funding capacity in line with balance sheet growth. The Company has increased RSFM for certain asset classes through the use of favorable legal entity structures, such as Lehman Brothers Bank (Thrift) and Lehman Brothers Bankhaus. These entities operate in a deposit protected environment and are therefore able to source low cost unsecured funds that are insulated from a companywide or market specific event, while providing reliable funding for mortgage products and other loan assets. 3. The Maximum Cumulative Outflow (“MCO”)—which estimates the size of the added liquidity requirement necessary to fund contingent cash outflows expected from a stress environment. The MCO model reflects our posture of constant liquidity readiness. On an ongoing basis, the Company projects, for our regulated and unregulated entities, the amount of cash we would have over the next three months, assuming that we immediately experience a very severe liquidity stress environment. The MCO assumptions, which presume a very severe liquidity stress environment, include the following: • • • • •

The Company is temporarily unable to replace maturing commercial paper and long-term debt. Collateral posting requirements increase as counterparties call for additional collateral. Contingent commitments are drawn as other liquidity-impacted institutions draw on their contractual facilities. The Company does not have to draw on its committed back-stop facilities. Secured funding consumes additional cash as haircuts widen to reflect stress levels.

The Company’s MCO standard is to operate in such a manner that even if a severe liquidity event ensues, three months forward the Company retains a substantial level of cash in both its regulated and unregulated subsidiaries.

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

4. The Contingency Funding Plan—which represents a detailed action plan to manage a stress liquidity event within the Company. The Company has developed a comprehensive Funding Action Plan to manage liquidity risk and communicate effectively with creditors, investors and customers during a funding crisis. The main focus of the plan is to detail how, in practice, we would manage our liquidity in a real situation, using the three components discussed above. 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 4% of adjusted total assets and less than 15% of total debt. Short-Term Debt to Adjusted Total Assets

Short-Term Debt to Total Debt

percentage

Lehman Brothers has lowered its Short-Term Debt to Adjusted Total Assets and its Short-Term Debt to Total Debt ratios over the past four years to lessen the impact of short-term dislocations in unsecured funding markets. Lehman Brothers has considerably lower ratios than its peer group.

percentage 30%

8%

24% 6%

18% 4% 12%

2% 6%

97

98

99

00

97

98

99

00

The Company’s Finance Committee is responsible for developing, implementing and enforcing the liquidity, funding and capital policies. These policies include recommendations for capital and balance sheet size as well as the allocation of capital and balance sheet to the business units. Through the establishment and enforcement of capital and funding limits, the Company’s Finance Committee seeks to ensure compliance throughout the organization so that the Company is not exposed to undue risk. MANAGING LIQUIDITY, FUNDING AND CAPITAL RESOURCES

TOTAL CAPITAL The Company’s Total Capital (defined as long-term debt, preferred securities subject to mandatory redemption and stockholders’ equity) increased 16% to $43.9 billion at November 30, 2000, compared to $37.7 billion at November 30, 1999. The increase in Total Capital resulted from a net increase in long-term debt, the retention of earnings, the net impact of various stock-based employee awards and the issuance of $250 million of Series E Preferred Stock. These were partially offset by repurchases of common stock (to fund stock-based employee awards) and $88 million of convertible Series B Preferred Stock.

Long-Term Debt November 30

2000

1999

1998

$32,106

$27,375

$23,873

3,127

3,316

3,468

35,233

30,691

27,341

860

710

Preferred Equity

700

688

908

Common Equity

7,081

5,595

4,505

(in millions)

in billions $40

Long-term Debt Senior Notes Subordinated Indebtedness Preferred Securities

$30

$20

Stockholders’ Equity

Total Capital

7,781

6,283

5,413

$43,874

$37,684

$32,754

$10

98

99

00

45

LEHMAN MD&A (36-53) 2/20/01 11:42 PM Page 46

During 2000, the Company issued $14.2 billion in long-term debt, which was $5.7 billion in excess of its maturing debt. Longterm debt increased to $35.2 billion at November 30, 2000 from $30.7 billion at November 30, 1999, with a weightedaverage maturity of 3.8 years at November 30, 2000 and 3.7 years at November 30, 1999. The Company operates in many regulated businesses that require various minimum levels of capital. These businesses are also subject to regulatory requirements that may restrict the free flow of funds to affiliates. Regulatory approval is generally required for paying dividends in excess of certain established levels, making affiliated investments and entering into management and service agreements with affiliated companies. Additional information about the Company’s capital requirements can be found in Note 9 to the Consolidated Financial Statements. Holdings maintains a Revolving Credit Agreement (the “Credit Agreement”) with a syndicate of banks. Under the terms of the Credit Agreement, the banks have committed to provide up to $2 billion for up to 364 days. Any loans outstanding on the commitment termination date may be extended for up to an additional year at the option of Holdings. The Credit Agreement contains covenants, which require, among other things that the Company maintain specified levels of liquidity and tangible net worth. BACK-UP CREDIT FACILITIES

In July 2000, the Company entered into a $1 billion Committed Securities Repurchase Facility (the “Facility”) for Lehman Brothers International (Europe) (“LBIE”), the Company’s major operating entity in Europe. The Facility provides secured multi-currency financing for a broad range of collateral types. Under the terms of the Facility, the bank group will agree to provide funding for up to one year on a secured basis. Any loans outstanding on the commitment termination date may be extended for up to an additional year at the option of LBIE. The Facility contains convenants that require, among other things, that LBIE maintain specified levels of tangible net worth. There are no borrowings outstanding under either the Credit Agreement or the Facility. The Company may use the Credit Agreement and the Facility for general corporate purposes from time to time. The Company has maintained compliance with the applicable covenants for both the Credit Agreement and the Facility at all times. The Company’s total assets increased to $224.7 billion at November 30, 2000 from $192.2 billion at November 30, 1999. The Company’s adjusted total assets, defined as total assets less the lower of securities purchased under agreements to resell or securities sold under agreements to repurchase, were $143.5 billion at November 30, 2000 compared to $130.0 billion at November 30, 1999. The Company believes adjusted total assets is a more effective measure of evaluating balance sheet usage when comparing companies in the securities industry. The increase in adjusted total assets reflects a higher level of securities owned associated with increased customer flow activities across the Capital Markets businesses, principally in the Company’s equity businesses.

BALANCE SHEET

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. 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 leverage ratios based on adjusted total assets were 16.6x and 18.6x as of November 30, 2000 and 1999, respectively. Consistent with maintaining a single A credit rating, the Company targets an adjusted leverage ratio of approximately 20.0x. The Company operated below this level at November 30, 2000 principally due to the sub-optimal market environment at year-end. 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 year-end or quarter-end amounts.

FINANCIAL LEVERAGE

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CREDIT RATINGS The Company, like other companies in the securities industry, relies on external sources to finance a significant portion of its day-to-day operations. The Company’s access to and cost of funding is generally dependent upon its short- and long-term debt ratings. On November 3, 2000, Moody’s Investors Service upgraded Holdings senior debt from A3 to A2 and commercial paper from P-2 to P-1. As of November 30, 2000 the short- and long-term debt ratings of Holdings and Lehman Brothers Inc. (“LBI”) were as follows:

Holdings

LBI

Short-term

Long-term

Short-term

Fitch IBCA, Inc.

F-1

A

F-1

A/A–

Moody’s

P-1

A2

P-1

A1*/A2

A-1

A

A-1

A+*/A

TBW-1

A

TBW-1

A+/A

Standard & Poor’s Corp. Thomson BankWatch

Long-term**

* Provisional ratings on shelf registration ** Senior/subordinated

HIGH YIELD SECURITIES The Company underwrites, trades, invests and makes markets in high yield corporate debt securities. The Company also syndicates, trades and invests in loans to below investment grade-rated companies. For purposes of this discussion, high yield debt 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 November 30, 2000 and 1999 included long positions with an aggregate market value of approximately $3.5 billion and $3.0 billion, respectively, and short positions with an aggregate market value of approximately $745 million and $290 million, respectively. The Company mitigates its aggregate and single-issuer net exposure through the use of derivatives, sole-recourse securitization financing and other financial instruments.

Additional information about the Company’s high yield securities and lending activities, including related commitments, can be found in Note 14 to the Consolidated Financial Statements. The Company has investments in twenty private equity partnerships, for which the Company acts as general partner, as well as related direct investments. At November 30, 2000 and 1999, the Company’s investment in these partnerships totaled $149 million and $134 million, respectively, and direct investments totaled $678 million and $375 million, respectively. 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 14 to the Consolidated Financial Statements. PRIVATE EQUITY

OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES OVERVIEW Derivatives are financial instruments, which include swaps, options, futures, forwards and warrants, whose value is based upon an underlying asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). A derivative contract may be traded on an exchange or negotiated in the over-the-counter markets. Exchange-traded derivatives are standardized and include futures, warrants and certain option contracts listed on an exchange. Over-the-counter (“OTC”) derivative contracts are individually negotiated between contracting parties and include forwards, swaps and certain options, including caps, collars and floors. The use of derivative financial instruments has expanded significantly over the past decade. One reason for this expansion is that derivatives provide a cost-effective alternative for managing market risk. In this regard, derivative contracts provide a reduced funding alternative for managing market risk since derivatives are based upon notional amounts, which are generally not exchanged, but rather are used merely as a basis for exchanging cash flows during the duration of the contract. Derivatives are also utilized extensively as highly effective tools that enable users to adjust risk profiles,

47

LEHMAN MD&A (36-53) 2/20/01 11:43 PM Page 48

such as interest rate, currency, or other market risks, since OTC derivative instruments can be tailored to meet individual client needs. Additionally, derivatives provide users with access to market risk management tools that are often unavailable in traditional cash instruments. Derivatives can also be used to take proprietary trading positions. Derivatives are subject to various risks similar to non-derivative financial instruments including market, credit and operational risk. Market risk is the potential for a financial loss due to changes in the value of derivative financial instruments due to market changes, including changes in interest rates, foreign exchange rates and equity and commodity prices. Credit risk results from the possibility that a counterparty to a derivative transaction may fail to perform according to the terms of the contract. Therefore, the Company’s exposure to credit risk is represented by its net receivable from derivative counterparties, after consideration of collateral. Operational risk is the possibility of financial loss resulting from a deficiency in the Company’s systems for executing derivative transactions. In addition to these risks, counterparties to derivative financial instruments may also be exposed to legal risks related to derivative activities, including the possibility that a transaction may be unenforceable under applicable law. The risks of derivatives should not be viewed in isolation but rather should be considered on an aggregate basis along with the Company’s other trading-related activities. As derivative products have continued to expand in volume, so has market participation and competition. As a result, additional liquidity has been added into the markets for conventional derivative products, such as interest rate swaps. Competition has also contributed to the development of more complex products structured for specific clients. It is this rapid growth and complexity of certain derivative products, which has led to the perception, by some, that derivative products are unduly risky to users and the financial markets. In order to remove the public perception that derivatives may be unduly risky and to ensure ongoing liquidity of derivatives in the marketplace, the Company supports the efforts of the regulators in striving for enhanced risk management disclosures which consider the effects of both derivative products and cash instruments. In addition, the Company supports the activities of regulators that are designed to ensure that users of derivatives are fully aware of the nature of risks inherent within derivative transactions. As evidence of this support, the Company is an active participant in the Derivative Policy Group and has been actively involved with the various regulatory and accounting authorities in the development of additional enhanced reporting requirements related to derivatives. The Company strongly believes that derivatives provide significant value to the financial markets and is committed to providing its clients with innovative products to meet their financial needs. LEHMAN BROTHERS’ USE OF DERIVATIVE INSTRUMENTS In the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end user. As an end user, the Company utilizes derivative products to adjust the interest rate nature of its funding sources from fixed to floating interest rates, and to change the index upon which floating interest rates are based (e.g., Prime to LIBOR) (collectively, “End User Derivative Activities”). For a further discussion of the Company’s End User Derivative Activities, see Note 12 to the Consolidated Financial Statements.

The Company utilizes derivative products in a trading capacity both as a dealer to satisfy the financial needs of its clients and in each of its trading businesses (collectively, “Trading-Related Derivative Activities”). The Company’s use of derivative products in its trading businesses is combined with cash instruments to fully execute various trading strategies. The Company conducts its derivative activities through a number of wholly-owned subsidiaries. The Company’s fixed income derivative products business is conducted through its special purpose subsidiary, Lehman Brothers Special Financing Inc., and separately capitalized “AAA” rated subsidiaries, Lehman Brothers Financial Products Inc. and Lehman Brothers Derivative Products Inc. The Company’s equity derivative product business is conducted through Lehman Brothers Finance S.A. In addition, as a global investment bank, the Company is also a market-maker in a number of foreign currencies and actively trades in the global commodity markets. Counterparties to the Company’s derivative product transactions are primarily financial intermediaries (U.S. and foreign banks), securities firms, corporations, governments and their agencies, finance companies, insurance companies, investment companies and pension funds. The Company manages the risks associated with derivatives on an aggregate basis, along with the risks associated with its non-derivative trading and market-making activities in cash instruments, as part of its firmwide risk management policies. For a further discussion of the Company’s risk management policies refer to the discussion which follows.

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

See Notes 1 and 12 to the Consolidated Financial Statements for a description of the Company’s accounting polices and a further discussion of the Company’s Trading-Related Derivative Activities. RISK MANAGEMENT As a leading global investment banking company, risk is an inherent part of the Company’s businesses. Global markets, by their nature, are prone to uncertainty and subject participants to a variety of risks. The Company has developed policies and procedures to identify, measure and monitor each of the risks involved in its trading, brokerage and investment banking activities on a global basis. The principal risks of Lehman Brothers are market, credit, liquidity, legal and operational risks. Risk Management is considered to be of paramount importance. Consequently, the Company devotes significant resources across all of its worldwide trading operations to the measurement, management and analysis of risk, including investments in personnel and technology. The Company seeks to reduce risk through the diversification of its businesses, counterparties and activities in geographic regions. The Company accomplishes this objective by allocating the usage of capital to each of its businesses, establishing trading limits for individual products and traders and setting credit limits for individual counterparties, including regional concentrations. The Company seeks to achieve adequate returns from each of its businesses commensurate with the risks that they assume. Overall risk management policy is established by a Risk Management Committee (the “Committee”) comprised of the Chief Executive Officer, the Global Risk Manager, the Chief Financial Officer, the Chief Administrative Officer and the Heads of Capital Markets and Investment Banking. The Committee brings together senior management with the sole intent of discussing risk-related issues and provides an effective forum for managing risk at the highest levels within the Company. The Committee meets on a monthly basis, or more frequently if required, to discuss, among other matters, significant market exposures, concentrations of positions (e.g., counterparty, market risk), potential new transactions or positions and risk limit exceptions. The Global Risk Management Group (the “Group”) supports the Committee, is independent of the trading areas and reports directly to the Chief Executive Officer. The Group combines two departments, credit risk management and market risk management, into one unit. This facilitates the analysis of counterparty credit and market risk exposures and leverages personnel and information technology resources in a cost-efficient manner. The Group maintains staff in each of the Company’s regional trading centers and has daily contact with trading staff at all levels within the Company. These discussions include a review of trading positions and risk exposures. CREDIT RISK Credit risk represents the possibility that a counterparty will be unable to honor its contractual obligations to the Company. Credit risk management is therefore an integral component of the Company’s overall risk management framework. The Credit Risk Management Department (“CRM Department”) has global responsibility for implementing the Company’s overall credit risk management framework.

The CRM Department manages the credit exposure related to trading activities by giving initial credit approval for counterparties, establishing credit limits by counterparty, country and industry group and by requiring collateral in appropriate circumstances. In addition, the CRM Department strives to ensure that master netting agreements are obtained whenever possible. The CRM Department also considers the duration of transactions in making its credit decisions, along with the potential credit exposure for complex derivative transactions. The CRM Department is responsible for the continuous monitoring and review of counterparty credit exposure and creditworthiness and recommending valuation adjustments where appropriate. Credit limits are reviewed periodically to ensure that they remain appropriate in light of market events or the counterparty’s financial condition. Market risk represents the potential change in value of a portfolio of financial instruments due to changes in market rates, prices and volatilities. Market risk management also is an essential component of the Company’s overall risk management framework. The Market Risk Management Department (“MRM Department”) has global responsibility for implementing the Company’s overall market risk management framework. It is responsible for the preparation and dissemination of risk reports, developing and implementing the firmwide Risk Management Guidelines and evaluating adherence to these

MARKET RISK

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LEHMAN MD&A (36-53) 2/20/01 11:43 PM Page 50

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 marketmaking transactions, the size of the Company’s proprietary and arbitrage positions and the volatility of financial instruments traded. The Company seeks to mitigate, whenever possible, excess market risk exposures through the use of futures and option contracts and offsetting cash market instruments. The Company participates globally in interest rate, equity and foreign exchange markets. The Company’s Fixed Income division has a broadly diversified market presence in U.S. and foreign government bond trading, emerging market securities, corporate debt (investment and non-investment grade), money market instruments, mortgages and mortgage-backed securities, asset-backed securities, municipal bonds and interest rate derivatives. The Company’s Equities division facilitates domestic and foreign trading in equity instruments, indices and related derivatives. The Company’s foreign exchange businesses are involved in trading currencies on a spot and forward basis as well as through derivative products and contracts. The Company incurs short-term interest rate risk when facilitating the orderly flow of customer transactions through the maintenance of government and high-grade corporate bond inventories. Market-making in high yield instruments exposes the Company to additional risk due to potential variations in credit spreads. Trading in international markets exposes the Company to spread risk between the term structure of interest rates in differing countries. Mortgages and mortgage-related securities are subject to prepayment risk and changes in the level of interest rates. Trading in derivatives and structured products exposes the Company to changes in the level and volatility of interest rates. The Company actively manages interest rate risk through the use of interest rate futures, options, swaps, forwards and offsetting cash market instruments. Inventory holdings, concentrations and agings are monitored closely and used by management to selectively hedge or liquidate undesirable exposures. The Company is a significant intermediary in the global equity markets through its market-making in U.S. and non-U.S. equity securities, including common stock, convertible debt, exchange-traded and OTC equity options, equity swaps and warrants. These activities expose the Company to market risk as a result of price and volatility changes in its equity inventory. Inventory holdings are also subject to market risk resulting from concentrations and liquidity that may adversely impact market valuation. Equity market risk is actively managed through the use of index futures, exchange-traded and OTC options, swaps and cash instruments. The Company enters into foreign exchange transactions in order to facilitate the purchase and sale of non-dollar instruments, including equity and interest rate securities. The Company is exposed to foreign exchange risk on its holdings of non-dollar assets and liabilities. The Company is active in many foreign exchange markets and has exposure to the euro, Japanese yen, British pound, Swiss franc and Canadian 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. 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 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. VALUE-AT-RISK

50

LEHMAN MD&A (51 only) 2/22/01 4:34 PM Page 51

MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company’s methodology estimates a reporting day value-at-risk using actual daily trading revenues over the previous 250 trading days. This estimate is measured as the loss, relative to the median daily trading revenue. The Company also estimates an average value-at-risk measure over 250 rolling reporting days, thus looking back a total of 500 trading days. The Company’s average value-at-risk for each component of market risk, and in total was as follows (in millions):

2000

1999

Interest rate risk

$12.8

$21.6

Equity price risk

11.2

11.9

2.1

3.2

Foreign exchange risk Diversification benefit Total Company

(5.3) $20.8

(5.8) $30.9

During 2000, the Company’s value-at-risk varied from a high of $23.7 million to a low of $18.4 million. During 1999, the Company’s value-at-risk varied from a high of $36.2 million to a low of $19.0 million. Average value-at-risk decreased in 2000 compared to 1999 due to the effects on the 1999 value-at-risk related to the extreme market volatility experienced during the August-October 1998 period. Excluding the data points during this volatile time period, the adjusted average value-at-risk was $18.9 million during 1999. Value-at-risk at November 30, 2000 and 1999 was $23.7 million and $19.2 million, respectively. Value-at-risk is one measure 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. As discussed throughout the Management’s Discussion and Analysis, the Company seeks to reduce risk through the diversification of its businesses and a focus on customer flow activities. This diversification and focus, combined with the Company’s risk management controls and processes, helps mitigate the net revenue volatility inherent in the Company’s trading activities. Although historical performance is not necessarily indicative of future performance, the Company believes its focus on business diversification and customer flow activities should continue to help mitigate the volatility of future net trading revenues. NEW ACCOUNTING DEVELOPMENTS In June 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), which requires all derivatives to be recorded on the balance sheet at fair value. In June 1999, the FASB issued FASB No. 137 which extended the implementation date of SFAS No. 133 by one year. In June 2000, the FASB issued SFAS No. 138, which amended SFAS 133. The Company will adopt SFAS 133 as amended on December 1, 2000 (Fiscal Year 2001). SFAS 133 will not affect the accounting for the Company’s trading-related derivative activities, as such derivatives are already recognized on a mark-to-market basis through earnings. Rather, SFAS 133 will affect the accounting for derivatives utilized as hedging instruments as part of the Company’s end-user activities. As an end user, the Company primarily utilizes derivatives to modify the interest rate characteristics of its long-term debt and secured financing activities (“end-user derivative activities”). The Company currently accounts for its end-user derivative activities on an accrual basis provided that the derivative is deemed a highly effective hedge. SFAS 133 generally will require the Company to recognize its end-user derivatives at fair value through earnings, with an offset recognized through earnings for changes in the fair value of the hedged item. Any ineffectiveness in a hedging relationship generally will require immediate earnings recognition. In addition to these changes, SFAS 133 will result in certain derivatives no longer qualifying for hedge accounting, requiring such derivatives to be marked-tomarket through earnings without offset. Derivatives that will not qualify for hedge accounting under SFAS 133 include U.S. dollar and foreign currency basis swaps.

51

LEHMAN MD&A (36-53) 2/20/01 11:43 PM Page 52

The Company has devoted significant resources to prepare for the adoption of SFAS 133. The adoption of SFAS 133 will not have a material impact to the Company’s financial position or results of operations. In September 2000, the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a replacement of FASB No. 125.” (“SFAS 140”). SFAS 140 carries over the fundamental control premise of SFAS No. 125, which requires an entity to recognize only assets it controls and to derecognize assets only when control has been surrendered. SFAS 140 amends the control framework of SFAS 125 by revising the criteria to be used for evaluating whether a financial asset is controlled and providing new criteria necessary to meet the definition of a Qualifying Special Purpose Entity (“QSPE”). A QSPE is a limited-purpose vehicle often used for asset securitizations. SFAS 140 will also change the accounting for collateral. SFAS 140 will no longer require entities to recognize controlled collateral as an asset on the balance sheet. Rather, SFAS 140 will require entities to separately classify financial assets owned and pledged. SFAS 140 also requires new disclosures for collateral and retained interests in securitizations. SFAS 140 has multiple effective dates. The accounting for new transfers of financial assets will begin March 31, 2001 unless grandfathering provisions have been met. The collateral accounting and disclosure rules are effective for the financial statement period ending after December 15, 2000. The adoption of SFAS 140 is not expected to have a material impact to the Company’s financial position or results of operations. EFFECTS OF INFLATION Because the Company’s assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation affects the Company’s expenses, such as employee compensation, office space leasing costs and communications charges, which may not be readily recoverable in the price of services offered by the Company. To the extent inflation results in rising interest rates and has other adverse effects upon the securities markets, it may adversely affect the Company’s financial position and results of operations in certain businesses.

52

LEHMAN MD&A (36-53) 2/20/01 11:43 PM Page 53

REPORT OF INDEPENDENT AUDITORS

Report The Board of Directors and Stockholders of Lehman Brothers Holdings Inc. We have audited the accompanying consolidated statement of financial condition of Lehman Brothers Holdings Inc. and Subsidiaries (the “Company”) as of November 30, 2000 and 1999, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the three years in the period ended November 30, 2000. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lehman Brothers Holdings Inc. and Subsidiaries at November 30, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended November 30, 2000, in conformity with accounting principles generally accepted in the United States.

New York, New York January 4, 2001

53

LEHMAN FINS (54-59) 2/20/01 11:45 PM Page 54

Consolidated Statement of Income Twelve months ended November 30

2000

1999

1998

$ 3,713

$ 2,341

$ 1,373

2,216

1,682

1,441

944

651

513

19,440

14,251

16,542

(in millions, except per share data)

REVENUES Principal transactions Investment banking Commissions Interest and dividends Other

134

64

25

Total revenues

26,447

18,989

19,894

Interest expense

18,740

13,649

15,781

7,707

5,340

4,113

Net revenues NON-INTEREST EXPENSES Compensation and benefits

3,931

2,707

2,086

Technology and communications

341

327

316

Brokerage and clearance

264

232

239 109

Professional fees

184

115

Business development

182

122

109

Occupancy

135

116

113

91

90

89

5,128

3,709

3,061

2,579

1,631

1,052

748

457

316

56

42

Net income

$ 1,775

$ 1,132

$

736

Net income applicable to common stock

$ 1,679

$ 1,037

$

649

Basic

$

6.89

$

4.27

$

2.68

Diluted

$

6.38

$

4.08

$

2.60

Other Total non-interest expenses Income before taxes and dividends on trust preferred securities Provision for income taxes Dividends on trust preferred securities

Earnings per common share

See Notes to Consolidated Financial Statements.

54

LEHMAN FINS (54-59) 2/20/01 11:45 PM Page 55

Consolidated Statement of Financial Condition November 30

2000

(in millions)

1999

ASSETS Cash and cash equivalents Cash and securities segregated and on deposit for regulatory and other purposes

$

5,160 2,434

$

5,186 1,989

Securities and other financial instruments owned: Governments and agencies

27,381

29,959

Mortgages and mortgage-backed

24,670

22,643

Corporate equities

24,042

12,790

Corporate debt and other

16,098

11,096

Derivatives and other contractual agreements

9,583

10,306

Certificates of deposit and other money market instruments

3,433

2,265

105,207

89,059

Collateralized short-term agreements: Securities purchased under agreements to resell

81,242

62,222

Securities borrowed

17,618

19,397

Brokers, dealers and clearing organizations

1,662

1,674

Customers

7,585

9,332

Others

1,135

1,354

671

485

1,826

1,408

Receivables:

Property, equipment and leasehold improvements (net of accumulated depreciation and amortization of $855 in 2000 and $903 in 1999) Other assets Excess of cost over fair value of net assets acquired (net of accumulated amortization of $138 in 2000 and $129 in 1999) Total assets

180

138

$224,720

$192,244

See Notes to Consolidated Financial Statements.

55

LEHMAN FINS (54-59) 2/20/01 11:46 PM Page 56

Consolidated Statement of Financial Condition

(continued)

November 30

2000

(in millions, except share data)

1999

LIABILITIES AND STOCKHOLDERS’ EQUITY Commercial paper and short-term debt

$

5,800

$

5,476

Securities and other financial instruments sold but not yet purchased: 14,998

22,396

Derivatives and other contractual agreements

Governments and agencies

8,568

9,582

Corporate equities

6,623

12,344

Corporate debt and other

5,096

2,288

35,285

46,610

110,225

81,083

7,242

4,568

1,922

1,184

11,637

10,971

8,735

4,668

32,106

27,375

Collateralized short-term financing: Securities sold under agreements to repurchase Securities loaned Payables: Brokers, dealers and clearing organizations Customers Accrued liabilities and other payables Long-term debt: Senior notes Subordinated indebtedness Total liabilities

3,127

3,316

216,079

185,251

860

710

700

688

Commitments and contingencies Preferred securities subject to mandatory redemption STOCKHOLDERS’ EQUITY Preferred stock Common stock, $0.10 par value; 300,000,000 shares authorized; Shares issued: 251,629,126 in 2000 and 245,238,920 in 1999; Shares outstanding: 236,395,332 in 2000 and 239,825,620 in 1999 Additional paid-in capital Accumulated other comprehensive income (net of tax) Retained earnings Other stockholders’ equity, net

25

25

3,589

3,374

(8)

(2)

3,713

2,094

597

254

Common stock in treasury, at cost: 15,233,794 shares in 2000 and 5,413,300 shares in 1999 Total stockholders’ equity Total liabilities and stockholders’ equity See Notes to Consolidated Financial Statements.

56

(835)

(150)

7,781

6,283

$224,720

$192,244

LEHMAN FINS (54-59) 2/20/01 11:46 PM Page 57

Consolidated Statement of Changes in Stockholders’ Equity Twelve months ended November 30

2000

(in millions)

1999

1998

PREFERRED STOCK 5% Cumulative Convertible Voting, Series A: Beginning balance

$

Series A exchanged for Series B

1

$

1

(1)

Ending balance

1

5% Cumulative Convertible Voting, Series B: Beginning balance

$ 238

Series A exchanged for Series B Shares subject to redemption Shares repurchased

457

507

1 (150) (88)

Ending balance

(220) 238

(50) 457

5.94% Cumulative, Series C: Beginning balance

250

250

250

250

200

200

200

200

200

700

688

908

25

25

25

25

25

25

3,374

3,521

3,423

Shares issued

250

Ending balance

250

5.67% Cumulative, Series D: Beginning balance Shares issued

200

Ending balance 7.115% Cumulative, Series E: Beginning balance Shares issued

250

Ending Balance

250

Redeemable Voting: Beginning and ending balance Total Preferred Stock, ending balance COMMON STOCK(1) Beginning balance Ending balance ADDITIONAL PAID-IN

CAPITAL(1)

Beginning balance RSUs exchanged for Common Stock

(54)

Employee stock-based awards

101

Shares issued to RSU Trust Tax benefits from the issuance of stock-based awards

(210) 373

Other, net

5

Ending balance

$3,589

(63) 9

37

(181) 90 (2) $3,374

59 2 $3,521

(1) Amounts have been retroactively adjusted to give effect for the two-for-one common stock split, effected in the form of a 100% stock dividend, which became effective on October 20, 2000.

See Notes to Consolidated Financial Statements.

57

LEHMAN FINS (54-59) 2/20/01 11:46 PM Page 58

Consolidated Statement of Changes in Stockholders’ Equity

(continued)

Twelve months ended November 30

2000

(in millions)

1999

1998

ACCUMULATED OTHER COMPREHENSIVE INCOME Beginning balance Translation adjustment, net(2) Ending balance

$

(2)

$

15

$

12

(6)

(17)

3

(8)

(2)

15

RETAINED EARNINGS Beginning balance

2,094

1,105

498

Net income

1,775

1,132

736

Dividends declared: 5% Cumulative Convertible Voting Series A and B Preferred Stock

(9)

(20)

(25)

5.94% Cumulative, Series C Preferred Stock

(15)

(15)

(8)

5.67% Cumulative, Series D Preferred Stock

(11)

(10)

(4)

7.115% Cumulative, Series E Preferred Stock

(12)

Redeemable Voting Preferred Stock

(50)

(50)

(50)

Common Stock

(59)

(48)

(37)

Other Ending balance

(5) 3,713

2,094

1,105

1,768

1,318

911

COMMON STOCK ISSUABLE Beginning balance RSUs exchanged for Common Stock Deferred stock awards granted Ending balance

(247)

(83)

(10)

1,003

533

417

2,524

1,768

1,318

COMMON STOCK HELD IN RSU TRUST Beginning balance

(717)

(422)

(325)

Shares issued to RSU Trust

(231)

(441)

(107)

301

146

(647)

(717)

(422)

(797)

(627)

(431)

(1,003)

(533)

(417)

RSUs exchanged for Common Stock Ending balance

10

DEFERRED STOCK COMPENSATION Beginning balance Deferred stock awards granted Amortization of deferred compensation, net Ending balance

363

221

(1,280)

520

(797)

(627)

(150)

(430)

(98)

(1,203)

(353)

(469)

COMMON STOCK IN TREASURY, AT COST Beginning balance Treasury stock purchased Employee stock-based awards Shares issued to RSU Trust Ending balance Total stockholders’ equity (2) Net of income taxes of $(8) in 2000, $(11) in 1999, and $2 in 1998.

See Notes to Consolidated Financial Statements.

58

77

11

30

441

622

107

(835)

(150)

(430)

$7,781

$6,283

$5,413

LEHMAN FINS (54-59) 2/20/01 11:46 PM Page 59

Consolidated Statement of Cash Flows Twelve months ended November 30

2000

1999

$ 1,775

$ 1,132

Depreciation and amortization

102

88

Deferred tax provision (benefit)

(169)

(145)

(284)

520

363

221

(in millions)

1998

CASH FLOWS FROM OPERATING ACTIVITIES Net Income

$

736

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Amortization of deferred stock compensation Other adjustments

65

(129)

91

80

Net change in: Cash and securities segregated and on deposit Securities and other financial instruments owned Securities borrowed Receivables from brokers, dealers and clearing organizations Receivables from customers Securities and other financial instruments sold but not yet purchased Securities loaned

(445)

(806)

(34)

(16,148)

(12,059)

(138)

(3,056)

(2,195)

1,779 12 1,747 (11,325) 2,674

624 (1,574)

(105) 1,347

17,807

(1,277)

1,403

(4,681)

Payables to brokers, dealers and clearing organizations

738

Payables to customers

666

1,768

(2,499)

4,041

377

(152)

Accrued liabilities and other payables Other operating assets and liabilities, net Net cash provided by (used in) operating activities

(138)

(833)

(765)

686

(279)

(14,733)

6,341

(10,002)

9,753

11,091

CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of senior notes

14,225

Principal payments of senior notes

(8,353)

Proceeds from issuance of subordinated indebtedness Principal payments of subordinated indebtedness Net proceeds from (payments for) commercial paper and short-term debt Resale agreements net of repurchase agreements Payments for repurchases of preferred stock Payments for treasury stock purchases Dividends paid Issuances of common stock Issuance of preferred stock, net of issuance costs

(4,298)

200

600

(370)

(356)

324

(1,181)

(1,161)

10,122

(6,488)

5,751

(192)

(88)

(220)

(50)

(1,203)

(353)

(469)

(149)

(139)

(122)

99

8

250

Issuance of trust preferred securities, net of issuance costs Net cash provided by (used in) financing activities

(6,037)

61 444

690 15,035

(4,137)

11,491

CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, equipment and leasehold improvements, net Acquisition, net of cash acquired Net cash used in investing activities Net change in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period

(287)

(73)

(119)

(41) (328) (26)

(73) 2,131

(119) 1,370

5,186

3,055

1,685

$ 5,160

$ 5,186

$ 3,055

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions) Interest paid totaled $18,500 in 2000, $13,513 in 1999 and $15,473 in 1998. Income taxes paid totaled $473 in 2000, $103 in 1999 and $541 in 1998. See Notes to Consolidated Financial Statements.

59

LEHMAN NOTES (60-88) 2/20/01 11:48 PM Page 60

TABLE OF CONTENTS Note 1 Note 2 Note 3 Note 4 Note 5 Note 6 Note 7 Note 8 Note 9 Note 10 Note 11 Note 12 Note 13 Note 14 Note 15 Note 16

Summary of Significant Accounting Policies Short-term Financings Long-term Debt Preferred Securities Subject to Mandatory Redemption Preferred Stock Common Stock Incentive Plans Earnings Per Common Share Capital Requirements Employee Benefit Plans Income Taxes Derivative Financial Instruments Fair Value of Financial Instruments Other Commitments and Contingencies Segments Quarterly Information (Unaudited)

61 64 65 67 68 69 70 73 74 75 76 78 83 84 85 87

LEHMAN NOTES (60-88) 2/20/01 11:48 PM Page 61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Notes NOTE 1 / SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 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 in the U.S. All material intercompany accounts and transactions have been eliminated in consolidation.

The consolidated financial statements are prepared in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates. The Company uses the trade date basis of accounting. Certain prior period amounts reflect reclassifications to conform to the current period’s presentation. Securities and other financial instruments owned and securities and other financial instruments sold but not yet purchased are valued at market or fair value, as appropriate, with unrealized gains and losses reflected in Principal transactions in the Consolidated Statement of Income. Market value is generally based on listed market prices. If 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.

SECURITIES AND OTHER FINANCIAL INSTRUMENTS

A derivative is typically defined as an instrument whose value is “derived” from an underlying instrument, index or rate, such as a future, forward, swap, or option contract, or other financial instrument with similar characteristics. A derivative contract generally represents future commitments to exchange interest payment streams or currencies based on the contract or notional amount or to purchase or sell other financial instruments at specified terms on a specified date.

DERIVATIVE FINANCIAL INSTRUMENTS

Derivatives utilized for trading purposes are recorded at market or fair value in the Consolidated Statement of Financial Condition on a net by counterparty basis where a legal right of set-off exists and are netted across products when such provisions are stated in the master netting agreement. The market or fair value related to swap and forward transactions, as well as options and warrants, is reported in the Consolidated Statement of Financial Condition as an asset or liability in Derivatives and other contractual agreements, as appropriate. Margin on futures contracts is included in receivables and payables, as applicable. Changes in fair values of derivatives are recorded as principal transactions revenues in the current period. 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 incorporate business and economic conditions, historical experience, concentrations, estimates of expected losses and the character, quality and performance of credit sensitive financial instruments.

61

LEHMAN NOTES (60-88) 2/20/01 11:48 PM Page 62

The Company enters into various derivative financial instruments for non-trading purposes as an end user to modify the market risk exposures of certain assets and liabilities. In this regard, the Company utilizes interest rate and currency swaps to modify the interest rate and foreign currency exposure of existing assets and liabilities. The Company also utilizes equity derivatives to hedge its exposure to equity price risk embedded in certain of its debt obligations. In addition to modifying the interest rate and foreign currency exposure of existing assets and liabilities, the Company utilizes derivative financial instruments as an end user to modify the interest rate characteristics of certain anticipated transactions related to its secured financing activities, where there is a high degree of certainty that the Company will enter into such contracts. Derivatives that have been designated as non-trading related positions are accounted for on an accrual basis. Under the accrual basis, interest is accrued into income or expense over the life of the contract, resulting in the net interest impact of the derivative and the underlying hedged item being recognized in income throughout the hedge period. Related unrealized receivables or payables due from or to counterparties are included in receivables from or payables to brokers, dealers and clearing organizations. The Company also utilizes foreign exchange forward contracts to manage the currency exposure related to its net monetary investment in non-U.S. dollar functional currency operations. The gain or loss from revaluing these contracts is deferred and reported within Accumulated other comprehensive income in stockholders’ equity. The related unrealized receivables or payables due from or to counterparties are included in receivables from or payables to brokers, dealers and clearing organizations. In the event that a hedge is no longer effective, the derivative transaction is no longer accounted for as a hedge on an accrual basis. Instead, the Company immediately recognizes the market or fair value of the derivative financial instrument through earnings. Changes in the fair value of such derivative contracts would then be accounted for as a derivative used for trading purposes as discussed above. Realized gains or losses on early terminations of derivatives that were classified as hedges are deferred and amortized to interest income or interest expense over the remaining life of the instrument being hedged. Securities purchased under agreements to resell and securities sold under agreements to repurchase, which are treated as financing transactions for financial reporting purposes, are collateralized primarily by government and government agency securities and are carried net by counterparty, when permitted, at the amounts at which the securities will be subsequently resold or repurchased plus accrued interest. It is the policy of the Company to take possession of securities purchased under agreements to resell. The Company monitors the market value of the underlying positions on a daily basis as compared to the related receivable or payable balances, including accrued interest. The Company requires counterparties to deposit additional collateral or return collateral pledged as necessary, to ensure that the market value of the underlying collateral remains sufficient. Securities and other financial instruments owned that are financed under repurchase agreements are carried at market value with changes in market value reflected in the Consolidated Statement of Income.

REPURCHASE AND RESALE AGREEMENTS

SECURITIES BORROWED AND LOANED Securities borrowed and securities loaned are carried at the amount of cash collateral advanced or received plus accrued interest. It is the Company’s policy to value the securities borrowed and loaned on a daily basis, and to obtain additional cash as necessary to ensure such transactions are adequately collateralized.

The Company carries its private equity investments, including its partnership interests, at fair value based upon the Company’s assessment of the underlying investments.

PRIVATE EQUITY INVESTMENTS

INVESTMENT BANKING Underwriting revenues and fees for merger and acquisition advisory services are recognized when services for the transactions are determined to be completed. Underwriting expenses are deferred and recognized at the time the related revenues are recorded. INCOME TAXES The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” The Company recognizes the current and deferred tax consequences of all transactions that have been recognized in the financial statements using the provisions of the enacted tax laws. In this regard, deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for tax loss carry-forwards, if in the opinion of management, it is more likely than not that the deferred tax asset will be realized. SFAS 109 requires companies to set up a valuation allowance for that component of net deferred tax assets which does

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

not meet the “more likely than not” criterion for realization. Deferred tax liabilities are recognized for temporary differences that will result in taxable income in future years. Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at exchange rates at the statement of financial condition date. Revenues and expenses are translated at average exchange rates during the period. The gains or losses resulting from translating foreign currency financial statements into U.S. dollars, net of hedging gains or losses and taxes, are included in Accumulated other comprehensive income, a separate component of stockholders’ equity. Gains or losses resulting from foreign currency transactions are included in the Consolidated Statement of Income.

TRANSLATION OF FOREIGN CURRENCIES

Property, equipment and leasehold improvements are recorded at historical cost, net of accumulated depreciation and amortization. Depreciation is recognized on a straight-line basis over the estimated useful lives of the related assets. Leasehold improvements are amortized over the lesser of their economic useful lives or the terms of the underlying leases. Internal use software which qualifies for capitalization under AICPA Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” is capitalized and subsequently amortized over the softwares’ estimated useful life. PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

GOODWILL Excess of cost over fair value of net assets acquired (“goodwill”) is amortized using the straight-line method over periods not exceeding 35 years. Goodwill is evaluated periodically for impairment and also is reduced upon the recognition of certain acquired net operating loss carryforward benefits. STOCK-BASED AWARDS SFAS No. 123, “Accounting for Stock-Based Compensation,” established financial accounting and reporting standards for stock-based employee compensation plans. SFAS No. 123 permits companies to either continue accounting for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (“APB 25”) or using the fair value method prescribed by SFAS No. 123. The Company continues to follow APB 25 and its related interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation expense has been recognized for stock option awards because the exercise price was at or above the fair market value of the Company’s common stock on the grant date. STATEMENT OF CASH FLOWS For purposes of the Consolidated Statement of Cash Flows, the Company defines cash equivalents as highly liquid investments with original maturities of three months or less, other than those held for sale in the ordinary course of business.

The Company computes earnings per common share in accordance with SFAS No. 128, “Earnings per Share.” Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive securities. All share and per share amounts have been restated for the two-for-one common stock split, effected in the form of a 100% stock dividend, which became effective October 20, 2000. See Notes 6 and 8 of Notes to Consolidated Financial Statements for more information.

EARNINGS PER COMMON SHARE

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NOTE 2 / SHORT-TERM FINANCINGS The Company obtains short-term financing on both a secured and unsecured basis. The secured financing is obtained through the use of repurchase agreements and securities loaned agreements, which are primarily collateralized by government, agency and equity securities. The unsecured financing is generally obtained through short-term debt and the issuance of commercial paper. The Company’s commercial paper and short-term debt financing is comprised of the following:

November 30

2000

1999

$3,643

$3,642

Bank loans

320

238

Payables to banks

687

575

(in millions)

Commercial paper Short-term debt

Other short-term

debt(1)

Total

1,150

1,021

$5,800

$5,476

The Company’s weighted-average interest rates were as follows:

November 30

2000 Commercial

paper(2)

6.5%

1999 5.5%

Short-term debt(3)

5.5%

4.0%

Securities sold under agreements to repurchase

6.0%

5.2%

(1) Includes master notes, corporate loans and other short-term financings. (2) Includes weighted-average interest rates of 6.9% and 3.0% as of November 30, 2000 and 6.0% and 2.8% as of November 30, 1999 related to U.S. dollar and non-U.S. dollar obligations, respectively. (3) Includes $587 million and $770 million of short-term debt with weighted-average interest rates of 3.3% and 1.4% as of November 30, 2000 and 1999, respectively, related to non-U.S. dollar obligations.

BACK-UP CREDIT FACILITIES Holdings maintains a Revolving Credit Agreement (the “Credit Agreement”) with a syndicate of banks. Under the terms of the Credit Agreement, the banks have committed to provide up to $2 billion for up to 364 days. Any loans outstanding on the commitment termination date may be extended for up to an additional year at the option of Holdings. The Credit Agreement contains covenants, which require, among other things that the Company maintain specified levels of liquidity and tangible net worth.

In July 2000, the Company entered into a $1 billion Committed Securities Repurchase Facility (the “Facility”) for Lehman Brothers International (Europe) (“LBIE”), the Company’s major operating entity in Europe. The Facility provides secured multi-currency financing for a broad range of collateral types. Under the terms of the Facility, the bank group will agree to provide funding for up to one year on a secured basis. Any loans outstanding on the commitment termination date may be extended for up to an additional year at the option of LBIE. The Facility contains covenants that require, among other things that LBIE maintain specified levels of tangible net worth. There are no borrowings outstanding under either the Credit Agreement or the Facility. The Company may use the Credit Agreement and the Facility for general corporate purposes from time to time. The Company has maintained compliance with the applicable covenants for both the Credit Agreement and the Facility at all times.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 / LONG-TERM DEBT U.S. Dollar

Non-U.S. Dollar

Fixed Rate

Floating Rate

Fixed Rate

Floating Rate

2000

Maturing in Fiscal 2001

$ 1,929

$3,731

$ 789

$ 333

$ 6,782

3,588

Maturing in Fiscal 2002

1,698

2,587

887

701

5,873

4,448

Maturing in Fiscal 2003

2,290

1,501

754

444

4,989

3,736

Maturing in Fiscal 2004

1,757

388

883

554

3,582

3,308

Maturing in Fiscal 2005

2,217

575

234

733

3,759

385

(in millions)

November 30

1999

SENIOR NOTES Maturing in Fiscal 2000

December 1, 2005 and thereafter

$ 7,852

5,418

74

1,070

559

7,121

4,058

15,309

8,856

4,617

3,324

32,106

27,375

Maturing in Fiscal 2001

194

6

200

194

Maturing in Fiscal 2002

450

38

488

488

Maturing in Fiscal 2003

475

475

475

Maturing in Fiscal 2004

190

Maturing in Fiscal 2005

94

Senior Notes SUBORDINATED INDEBTEDNESS Maturing in Fiscal 2000

December 1, 2005 and thereafter Subordinated Indebtedness Long-term Debt

198

190

190

7

101

101

1,516

150

7

1,673

1,670

2,919

194

14

3,127

3,316

$18,228

$9,050

$4,631

$35,233

$30,691

$3,324

Of the Company’s long-term debt outstanding as of November 30, 2000, $654 million is repayable prior to maturity at the option of the holder, at par value. These obligations are reflected in the above table as maturing at their put dates, which range from fiscal 2001 to fiscal 2008, rather than at their contractual maturities, which range from fiscal 2004 to fiscal 2026. In addition, $1,732 million of the Company’s long-term debt is redeemable prior to maturity at the option of the Company under various terms and conditions. These obligations are reflected in the above table at their contractual maturity dates. The Company’s interest in 3 World Financial Center was financed with U.S. dollar fixed-rate senior notes totaling $224 million as of November 30, 2000. These notes were unconditionally guaranteed by American Express and collateralized by a first mortgage on the property. During the first quarter of 2001, these notes were redeemed on their contractual maturity date.

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As of November 30, 2000, the Company had approximately $10.5 billion available for the issuance of debt securities under various shelf registrations and debt programs, which includes $4.9 billion of issuance availability under the Company’s Euro medium-term note program. As of November 30, 2000, the Company’s U.S. dollar and non-U.S. dollar debt portfolios included approximately $849 million and $769 million, respectively, of debt for which the interest rates and/or redemption values or maturity have been linked to the performance of various indices including industry baskets of stocks or commodities or events. Generally such notes are issued as floating rate notes or the interest rates on such index notes are effectively converted to floating rates based primarily on LIBOR through the use of interest rate, currency and equity swaps. The Company utilizes a variety of derivative products including interest rate, currency and equity swaps as an end user to modify the interest rate characteristics of its long-term debt portfolio. The Company actively manages the interest rate exposure on its long-term debt portfolio through the use of interest rate and currency swaps to more closely match the terms of the assets being funded and to minimize interest rate risk. In addition, the Company utilizes crosscurrency swaps to hedge its exposure to foreign currency risk as a result of its non-U.S. dollar debt obligations, after consideration of non-U.S. dollar assets which are funded with long-term debt obligations in the same currency. In certain instances, two or more derivative contracts may be utilized by the Company to manage the interest rate nature and/or currency exposure of an individual long-term debt issuance. In these cases, the notional amount of the derivative contracts may exceed the carrying value of the related long-term debt issuance. END-USER DERIVATIVE ACTIVITIES

At November 30, 2000 and 1999, the notional amounts of the Company’s interest rate, currency and equity swaps related to its long-term debt obligations were approximately $26.9 billion and $27.1 billion, respectively. In terms of notional amounts outstanding, these derivative products mature as follows:

(in millions)

U.S. Dollar

NonU.S. Dollar

CrossCurrency

November 30

2000

Maturing in Fiscal 2000

1999 $ 6,935

Maturing in Fiscal 2001

$ 2,171

$ 206

$ 887

$ 3,264

3,059

Maturing in Fiscal 2002

3,140

746

630

4,516

4,178

Maturing in Fiscal 2003

3,273

806

94

4,173

3,778

Maturing in Fiscal 2004

2,018

143

816

2,977

3,225

Maturing in Fiscal 2005

2,371

276

698

3,345

475

December 1, 2005 and thereafter Total

6,959

989

685

8,633

5,424

$19,932

$3,166

$3,810

$26,908

$27,074

Weighted-average interest rate at November 30(1): Receive rate

7.27%

3.93%

4.54%

6.54%

6.15%

Pay rate

7.47%

4.01%

7.39%

7.13%

6.05%

(1) Weighted-average interest rates were calculated utilizing non-U.S. dollar interest rates, where applicable.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On an overall basis, the Company’s long-term debt-related end-user derivative activities resulted in an increase (decrease) in interest expense of approximately $35 million, $(67) million and $(84) million in 2000, 1999 and 1998, respectively. In addition, the Company’s end-user derivative activities resulted in the following changes to the Company’s mix of fixed and floating rate debt and effective weighted-average rates of interest:

November 30, 2000

Weighted-Average(1)

Long-Term Debt

(in millions)

Before End User Activities

After End User Activities

$18,228

$

Contractual Interest Rate

Effective Rate After End User Activities

USD Obligations Fixed rate Floating rate Non-USD Obligations Total

726

9,050

30,792

27,278

31,518

7,955

3,715

$35,233

$35,233

6.68%

7.13%

November 30, 1999

Weighted-Average(1)

Long-Term Debt

(in millions)

Before End User Activities

After End User Activities

$16,977

$

Contractual Interest Rate

Effective Rate After End User Activities

USD Obligations Fixed rate Floating rate Non-USD Obligations Total

353

7,653

27,902

24,630

28,255

6,061

2,436

$30,691

$30,691

6.30%

6.19%

(1) Weighted-average interest rates were calculated using non-U.S. dollar interest rates, where applicable.

NOTE 4 / PREFERRED SECURITIES SUBJECT TO MANDATORY REDEMPTION Preferred securities subject to mandatory redemption is composed of the following issues:

November 30 (in millions)

2000

1999

Lehman Brothers Holdings Capital Trust I

$325

$325

Lehman Brothers Holdings Capital Trust II

385

385

710

710

Trust Preferred Securities Subject to Mandatory Redemption Cumulative Convertible Voting, Series A and Series B Total

150 $860

$710

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During 1999, the Company formed two Delaware business trusts for the purposes of: (a) issuing trust securities representing ownership interests in the assets of the trust; (b) investing the gross proceeds of the trust securities in junior subordinated debentures of the Company; and (c) engaging in activities necessary or incidental thereto. Two such trusts have issued securities to date, having an aggregate liquidation value of $710 million. The following table summarizes the financial structure of each such trust at November 30, 2000:

TRUST PREFERRED SECURITIES SUBJECT TO MANDATORY REDEMPTION

ISSUANCE DATE

Lehman Brothers Holdings Capital Trust I

Lehman Brothers Holdings Capital Trust II

January 1999

April 1999

Trust Securities Preferred securities issued

13,000,000 Series I

15,400,000 Series J

Liquidation preference per security

$25

$25

Liquidation value (in millions)

$325

$385

Coupon rate

8%

7.875%

Distributions payable

Quarterly

Quarterly

Distributions guaranteed by

Lehman Brothers Holdings Inc.

Lehman Brothers Holdings Inc.

Mandatory redemption date

March 31, 2048

June 30, 2048

Redeemable by issuer on or after

March 31, 2004

June 30, 2004

Principal amount outstanding (in millions)

$325

$385

Coupon rate

8%

7.875%

Interest payable

Quarterly

Quarterly

Maturity date

March 31, 2048

June 30, 2048

Redeemable by issuer on or after

March 31, 2004

June 30, 2004

JUNIOR SUBORDINATED DEBENTURES

The Convertible Voting Preferred Shares had a liquidation preference of $39.10 per share. The Series A was issued in 1987. The Series B was issued in an exchange offer for the Series A on July 11, 1997. During the first quarter of 2000, Holdings repurchased 2,258,311 of the Series B for an aggregate cost of $88 million. During the fourth quarter, the Company exercised its option to redeem the shares of Cumulative Convertible Voting Preferred Stock, Series A and Series B (together the “Convertible Voting Preferred”) effective December 15, 2000. As of that date the Convertible Voting Preferred Shares were no longer outstanding. As of November 30, 2000, 1,900 shares of the Series A and 3,834,058 shares of the Series B were outstanding. Given the Company’s intention to redeem the remaining Convertible Voting Preferred, the $150 million aggregate redemption value was transferred on the Company’s Statement of Financial Condition from Preferred stock to Preferred securities subject to mandatory redemption.

CUMULATIVE CONVERTIBLE VOTING, SERIES A AND SERIES B

NOTE 5 / PREFERRED STOCK Holdings is authorized to issue a total of 38,000,000 shares of preferred stock. At November 30, 2000 and 1999, Holdings had 4,426,958 and 6,635,624, respectively, of shares authorized, issued and outstanding under various series as described below and under “Cumulative Convertible Preferred Shares” in Note 4. All preferred stock has a dividend preference over Holdings’ common stock in the paying of dividends and a preference in the liquidation of assets. SERIES C On May 11, 1998, Holdings issued 5,000,000 Depository Shares, each representing 1/10th of a share of 5.94% Cumulative Preferred Stock, Series C (“Series C Preferred Stock”), $1.00 par value. These shares have a redemption price of $500 per share, together with accrued and unpaid dividends. Holdings may redeem any or all of the outstanding shares of Series C Preferred Stock beginning on May 31, 2008. The $250 million redemption value of the shares outstanding at November 30, 2000 is classified on the Company’s Consolidated Statement of Financial Condition as a component of Preferred stock.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SERIES D On July 21, 1998, Holdings issued 4,000,000 Depository Shares, each representing 1/100th of a share of 5.67% Cumulative Preferred Stock, Series D (“Series D Preferred Stock”), $1.00 par value. These shares have a redemption price of $5,000 per share, together with accrued and unpaid dividends. Holdings may redeem any or all of the outstanding shares of Series D Preferred Stock beginning on August 31, 2008. The $200 million redemption value of the shares outstanding at November 30, 2000 is classified on the Company’s Consolidated Statement of Financial Condition as a component of Preferred stock.

On March 28, 2000, Holdings issued 5,000,000 Depository Shares, each representing 1/100th of a share of Fixed/Adjustable Rate Cumulative Preferred Stock, Series E (“Series E Preferred Stock”), $1.00 par value. The initial cumulative dividend rate on the Series E Preferred Stock is 7.115% per annum through May 31, 2005; thereafter the rate will be the higher of either the three-month U.S. Treasury Bill rate, the 10-year Treasury constant maturity rate or the 30-year U.S. Treasury constant maturity rate, in each case plus 1.15%, but in any event not less than 7.615% nor greater than 13.615%. These shares have a redemption price of $5,000 per share, together with accrued and unpaid dividends. Holdings may redeem any or all of the outstanding shares of Series E Preferred Stock beginning on May 31, 2005. The $250 million redemption value of the shares outstanding at November 30, 2000 is classified on the Company’s Consolidated Statement of Financial Condition as a component of Preferred stock.

SERIES E

In 1994, Holdings issued the Redeemable Voting Preferred Stock to American Express and Nippon Life for $1,000. The holders of the Redeemable Voting Preferred Stock are entitled to receive annual dividends through May 31, 2002 in an amount equal to 50% of the amount, if any, by which the Company’s net income for the preceding year exceeds $400 million, up to a maximum of $50 million, prorated in the case of the last dividend period, which runs from December 1, 2001 to May 31, 2002. For the years ended November 30, 2000 and 1999, the Company’s net income of $1,775 million and $1,132 million, respectively, resulted in the recognition of dividends in each year in the amount of $50 million on the Redeemable Voting Preferred Stock.

REDEEMABLE VOTING

Holdings may not redeem shares of the Redeemable Preferred Stock prior to the final dividend payment. However, in the event of a change of control of the Company, holders of the Redeemable Preferred Stock will have the right to require Holdings to redeem all of the stock for an aggregate redemption price equal to $50 million if such change of control occurs prior to November 30, 2001. If a change of control is not approved by a majority of Holdings’ Board of Directors, the funds for redemption must be raised by an offering of Holdings’ equity securities which are not redeemable. The Redeemable Preferred Stock is not convertible into common stock. NOTE 6 / COMMON STOCK On September 20, 2000, Lehman Brothers’ Board of Directors declared a two-for-one common stock split, to be effected in the form of a 100% stock dividend, which became effective on October 20, 2000. The par value of the common stock remained at $0.10 per share. Accordingly, a transfer from paid-in capital to common stock of $12.5 million was made to preserve the par value of the post-split shares. All share and per share amounts have been restated for the effect of the split. Changes in shares of Holdings’ common stock (the “Common Stock”) outstanding are as follows:

November 30

Shares outstanding, beginning of period Exercise of stock options and other share issuances Treasury stock purchases Issuances of shares to the RSU Trust Shares outstanding, end of period

2000

1999

1998

239,825,620

227,315,754

233,224,148

10,015,048

1,925,642

6,259,766

(25,245,336)

(12,415,776)

(17,168,160)

11,800,000

23,000,000

5,000,000

236,395,332

239,825,620

227,315,754

The Company had reserved for issuance approximately 2.4 million shares of Common Stock for conversion of the Convertible Voting Preferred.

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During the years ended November 30, 2000, 1999 and 1998, the Company repurchased or acquired shares of its Common Stock at an aggregate cost of approximately $1,203 million, $353 million and $469 million, respectively. These shares were acquired in the open market and from employees who had tendered mature shares to pay for the exercise cost of stock options and related tax withholding obligations. These shares are being reserved for future issuances under employee stock-based compensation plans. In 1997, the Company established an irrevocable grantor trust (the “RSU Trust”) in order to provide common stock voting rights to employees who hold outstanding restricted stock units and to encourage employees to think and act like owners. The RSU Trust was initially funded in 1997 with a total of 32.0 million shares consisting of 10.0 million treasury shares for restricted stock unit (“RSU”) awards under the Employee Incentive Plan and 22.0 million new issue shares of Common Stock for RSU awards under the 1994 Management Ownership Plan. In 2000, 1999 and 1998, 11.8 million, 23.0 million and 5.0 million treasury shares, respectively, were transferred into the RSU Trust. At November 30, 2000, approximately 42.4 million shares were held in the RSU Trust with a total value of approximately $647 million. For accounting purposes, these shares are valued at weighted-average grant prices. Shares transferred to the RSU Trust do not impact the total number of shares used in the computation of earnings per common share because the Company considers the RSUs as common stock equivalents for purposes of this computation. Accordingly, the establishment of the RSU Trust has had no effect on the total equity, net income or earnings per share of the Company. NOTE 7 / INCENTIVE PLANS EMPLOYEE STOCK PURCHASE PLAN The Employee Stock Purchase Plan (the “ESPP”) allows employees to purchase Common Stock at a 15% discount from market value, with a maximum of $25,000 in annual aggregate purchases by any one individual. The number of shares of Common Stock authorized for purchase by eligible employees is 12.0 million. As of November 30, 2000 and 1999, 5.2 million shares and 4.8 million shares, respectively, of Common Stock had been purchased by eligible employees through the ESPP.

The 1994 Management Replacement Plan (the “Replacement Plan”) provided awards similar to the American Express common shares granted to Company employees which were canceled as of the date of the spin-off from American Express. Through November 30, 2000, a total of 3.9 million awards had been granted under the Replacement Plan, including both stock options and restricted stock; 0.4 million were outstanding at November 30, 2000. No future awards will be granted under this plan.

1994 INCENTIVE PLANS

The Lehman Brothers Holdings Inc. 1994 Management Ownership Plan (the “1994 Plan”) provides for the issuance of RSUs, performance stock units (“PSUs”), stock options and other equity awards for a period of up to ten years to eligible employees. A total of 33.3 million shares of Common Stock may be granted under the 1994 Plan. At November 30, 2000, RSU and stock option awards with respect to 31.3 million shares of Common Stock have been made under the 1994 Plan of which 2.9 million are outstanding and 28.4 million have been converted to freely transferable Common Stock. The Company will utilize the remaining authorization of 2.0 million shares to satisfy dividend reinvestment requirements for outstanding awards and to fund the annual RSU awards for the Company’s non-employee directors. During 1996, the Company’s stockholders approved the 1996 Management Ownership Plan (the “1996 Plan”) under which awards similar to those of the 1994 Plan may be granted, and under which up to 42.0 million shares of Common Stock may be subject to awards. At November 30, 2000, RSU, PSU and stock option awards with respect to 29.7 million shares of Common Stock have been made under the 1996 Plan of which 21.5 million are outstanding and 8.2 million have been converted to freely transferable Common Stock.

1996 MANAGEMENT OWNERSHIP PLAN

The Employee Incentive Plan (“EIP”) has provisions similar to the 1994 Plan and the 1996 Plan, and authorization for up to 156.0 million shares of Common Stock which may be subject to awards. At November 30, 2000, awards with respect to 125.9 million shares of Common Stock have been made under the EIP of which 112.5 million are outstanding and 13.4 million have been converted to freely transferable Common Stock. Approximately 72.5 million of the outstanding awards consist of RSUs and PSUs which have vesting and transfer restrictions extending through the year 2006. EMPLOYEE INCENTIVE PLAN

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following is a summary of RSUs outstanding under Holdings’ stock-based incentive plans: RESTRICTED STOCK UNITS

1994 Plan

1996 Plan

EIP

Total

23,796,350

2,385,758

31,977,174

58,159,282

Granted

167,732

1,222,800

22,800,302

24,190,834

Canceled

(85,468)

Balance, November 30, 1997

Exchanged for stock without restrictions Balance, November 30, 1998

(487,582)

(224,954) (211,128)

(806,598) (180,634)

(1,117,020) (879,344)

23,391,032

3,172,476

53,790,244

80,353,752

Granted

386,422

2,376,634

13,960,994

16,724,050

Canceled

(122,826)

(3,678,534)

(3,861,094)

(733,752)

(10,150,928)

(59,734)

Exchanged for stock without restrictions

(9,375,418)

Balance, November 30, 1999

14,279,210

5,447,618

63,338,952

83,065,780

56,503

2,730,011

19,434,315

22,220,829

(2,746,069)

(3,416,523)

(7,487,129)

(19,247,545)

Granted Canceled Exchanged for stock without restrictions Balance, November 30, 2000

(180,445)

(41,758)

(490,009)

(11,760,416) 2,394,852

7,687,620

72,540,069

82,622,541

Eligible employees receive RSUs as a portion of their total compensation in lieu of cash. There is no further cost to employees associated with the RSU awards. The Company measures compensation cost for RSUs based on the market value of its Common Stock at the grant date and amortizes this amount to expense over the applicable vesting periods. RSU awards made to employees have various vesting provisions and generally convert to unrestricted freely transferable Common Stock five years from the grant date. Holdings accrues a dividend equivalent on each RSU outstanding (in the form of additional RSUs), based on dividends declared on its Common Stock. In the third quarter of 2000, the Company delivered 11.5 million shares of its Common Stock to current and former employees in satisfaction of RSUs awarded in 1995. Substantially all of the shares delivered were funded from the RSU Trust. The Company also received 3.6 million shares from current and former employees in satisfaction of applicable tax withholding requirements. Shares received were recorded as treasury stock at an aggregate value of $168 million. Of the RSUs outstanding at November 30, 2000, approximately 23.5 million RSUs were vested, approximately 14.0 million RSUs will vest during fiscal 2001, and the remaining RSUs will vest subsequent to November 30, 2001. At November 30, 2000, approximately 42.4 million shares of the Company’s Common Stock were held in the RSU Trust. In addition to the RSUs included in the previous table, the Company has awarded PSUs under the EIP to certain senior officers. The number of PSUs which may be earned is dependent upon the achievement of certain performance levels within predetermined performance periods. At the end of a performance period, any PSUs earned will convert one-for-one to RSUs which then vest in three, four or five years. As of December 31, 2000, approximately 6.9 million PSUs have been earned to date, subject to vesting and transfer restrictions. The compensation cost for the RSUs payable in satisfaction of PSUs is accrued over the combined performance and vesting periods. Total compensation cost recognized during 2000, 1999 and 1998 for the Company’s stock-based awards was approximately $520 million, $363 million and $221 million, respectively.

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LEHMAN NOTES (60-88) 2/20/01 11:49 PM Page 72

STOCK OPTIONS

Balance, November 30, 1997

1994 Plan

Replacement Plan

1996 Plan

4,251,280

1,257,788

6,150,000

6,100,000

17,759,068

$11.82

1/98-5/04

6,950,000

14,748,340

21,712,764

$24.86

12/02-11/08

(2,550,330)

(1,412,000)

(6,253,780)

$11.59

(7,893,000)

(7,893,834)

$30.24

10,549,670

11,543,340

25,324,218

$17.32

4,300,000

16,881,168

21,237,406

$27.16

(1,454,726)

$11.10

(828,142)

$22.12

Granted

14,424

Exercised

(1,978,802)

(312,648)

2,286,902

944,306

Canceled

(834)

Balance, November 30, 1998 Granted

56,238

Exercised

(889,598)

Canceled

(34,560)

Balance, November 30, 1999

1,418,982

Granted

(330,568) (3,670) 610,068

37,520

Exercised

(805,600)

Canceled

(165,600)

Balance, November 30, 2000

WeightedAverage Exercise Total Price

485,302

(257,500) (238) 352,330

EIP

(234,560) (200,000)

(589,912)

14,649,670

27,600,036

44,278,756

$22.15

6,600,000

18,469,555

25,107,075

$34.89

(3,273,872)

(9,476,558)

$17.04

(5,139,586) (2,300,000)

(2,875,796)

(5,341,634)

$24.89

13,810,084

39,919,923

54,567,639

$28.62

Expiration Dates

2/99-11/08

6/00-11/09

2/01-11/10

At November 30, 2000 and 1999, approximately 18.0 million and 19.4 million stock options, respectively, were exercisable at weighted-average prices of $22.49 and $17.28, respectively. The weighted-average remaining contractual life of the stock options outstanding at November 30, 2000 is 5.28 years. The exercise price for all stock options awarded has been equal to the market price of Common Stock on the day of grant. The following table provides further details relating to Holdings’ stock options outstanding as of November 30, 2000:

Options Outstanding

Number Outstanding

WeightedAverage Exercise Price

729,688

$ 9.00

$10.00-$19.99

4,472,094

$20.00-$29.99

25,407,604

$30.00-$39.99

17,809,838

$40.00-$49.99

5,998,415

Range Of Exercise Prices $ 9.00-$ 9.99

$50.00-$59.99

WeightedAverage Remaining Contractual Life (in years)

Options Exercisable WeightedAverage Remaining Contractual Life (in years)

Number Exercisable

WeightedAverage Exercise Price

2.18

729,688

$ 9.00

$14.17

.95

4,433,084

$14.12

.88

$23.19

4.76

8,278,578

$22.56

2.68

$33.52

5.66

4,532,806

$32.72

4.22

$49.53

10.00 17,974,156

$22.49

2.60

150,000

$55.56

4.97

54,567,639

$28.62

5.28

2.18

The disclosure requirements of SFAS No. 123 require companies which elect not to record the fair value of stock-based compensation awards in the Consolidated Statement of Income to provide pro forma disclosures of net income and earnings per share in the notes to the consolidated financial statements as if the fair value of stock-based compensation had been recorded. The Company utilized the Black-Scholes option-pricing model to quantify the pro forma effects on net income and earnings per common share of the fair value of the stock options granted and outstanding during 2000, 1999 and 1998. Based on the results of the model, the weighted-average fair value of the stock options granted was $9.91, $6.99 and $6.18 for 2000, 1999 and 1998, respectively. The weighted-average assumptions which were used for 2000, 1999 and 1998 included riskfree interest rates of 6.27%, 5.25% and 5.01%, an expected life of 3.6 years, 3.5 years and 4.0 years, and expected volatility of 35%, 35% and 30%, respectively. In addition, annual dividends of $0.22, $0.18 and $0.15 were assumed for the 2000, 1999 and 1998 options, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company’s 2000, 1999 and 1998 pro forma net income would have been $1,725 million, $1,091 million and $723 million, respectively, compared to actual net income of $1,775 million, $1,132 million and $736 million, respectively. Pro forma earnings per common share for 2000, 1999 and 1998 would have been $6.32, $3.99 and $2.55, respectively, compared to actual earnings per common share of $6.38, $4.08 and $2.60, respectively. The pro forma amounts reflect the effects of the Company’s stock option grants and the 15% purchase discount from market value offered to the Company’s employees who participate in the ESPP. NOTE 8 / EARNINGS PER COMMON SHARE Earnings per share was calculated as follows (in millions, except for per share data):

Three Years Ended

2000

1999

1998

$1,775

$1,132

$ 736

96

95

87

$1,679

$1,037

$ 649

8

17

$1,687

$1,054

$ 649

243.8

243.0

241.8

NUMERATOR: Net income Preferred stock dividends Numerator for basic earnings per share — income available to common stockholders Convertible preferred stock dividends Numerator for diluted earnings per share — income available to common stockholders (adjusted for assumed conversion of preferred stock) DENOMINATOR: Denominator for basic earnings per share — weighted-average shares Effect of dilutive securities: Employee stock options

13.0

6.2

4.8

Restricted stock units

5.0

3.8

3.4

Preferred shares assumed converted into common

2.4

5.6

Dilutive potential common shares

20.4

15.6

8.2

264.2

258.6

250.0

BASIC EARNINGS PER SHARE

$ 6.89

$ 4.27

$ 2.68

DILUTED EARNINGS PER SHARE

$ 6.38

$ 4.08

$ 2.60

Denominator for diluted earnings per share — adjusted weighted-average shares

Convertible Voting Preferred shares were convertible into common shares at a conversion price of approximately $61.50 per share. However, for purposes of calculating dilutive earnings per share, preferred shares were assumed to be converted into common shares when basic earnings per share exceeds preferred dividends per share obtainable upon conversion (approximately $3.08 on an annualized basis).

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NOTE 9 / 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 the Securities and Exchange Commission (“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 November 30, 2000, LBI’s regulatory net capital, as defined, of $1,984 million exceeded the minimum requirement by $1,874 million. LBIE, a United Kingdom registered broker-dealer and subsidiary of Holdings, is subject to the capital requirements of the Securities and Futures Authority (“SFA”) of the United Kingdom. Financial resources, as defined, must exceed the total financial resources requirement of the SFA. At November 30, 2000, LBIE’s financial resources of approximately $1,897 million exceeded the minimum requirement by approximately $381 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 November 30, 2000, had net capital of approximately $400 million which was approximately $108 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 November 30, 2000, these other subsidiaries were in compliance with their applicable local capital adequacy requirements. In addition, the Company’s “AAA” rated derivatives subsidiaries, Lehman Brothers Financial Products Inc. (“LBFP”) and Lehman Brothers Derivative Products Inc. (“LBDP”), have established certain capital and operating restrictions which are reviewed by various rating agencies. At November 30, 2000, LBFP and LBDP each had capital which exceeded the requirement of the most stringent rating agency by approximately $46 million and $26 million, respectively. The regulatory rules referred to above, and certain covenants contained in various debt agreements may restrict Holdings’ ability to withdraw capital from its regulated subsidiaries, which in turn could limit its ability to pay dividends to shareholders. At November 30, 2000, approximately $5.7 billion of net assets of subsidiaries were restricted as to the payment of dividends to Holdings.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 / EMPLOYEE BENEFIT PLANS The Company provides various pension plans for the majority of its employees worldwide. In addition, the Company provides certain other postretirement benefits, primarily health care and life insurance, to eligible employees. The following summarizes these plans:

(in millions, except for weighted-average)

Pension Benefits

Postretirement Benefits

November 30

November 30

2000

1999

2000

1999

$ 50

CHANGE IN BENEFIT OBLIGATION $654

$673

$ 47

Service cost before expenses

Benefit obligation at beginning of year

14

22

1

1

Interest cost

46

45

4

3

Actuarial (gain) loss Benefits paid Foreign currency exchange rate changes Benefit obligation at end of year

(5)

(49)

1

(4)

(23)

(32)

(3)

(3)

(19)

(5)

$667

$654

Fair value of plan assets at beginning of year

$918

$817

Actual return on plan assets, net of expenses

36

123

$ 50

$ 47

$(50)

$(47)

(22)

(24)

CHANGE IN PLAN ASSETS

Employer contribution Benefits paid Foreign currency exchange rate changes

2 (23) (19)

15 (32) (5)

Fair value of plan assets at end of year

$914

$918

Funded (underfunded) status

$247

$264

Unrecognized net actuarial (gain) loss

31

(15)

Unrecognized prior service cost (credit)

17

17

(5)

(6)

$295

$266

$(77)

$(77)

7.75%

7.75%

5.00%

5.00%

Prepaid (accrued) benefit cost WEIGHTED-AVERAGE ASSUMPTIONS Discount rate

7.42%

7.25%

Expected return on plan assets

10.88%

9.19%

Rate of compensation increase

4.96%

4.91%

75

LEHMAN NOTES (60-88) 2/21/01 9:00 PM Page 76

For measurement purposes, the annual health care cost trend rate was assumed to be 7.0% for the year ended November 30, 2001. The rate was assumed to decrease at the rate of 0.5% per year to 5.5% in the year ended November 30, 2004 and remain at that level thereafter.

Pension Benefits Twelve Months Ended

Postretirement Benefits Twelve Months Ended

November 30 (in millions)

November 30

2000

1999

1998

2000

1999

1998

$ 14

$ 22

$ 23

$1

$1

$1

4

4

3

(2)

(2)

(1)

COMPONENTS OF NET PERIODIC BENEFIT COST Service cost Interest cost Expected return on plan assets

46

45

39

(96)

(77)

(67)

Recognized net actuarial (gain) loss

1

2

Unrecognized prior service cost (credit)

1

2

Net periodic benefit (income) cost

$(34)

$ (6)

(1) $ (6)

$3

$3

$3

Assumed health care cost trend rates have an effect on the amount reported for postretirement benefits. A one-percentagepoint change in assumed health care cost trend rates would have the following effects:

(in millions)

1% Point Increase

1% Point Decrease

Effect on total service and interest cost components in fiscal 2000

$0.3

$(0.3)

Effect on postretirement benefit obligation at November 30, 2000

$4.0

$(3.9)

NOTE 11 / INCOME TAXES The Company files a consolidated U.S. federal income tax return reflecting the income of Holdings and its subsidiaries. The provision for income taxes consists of the following:

Twelve months ended November 30 (in millions)

2000

1999

1998

$ 295

$ 121

$ 238

45

117

63

577

364

299

917

602

600

CURRENT Federal State Foreign

DEFERRED Federal State Foreign

(114) (54)

(239) (6)

(1)

(93)

(39)

(169)

(145)

(284)

$ 748

76

2 (54)

$ 457

$ 316

LEHMAN NOTES (60-88) 2/20/01 11:50 PM Page 77

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Income before taxes included $1,287 million, $595 million, and $270 million that has also been subject to income taxes of foreign jurisdictions for 2000, 1999 and 1998, respectively. The income tax provision differs from that computed by using the statutory federal income tax rate for the reasons shown below:

Twelve months ended November 30 (in millions)

Federal income taxes at statutory rate State and local taxes Tax-exempt income Amortization of goodwill Foreign operations Other, net

2000

1999

1998

$ 903

$ 571

$368

(6) (130) 2

41 (109) 2

(15)

(6)

(6)

(42)

$ 748

$ 457

37 (71) 3 3 (24) $316

The effective tax rate increased in 2000 due to an overall increase in the level of pretax income, which lessened the relative impact of certain tax preference items. The increase was partially offset by a decrease in the state and local effective tax rate. For the years ended November 30, 2000 and 1999, a net tax benefit of approximately $373 million and $90 million, respectively, relating to stock-based awards was credited to Additional paid-in capital. In addition, the Company recorded $(8) million, $(11) million and $2 million of tax (benefits)/provisions from the translation of foreign currencies, which was recorded directly in Accumulated other comprehensive income, for the fiscal years 2000, 1999 and 1998, respectively. Effective for 2000, the Company permanently reinvested its earnings in certain foreign subsidiaries. As of November 30, 2000, $112 million of the Company’s accumulated earnings were permanently reinvested. At current tax rates, additional federal income taxes (net of available tax credits) of $15 million would become payable if such income were to be repatriated. Deferred income taxes are provided for the differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements. These temporary differences will result in future income or deductions for income tax purposes and are measured using the enacted tax rates that will be in effect when such items are expected to reverse. The Company provides for deferred income taxes on undistributed earnings of foreign subsidiaries, which are not permanently reinvested.

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At November 30, 2000 and 1999 the deferred tax assets and liabilities consisted of the following:

November 30 (in millions)

2000

1999

$ 439

$ 374

641

521

DEFERRED TAX ASSETS Liabilities/accruals not currently deductible Deferred compensation Unrealized trading and investment activity

75

Foreign tax credits

33

25

Undistributed earnings of foreign subsidiaries (net of credits)

12

36

NOL carryforwards Other Less: Valuation allowance Total deferred tax assets net of valuation allowance

5

5

95

69

$1,300

$1,030

18

15

$1,282

$1,015

$ 121

$ 112

78

60

DEFERRED TAX LIABILITIES Excess tax over financial depreciation Pension and retirement costs Unrealized trading and investment activity Other Total deferred tax liabilities Net deferred tax assets

51 57

11

$ 256

$ 234

$1,026

$ 781

The net deferred tax assets are included in Other assets in the accompanying Consolidated Statement of Financial Condition. The valuation allowance recorded against deferred tax assets at November 30, 2000 and 1999 will reduce goodwill if future circumstances permit recognition. The valuation allowance relates to temporary differences resulting from the 1988 acquisition of E.F. Hutton Group, Inc. (now known as LB I Group Inc.) which are subject to separate company limitations. If future circumstances permit the recognition of the acquired tax benefit, then goodwill will be reduced. The Company has approximately $14 million of NOL carryforwards, substantially all of which are attributable to the acquisition of LB I Group, Inc. NOTE 12 / DERIVATIVE FINANCIAL INSTRUMENTS Derivatives are financial instruments whose value is based upon an underlying asset (e.g., treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR). Over-the-counter (“OTC”) derivative products are privately negotiated contractual agreements that can be tailored to meet individual client needs and include forwards, swaps and certain options including caps, collars and floors. Exchange-traded derivative products are standardized contracts transacted through regulated exchanges and include futures and certain option contracts listed on an exchange. In the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end user. Acting in a trading capacity, the Company enters into derivative transactions to satisfy the needs of its clients and to manage the Company’s own exposure to market and credit risks resulting from its trading activities (collectively, “Trading-Related Derivative Activities”). As an end user, the Company primarily enters into interest rate swap and option contracts to adjust the interest rate nature of its funding sources from fixed to floating rates, and to change the index upon which floating interest rates are based (e.g., Prime to LIBOR) (collectively, “End User Derivative Activities”).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

There is an extensive volume of derivative products available in the marketplace, which can vary from a simple forward foreign exchange contract to a complex derivative instrument with multiple risk characteristics involving the aggregation of the risk characteristics of a number of derivative product types including swap products, options and forwards. Listed below are examples of various derivative product types along with a brief discussion of the performance mechanics of certain specific derivative instruments. Interest rate swap products include interest rate and currency swaps, leveraged swaps, swap options, and other interest rate option products including caps, collars and floors. An interest rate swap is a negotiated OTC contract in which two parties agree to exchange periodic interest payments for a defined period, calculated based upon a predetermined notional amount. Interest payments are usually exchanged on a net basis throughout the duration of the swap contract. A currency swap is an OTC agreement to exchange a fixed amount of one currency for a specified amount of a second currency at the outset and completion of the swap term. Leveraged swaps involve the multiplication of the interest rate factor upon which the interest payment streams are based (e.g., Party A pays three times the six-month LIBOR). Caps are contractual commitments that require the writer to pay the purchaser the amount by which an interest reference rate exceeds a defined contractual rate, if any, at specified times during the contract. Conversely, a floor is a contractual commitment that requires the writer to pay the amount by which a defined contractual rate exceeds an interest reference rate at specified times over the life of the contract, if any. Equity swaps are contractual agreements whereby one party agrees to receive the appreciation (or depreciation) value over a strike price on an equity investment in return for paying another rate, which is usually based upon equity index movements or interest rates. Commodity swaps are contractual commitments to exchange the fixed price of a commodity for a floating price (which is usually the prevailing spot price) throughout the swap term. SWAP PRODUCTS

OPTIONS Option contracts provide the option purchaser (holder) with the right but not the obligation to buy or sell a financial instrument, commodity or currency at a predetermined exercise price (strike price) during a defined period (American Option) or at a specified date (European Option). The option purchaser pays a premium to the option seller (writer) for the right to exercise the option. The option seller is obligated to buy (put) or sell (call) the item underlying the contract at a set price, if the option purchaser chooses to exercise. Option contracts also exist for various indices and are similar to options on a security or other instrument except that, rather than settling physical with delivery of the underlying instrument, they are cash settled. As a purchaser of an option contract, the Company is subject to credit risk, since the counterparty is obligated to make payments under the terms of the option contract, if the Company exercises the option. As the writer of an option contract, the Company is not subject to credit risk but is subject to market risk, since the Company is obligated to make payments under the terms of the option contract if exercised.

Option contracts may be exchange-traded or OTC. Exchange-traded options are the obligations of the exchange and generally have standardized terms and performance mechanics. In contrast, all of the terms of an OTC option including the method of settlement, term, strike price, premium and security are determined by negotiation of the parties. Futures contracts are exchange-traded contractual commitments to either receive (purchase) or deliver (sell) a standard amount or value of a financial instrument or commodity at a specified future date and price. Maintaining a futures contract requires the Company to deposit with the exchange an amount of cash or other specified assets as security for its obligation. Therefore, the potential for losses from exchange-traded products is limited. As of November 30, 2000 the Company had approximately $1,505 million on deposit with futures exchanges consisting of cash and securities (customer and proprietary), and had posted approximately $302 million of letters of credit. Additionally, futures exchanges generally require the daily cash settlement of unrealized gains/losses on open contracts with the futures exchange. Therefore, futures contracts provide a reduced funding alternative to purchasing the underlying cash position in the marketplace. Futures contracts may be settled by physical delivery of the underlying asset or cash settlement (for index futures) on the settlement date or by entering into an offsetting futures contract with the futures exchange prior to the settlement date.

FUTURES AND FORWARDS

Forwards are OTC contractual commitments to purchase or sell a specified amount of a financial instrument, foreign currency or commodity at a future date at a predetermined price. TBAs are forward contracts which give the purchaser/seller an obligation to obtain/deliver mortgage securities in the future. Therefore, TBAs subject the holder to both interest rate risk and principal prepayment risk.

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TRADING-RELATED DERIVATIVE ACTIVITIES Derivatives are subject to various risks similar to other financial instruments including market, credit and operational risk. In addition, the Company may also be exposed to legal risks related to its derivative activities including the possibility that a transaction may be unenforceable under applicable law. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with the Company’s other trading-related activities. The Company manages the risks associated with derivatives on an aggregate basis along with the risks associated with its proprietary trading and market-making activities in cash instruments as part of its firmwide risk management policies.

Derivatives are generally based upon notional amounts. Notional amounts are not recorded on-balance sheet, but rather are utilized solely as a basis for determining future cash flows to be exchanged. Therefore, notional amounts provide a measure of the Company’s involvement with such instruments, but are not indicative of actual or potential risk. The following table reflects the notional/contract amounts of the Company’s Trading-Related Derivative Activities: TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS

Notional/ Contract Amounts November 30 (in millions)

Interest rate and currency swaps and options (including caps, collars and floors) Foreign exchange forward and future contracts and options

WeightedAverage Maturity (in years)

November 30

November 30

2000

1999

2000

$2,406,501

$2,142,592

5.25

458,593

418,481

.46

496,641

254,662

.77

55,355

62,053

.82

347

173

1.69

$3,417,437

$2,877,961

3.88

Other fixed income securities contracts (including futures contracts, options and TBAs) Equity contracts (including equity swaps, futures, warrants and options) Commodity contracts (including swaps, futures, forwards and options) Total

Of the total notional amounts at November 30, 2000 and 1999, approximately $3,171 billion and $2,706 billion are over-thecounter and $246 billion and $172 billion are exchange-traded, respectively. The total weighted-average maturity at November 30, 2000, for over-the-counter and exchange-traded contracts was 3.88 years and 3.73 years, respectively. Approximately $1,213 billion of the notional/contract amount of the Company’s Trading-Related Derivative Activities mature within the year ended November 30, 2001, of which approximately 36% have maturities of less than one month. The Company records its Trading-Related Derivative Activities on a mark-to-market basis with realized and unrealized gains and losses recognized currently in Principal transactions in the Consolidated Statement of Income. 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. The Company offers equity, fixed income and foreign exchange products to its customers. Because of the integrated nature of the market for such products, each product area trades cash instruments as well as related derivative products.

80

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Listed in the following table is the fair value of the Company’s Trading-Related Derivative Activities as of November 30, 2000 and 1999 as well as the average fair value of these instruments. Average fair values of these instruments were calculated based upon month-end statement of financial condition values, which the Company believes do not vary significantly from the average fair value calculated on a more frequent basis. Variances between average fair values and period-end values are due to changes in the volume of activities in these instruments and changes in the valuation of these instruments due to variations in market and credit conditions. FAIR VALUE OF TRADING-RELATED DERIVATIVE FINANCIAL INSTRUMENTS

Average Fair Value* Fair Value*

Twelve Months Ended

November 30, 2000 (in millions)

November 30, 2000

Assets

Liabilities

Assets

Liabilities

$4,349

$3,390

$ 4,525

$ 3,051

902

1,361

1,180

961

Interest rate and currency swaps and options (including caps, collars and floors) Foreign exchange forward contracts and options Other fixed income securities contracts (including options and TBAs) Equity contracts (including equity swaps, warrants, and options) Total

496

418

1,269

1,113

3,836

3,399

6,664

5,885

$9,583

$8,568

$13,638

$11,010

Average Fair Value* Fair Value*

Twelve Months Ended

November 30, 1999 (in millions)

November 30, 1999

Assets

Liabilities

Assets

Liabilities

$ 4,807

$3,633

$4,406

$3,030

878

1,310

1,226

1,287

Interest rate and currency swaps and options (including caps, collars and floors) Foreign exchange forward contracts and options Other fixed income securities contracts (including options and TBAs) Equity contracts (including equity swaps, warrants and options)

254

195

257

240

4,367

4,444

2,478

3,291

15

5

$10,306

$9,582

$8,382

$7,853

Commodity contracts (including swaps, forwards, and options) Total

*Amounts represent carrying value (exclusive of collateral) and do not include receivables or payables related to exchange-traded futures contracts.

Assets included in the table above represent the Company’s unrealized gains, net of unrealized losses for situations in which the Company has a master netting agreement. Similarly, liabilities represent net amounts owed to counterparties. Therefore, the fair value of assets/liabilities related to derivative contracts at November 30, 2000 represents the Company’s net receivable/payable for derivative financial instruments before consideration of collateral. Included within the $9,583 million fair value of assets at November 30, 2000 was $8,643 million related to swaps and other OTC contracts and $940 million related to exchange-traded option and warrant contracts. Included within the $10,306 million fair value of assets at November 30, 1999 was $9,002 million related to swaps and other OTC contracts and $1,304 million related to exchange-traded option and warrant contracts. The primary difference in risks related to OTC and exchange-traded contracts is credit risk. OTC contracts contain credit risk for unrealized gains from various counterparties for the duration of the contract, net of collateral. With respect to OTC contracts, including swaps, the Company views its net credit exposure to be $6,304 million at November 30, 2000, representing the fair value of the Company’s OTC contracts in an unrealized gain position, after consideration of collateral.

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LEHMAN NOTES (60-88) 2/23/01 1:29 PM Page 82

Counterparties to the Company’s OTC derivative products are primarily financial intermediaries (U.S. and foreign banks), securities firms, corporations, governments and their agencies, finance companies, insurance companies, investment companies and pension funds. Collateral held related to OTC contracts generally includes cash and U.S. government and federal agency securities. Presented below is an analysis of the Company’s net credit exposure at November 30, 2000 for OTC contracts based upon actual ratings made by external rating agencies or by equivalent ratings established and utilized by the Company’s Credit Risk Management Department. 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 1 AAA/Aaa 11% directly on the exchange. To protect against the potential for a 2 AA – /Aa3 or higher 29% default, all exchange clearinghouses impose net capital require3 A – /A3 or higher 39% ments for their membership. Additionally, the exchange clear4 BBB – /Baa3 or higher 15% inghouse requires counterparties to futures contracts to post 5 BB – /Ba3 or higher 3% margin upon the origination of the contract and for any 6 B+/B1 or lower 3% changes in the market value of the contract on a daily basis (certain foreign exchanges provide for settlement within three days). Therefore, the potential for losses from exchange-traded products is limited. Counterparty Risk Rating

S&P/Moody’s Equivalent

Net Credit Exposure

The Company utilizes a variety of derivative products as an end user to modify the interest rate characteristics of its long-term debt portfolio. The Company actively manages the interest rate exposure on its longterm debt portfolio through the use of interest rate and currency swaps to more closely match the terms of its debt portfolio to the assets being funded and to minimize interest rate risk. At November 30, 2000 and 1999, the notional amounts of the Company’s end-user activities related to its long-term debt obligations were approximately $26.9 billion and $27.1 billion, respectively. (For a further discussion of the Company’s long-term debt related end-user derivative activities see Note 3.)

END-USER DERIVATIVE ACTIVITIES

The Company also utilizes derivative products as an end user to modify its interest rate exposure associated with its secured financing activities, including securities purchased under agreements to resell, securities borrowed, securities sold under agreements to repurchase and securities loaned. At November 30, 2000 and 1999, the Company had $216 billion and $167 billion, respectively, of such secured financing activities. As with the Company’s long-term debt, its secured financing activities expose the Company to interest rate risk. The Company, as an end user, manages the interest rate risk related to these activities by utilizing derivative financial instruments, including interest rate swaps and purchased options. The Company designates certain specific derivative transactions against specific assets and liabilities with matching maturities. In addition, the Company manages the interest rate risk of anticipated secured financing transactions with derivative products. The Company actively monitors the level of anticipated secured financing transactions to ensure there is a high degree of certainty that such secured financing transactions will be executed at levels at least equal to the designated derivative product transactions. At November 30, 2000 and 1999, the Company, as an end user, utilized derivative financial instruments with an aggregate notional amount of $8.5 billion and $12.9 billion, respectively, to modify the interest rate characteristics of its secured financing activities. The total notional amount of these agreements had a weighted-average maturity of 3.5 years and 2.3 years as of November 30, 2000 and 1999, respectively. On an overall basis, the Company’s secured financing end-user derivative activities (decreased) increased net revenues by approximately $(14) million, $(13) million and $4 million for 2000, 1999 and 1998, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 / FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107 “Disclosures about Fair Value of Financial Instruments” requires the Company to report the fair value of financial instruments, as defined. Assets and liabilities that are carried at fair value include all of the Company’s trading assets and liabilities including derivative financial instruments used for trading purposes as described in Note 1, which are recorded as securities and other financial instruments owned and securities and other financial instruments sold but not yet purchased. Assets and liabilities, which are recorded at contractual amounts that approximate market or fair value include cash and cash equivalents, cash and securities segregated and on deposit for regulatory and other purposes, receivables, certain other assets, commercial paper and short-term debt, and payables. The market value of such items are not materially sensitive to shifts in market interest rates because of the limited term to maturity of these instruments and their variable interest rates. Financial instruments which are recorded at amounts that do not necessarily approximate market or fair value include longterm debt, certain secured financing activities and the related financial instruments utilized by the Company as an end user to manage the interest rate risk of these exposures. The Company’s long-term debt is recorded at contractual or historical amounts. The following table provides a summary of the fair value of the Company’s long-term debt and related end-user derivative activities. The fair value of the Company’s long-term debt was estimated using either quoted market prices or discounted cash flow analyses based on the Company’s current borrowing rates for similar types of borrowing arrangements. The fair value of the Company’s long-term debt is subject to changes in its credit spreads, which fluctuated significantly in 2000 and 1999. The unrecognized net gain (loss) related to the Company’s end-user derivative activities reflects estimated fair values based on market rates at November 30, 2000 and 1999, respectively.

November 30

2000

1999

$35,233

$30,691

(in millions)

Carrying value of long-term debt Fair value of long-term debt

35,193

Unrecognized net gain (loss) on long-term debt

$

Unrecognized net gain (loss) on long-term debt end user activities

$

40 (201)

30,454 $

237

$

(439)

The Company carries its secured financing activities, including securities purchased under agreements to resell, securities borrowed, securities sold under agreements to repurchase, and securities loaned, at their original contract amount plus accrued interest. As the majority of such financing activities are short-term in nature, carrying value approximates fair value. At November 30, 2000 and 1999, the Company had $216 billion and $167 billion, respectively, of such secured financing activities. As with the Company’s long-term debt, its secured financing activities expose the Company to interest rate risk. At November 30, 2000 and 1999, the Company, as an end-user, utilized derivative financial instruments with an aggregate notional amount of $8.5 billion and $12.9 billion, respectively, to modify the interest rate characteristics of its secured financing activities. The unrecognized net losses related to these derivative financial instruments were $22 million and $11 million at November 30, 2000 and 1999, respectively, which were substantially offset by unrecognized net gains on the Company’s secured financing activities, including anticipated transactions during the hedge period. Additionally, at November 30, 2000 the Company had approximately $8 million of unrecognized losses related to approximately $1.4 billion of long-term fixed rate repurchase agreements as compared to unrecognized net gains of approximately $23 million on approximately $2.5 billion of such agreements at November 30, 1999.

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NOTE 14 / OTHER COMMITMENTS AND CONTINGENCIES As of November 30, 2000 and 1999, the Company was contingently liable for $2.1 billion 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 $3.2 billion and $4.5 billion, at November 30, 2000 and 1999, 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 overcollateralization based upon the borrowers’ creditworthiness. In addition, the Company, through its high grade and high yield sales, trading and underwriting activities, makes commitments to extend credit in loan syndication transactions and then participates out a significant portion of these commitments. The Company had lending commitments to high grade borrowers of $4.4 billion and $2.9 billion at November 30, 2000 and 1999, respectively. In addition, lending commitments to high yield borrowers totaled $1.3 billion and $1.4 billion at November 30, 2000 and 1999, respectively. All of these commitments and any related draw downs of these facilities are typically secured against the borrower’s assets, have fixed maturity dates, and are generally contingent upon certain representations, warranties and contractual conditions applicable to the borrower. Total commitments are not indicative of actual risk or funding requirements, as the commitments may not be drawn or fully utilized, and the Company will continue to syndicate and/or sell these commitments. As of November 30, 2000, the Company had pledged securities, primarily fixed income, having a market value of approximately $30.4 billion, as collateral for securities borrowed having a market value of approximately $28.7 billion. Securities and other financial instruments sold but not yet purchased represent obligations of the Company to purchase the securities at prevailing market prices. Therefore, the future satisfaction of such obligations may be for an amount greater or less than the amount recorded. The ultimate gain or loss is dependent upon the price at which the underlying financial instrument is purchased to settle its obligation under the sale commitment. In the normal course of business, the Company is exposed to off-balance sheet credit and market risk as a result of executing, financing and settling various customer security and commodity transactions. Off-balance sheet risk arises from the potential that customers or counterparties fail to satisfy their obligations and that the collateral obtained is insufficient. In such instances, the Company may be required to purchase or sell financial instruments at unfavorable market prices. The Company seeks to control these risks by obtaining margin balances and other collateral in accordance with regulatory and internal guidelines. At November 30, 2000 and 1999, the Company had commitments to invest up to $357 million and $411 million, respectively, directly and through partnerships in private equity related investments. These commitments will be funded as required through the end of the respective investment periods, principally expiring in 2004. Subsidiaries of the Company, as general partner, are contingently liable for the obligations of certain public and private limited partnerships organized as pooled investment funds or engaged primarily in real estate activities. In the opinion of the Company, contingent liabilities, if any, for the obligations of such partnerships will not in the aggregate have a material adverse effect on the Company’s consolidated financial position or results of operations. In the normal course of its business, the Company has been named a defendant in a number of lawsuits and other legal proceedings. After considering all relevant facts, available insurance coverage and the advice of outside counsel, in the opinion of the Company such litigation will not, in the aggregate, have a material adverse effect on the Company’s consolidated financial position or results of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As a leading global investment bank, the Company is actively involved in securities underwriting, brokerage, distribution and trading. These and other related services are provided on a worldwide basis to a large and diversified group of clients and customers, including multinational corporations, governments, emerging growth companies, financial institutions and individual investors.

CONCENTRATIONS OF CREDIT RISK

A substantial portion of the Company’s securities and commodities transactions is collateralized and is executed with, and on behalf of, commercial banks and other institutional investors, including other brokers and dealers. The Company’s exposure to credit risk associated with the non-performance of these customers and counterparties in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile or illiquid trading markets, which may impair the ability of customers and counterparties to satisfy their obligations to the Company. Securities and other financial instruments owned by the Company include U.S. government and agency securities, and securities issued by non-U.S. governments, which in the aggregate, represented 12% of the Company’s total assets at November 30, 2000. In addition, primarily all of the collateral held by the Company for resale agreements represented 36% of total assets at November 30, 2000, and consisted of securities issued by the U.S. government, federal agencies or non-U.S. governments. The Company’s most significant industry concentration is financial institutions, which include other brokers and dealers, commercial banks and institutional clients. This concentration arises in the normal course of the Company’s business. The Company leases office space and equipment throughout the world and is a party to a ground lease with the Battery Park City Authority covering its headquarters at 3 World Financial Center which extends through 2069. Total rent expense for 2000, 1999 and 1998 was $47 million, $37 million and $39 million, respectively. Certain leases on office space contain escalation clauses providing for additional rentals based upon maintenance, utility and tax increases.

LEASE COMMITMENTS

Minimum future rental commitments under non-cancelable operating leases (net of subleases of $57 million) are as follows:

(in millions)

Fiscal 2001

$

65

Fiscal 2002

60

Fiscal 2003

55

Fiscal 2004

69

Fiscal 2005 December 1, 2005 and thereafter

71 1,013 $1,333

NOTE 15 / SEGMENTS Lehman Brothers 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.

85

LEHMAN NOTES (60-88) 2/20/01 11:51 PM Page 86

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 twenty private equity partnerships. In addition, these revenues also include the appreciation of its general partnership interests. The Company’s segment information for fiscal years 2000, 1999 and 1998 is presented below and was developed consistent with the accounting policies used to prepare the Company’s consolidated financial statements.

(in millions)

Investment Banking

Capital Markets

Client Services

Total

$2,179

$4,689

$ 839

$7,707

NOVEMBER 30, 2000 Net revenue Earnings before

taxes(1)

$ 499

$1,801

$ 279

$2,579

$

0.5

$213.8

$10.4

$224.7

Net revenue

$1,664

$3,093

$ 583

$5,340

Earnings before taxes(1)

$ 509

$ 978

$ 144

$1,631

Segment assets (billions)

$

0.3

$182.5

$ 9.4

$192.2

Net revenue

$1,401

$2,113

$ 599

$4,113

Earnings before taxes(1)

$ 530

$ 359

$ 163

$1,052

Segment assets (billions)

$

$141.3

$12.0

$153.9

Segment assets (billions) NOVEMBER 30, 1999

NOVEMBER 30, 1998

0.6

(1) And before dividends on preferred securities.

The following are net revenues by geographic region:

Twelve Months ended November 30 (in millions)

U.S. Europe Asia Pacific and other Total

2000

1999

1998

$4,492

$3,160

$2,692

2,389

1,650

870

826

530

551

$7,707

$5,340

$4,113

The following information describes the Company’s methods of allocating consolidated net revenues to geographic regions. Net revenues, if syndicated or trading-related, have been distributed based upon the location where the primary or secondary position was fundamentally risk managed: if fee-related, by the location of the senior coverage banker; if commission-related, by the location of the salespeople. In addition, certain revenues associated with domestic products and services which resulted from relationships with international clients and customers have been reclassified as international revenues using an allocation consistent with the Company’s internal reporting.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 16 / QUARTERLY INFORMATION (unaudited) The following information represents the Company’s unaudited quarterly results of operations for 2000 and 1999. Certain amounts reflect reclassifications to conform to the current period’s presentation. These quarterly results reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results. Revenues and earnings of the Company can vary significantly from quarter to quarter due to the nature of the Company’s business activities.

2000

1999

(in millions, except per share amounts)

Nov. 30

Aug. 31

May 31

Feb. 29

Nov. 30

Aug. 31

May 31

Feb. 28

Total revenues

$6,414

$7,359

$6,334

$6,340

$4,701

$4,765

$4,932

$4,591

Interest expense

4,716

5,307

4,579

4,138

3,290

3,409

3,477

3,473

Net revenues

1,698

2,052

1,755

2,202

1,411

1,356

1,455

1,118

Compensation and benefits

806

1,067

912

1,145

715

688

738

567

Other expenses

338

312

285

263

258

251

251

242

1,144

1,379

1,197

1,408

973

939

989

809

554

673

558

794

438

417

466

309

141

202

166

239

122

112

126

96

14

14

14

14

15

15

10

2

$ 399

$ 457

$ 378

$ 541

$ 301

$ 290

$ 330

$ 211

$ 386

$ 444

$ 366

$ 482

$ 292

$ 279

$ 268

$ 198

Basic

241.9

242.3

246.3

246.1

241.5

242.6

244.2

243.8

Diluted

265.4

265.0

265.3

262.4

258.0

258.2

260.8

251.6

$ 1.60

$ 1.83

$ 1.49

$ 1.96

$ 1.21

$ 1.15

$ 1.10

$ 0.81

Non-interest expenses:

Total non-interest expenses Income before taxes and dividends on trust preferred securities Provision for income taxes Dividends on trust preferred securities Net income Net income applicable to common stock Weighted-average shares

Earnings per common share Basic Diluted Dividends per common share

$ 1.46

$ 1.68

$ 1.39

$ 1.84

$ 1.14

$ 1.10

$ 1.05

$ 0.79

$0.055

$0.055

$0.055

$0.055

$0.045

$0.045

$0.045

$0.045

$28.78

$27.58

$25.59

$24.40

$22.75

$21.46

$20.29

$19.36

Book value per common share (at period end)

87

LEHMAN NOTES (60-88) 2/23/01 1:29 PM Page 88

SELECTED FINANCIAL DATA

Data The following table summarizes certain consolidated financial information included in the audited consolidated financial statements.

Twelve Months ended November 30

2000

(in millions, except per share, other data and financial ratios)

CONSOLIDATED STATEMENT OF INCOME Revenues: Principal transactions Investment banking Commissions Interest and dividends Other

$

Total revenues Interest expense Net revenues Non-interest expenses: Compensation and benefits Other expenses Severance and other charges Total non-interest expenses Income before taxes and dividends on trust preferred securities Provision for income taxes Dividends on trust preferred securities

3,713 2,216 944 19,440 134

1999

$

2,341 1,682 651 14,251 64

1998

$

1,373 1,441 513 16,542 25

1997

$

1,461 1,275 423 13,635 89

1996

$

1,579 981 362 11,298 40

26,447 18,740

18,989 13,649

19,894 15,781

16,883 13,010

14,260 10,816

7,707

5,340

4,113

3,873

3,444

3,931 1,197

2,707 1,002

2,086 975

1,964 972

1,747 976 84

5,128

3,709

3,061

2,936

2,807

2,579 748 56

1,631 457 42

1,052 316

937 290

637 221

Net income

$

1,775

$

1,132

$

736

$

647

$

416

Net income applicable to common stock

$

1,679

$

1,037

$

649

$

572

$

378

CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (AT PERIOD END) Total assets Total assets excluding matched book(a) Long-term debt(b) Preferred securities subject to mandatory redemption Total stockholders’ equity Total capital(c)

$224,720 143,478 35,233 860 7,781 43,874

$192,244 130,022 30,691 710 6,283 37,684

$153,890 111,509 27,341

$151,705 108,099 20,261

$128,596 96,256 15,922

5,413 32,754

4,523 24,784

3,874 19,796

PER SHARE DATA(d) Net income Dividends declared per common share Book value per common share (at period end)

$ $ $

$ $ $

$ $ $

6.38 0.22 28.78

4.08 0.18 22.75

2.60 0.15 18.53

$ $ $

2.36 0.12 16.70

$ $ $

1.62 0.10 14.42

OTHER DATA (AT PERIOD END) Ratio of total assets to total stockholders’ equity and preferred securities Ratio of total assets excluding matched book to total stockholders’ equity and preferred securities(a) Employees FINANCIAL RATIOS (%): Compensation and benefits/net revenues Pretax operating margin Effective tax rate Return on average common equity(e)

26.0X

27.5X

28.4X

33.5X

33.2X

16.6X 11,326

18.6X 8,893

20.6X 8,873

23.9X 8,340

24.8X 7,556

51.0 33.5 29.0 26.6

50.7 30.5 28.0 20.8

50.7 25.6 30.0 15.2

50.7 24.2 30.9 15.6

50.7 18.5 35.4 12.1

(a) Matched book represents “securities purchased under agreements to resell” (“reverse repos”) to the extent that such balance is less than “securities sold under agreements to repurchase” (“repos”) as of the statement of financial condition date. Several nationally recognized rating agencies consider such reverse repos to be a proxy for matched book assets when evaluating the Company’s capital strength and financial ratios. Such agencies consider matched book assets to have a low risk profile and exclude such amounts in the calculation of leverage (total assets divided by total stockholders’ equity and trust preferred securities). Although there are other assets with similar risk characteristics on the Company’s Consolidated Statement of Financial Condition, the exclusion of reverse repos from total assets in this calculation reflects the fact that these assets are matched against liabilities of a similar nature, and therefore require minimal amounts of capital support. Accordingly, the Company believes the ratio of total assets excluding matched book to total stockholders’ equity and trust preferred securities to be a more meaningful measure of the Company’s leverage. (b) Long-term debt includes senior notes and subordinated indebtedness. (c) Total capital includes long-term debt, stockholders’ equity and preferred securities subject to mandatory redemption. (d) All share and per share data have been restated for the two-for-one common stock split effective October 20, 2000. (e) After redeemable preferred dividend.

88

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Board of Directors Richard S. Fuld, Jr.

Thomas H. Cruikshank

Chairman and Chief Executive Officer

Retired Chairman and Chief Executive Officer of Halliburton Company

Michael L. Ainslie

Former President and Chief Executive Officer of Sotheby’s Holdings

Dr. Henry Kaufman

John F. Akers

John D. Macomber

Retired Chairman of International Business Machines Corporation

Principal of JDM Investment Group

President of Henry Kaufman & Company, Inc.

Dina Merrill Roger S. Berlind

Theatrical Producer

Director and Vice Chairman of RKO Pictures, Inc. and Actress

89

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Operating Committee Richard S. Fuld, Jr.*

Herbert H. McDade, III

Chairman and Chief Executive Officer

Managing Director Co-Head of Fixed Income

Jasjit S. Bhattal

Roger B. Nagioff

Managing Director Chief Executive Officer, Lehman Brothers Asia

Managing Director Co-Head of Equities Michael J. Odrich

J. Stuart Francis

Managing Director Investment Banking

Managing Director Head of Private Equity James A. Rosenthal

Managing Director Chief Financial Officer

Managing Director Head of Strategy, Recruiting & E-Commerce

Joseph M. Gregory*

Mark Rufeh

Managing Director Chief Administrative Officer

Managing Director Chief Operations Officer

Jeremy M. Isaacs*

Thomas A. Russo

Managing Director Chief Executive Officer, Lehman Brothers Europe & Asia

Managing Director Chief Legal Officer

Dave Goldfarb

Robert S. Shafir Bradley H. Jack*

Managing Director Head of Investment Banking

Managing Director Co-Head of Equities Jeffrey Vanderbeek*

Theodore P. Janulis

Managing Director Co-Head of Fixed Income

Managing Director Head of Capital Markets Jarett F. Wait

Stephen M. Lessing*

Senior Client Relationship Manager & Head of Private Client Group Roberto Llamas

Managing Director Co-Head of E-Commerce Paul G. Zoidis

Managing Director Investment Banking

Managing Director Chief Human Resources Officer

* Member of Lehman Brothers’ Executive Committee

90

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Vice Chairmen VICE CHAIRMEN OF LEHMAN BROTHERS INC.

VICE CHAIRMEN OF LEHMAN BROTHERS INTERNATIONAL (EUROPE)

Howard L. Clark, Jr.

Vice Chairman and Member of Board of Directors Lehman Brothers Inc. Frederick Frank

Vice Chairman and Member of Board of Directors Lehman Brothers Inc. Allan S. Kaplan

Vice Chairman Lehman Brothers Inc.

Ruggero F. Magnoni

Vice Chairman and Member of Board of Directors Lehman Brothers International (Europe) Raymond G.H. Seitz

Vice Chairman and Member of Board of Directors Lehman Brothers International (Europe)

Harvey M. Krueger

Vice Chairman and Member of Board of Directors Lehman Brothers Inc. Sherman R. Lewis, Jr.

Vice Chairman and Member of Board of Directors Lehman Brothers Inc. Thomas A. Russo

Vice Chairman Lehman Brothers Inc.

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Locations Worldwide THE AMERICAS World Headquarters – New York

3 World Financial Center New York, NY 10285 (212) 526-7000 Albany

80 State Street Albany, NY 12207 (518) 463-5244 Atlanta

3414 Peachtree Road Atlanta, GA 30326 (404) 262-4800

401 South LaSalle Street Chicago, IL 60605 (312) 845-4787 Cleveland

1375 East 9th Street Cleveland, OH 44114 (800) 321-3861 (216) 621-8300 Columbus

HQ Crosswoods Center 100 East Campus View Blvd. Worthington, OH 43235 (614) 438-2600 Dallas

Bermuda

Lehman Re Ltd. Ram Re House, 46 Reid Street Hamilton HM12, Bermuda 441-294-0000

Chase Tower 2200 Ross Avenue Dallas, TX 75201 (214) 720-5400 Dayton

Boston

260 Franklin Street Boston, MA 02110 (617) 330-5800 Two International Place Boston, MA 02110 (617) 946-3991

Courthouse Plaza NE Dayton, OH 45402 (800) 421-5677 (937) 226-4800 Hato Rey (San Juan)

270 Munoz Rivera Hato Rey, PR 00918 (787) 759-8915

Buenos Aires

Torre Alem Plaza Av. Leandro N. Alem 855 1001 Buenos Aires Argentina 5411-4319-2700 Chicago

190 South LaSalle Street Chicago, IL 60603 (312) 609-7200

92

Houston

600 Travis Street Houston, TX 77002 (713) 236-3950 1111 Bagby Street Houston, TX 77002 (800) 231-7811 (713) 652-7100

pages 26-35, 89-96 2/23/01 1:31 PM Page 93

Jersey City

New York

101 Hudson Street Jersey City, NJ 07302 (201) 524-4000

1 World Financial Center New York, NY 10281 (800) 392-5000 (212) 526-7000

Los Angeles

601 South Figueroa Street Los Angeles, CA 90017 (213) 362-2500 Westwood Center 1100 Glendon Avenue Los Angeles, CA 90024 (800) 582-4904 10880 Wilshire Boulevard Los Angeles, CA 90024 (310) 481-2600

280 Park Avenue West Building New York, NY 10017 (800) 221-7083 (212) 681-2700 50 Broadway New York, NY 10004 (212) 526-7000 1 World Trade Center New York, NY 10048 (212) 526-7000

Menlo Park

155 Linfield Drive Menlo Park, CA 94025 (650) 289-6000

Palm Beach

450 Royal Palm Way Palm Beach, FL 33480 (800) 924-0148

Mexico City

Av. Paseo de la Reforma 265 Col. Cuauhtemoc Mexico City, Mexico 06500 525-242-4900

Philadelphia

Miami

San Francisco

1221 Brickell Avenue Miami, FL 33131 (305) 789-8700

555 California Street San Francisco, CA 94104 (415) 274-5400

Montevideo

Sao Paulo

Rincon 487 Montevideo, Uruguay 598-2402-5716

Av. Brigadeiro Faria Lima 1276-ED OS Bandirantes Sao Paulo, Brazil 5511-3037-8000

1600 Market Street Philadelphia, PA 19103 (215) 231-9300

Nashville

1130 Eighth Avenue South Nashville, TN 37203 (888) 272-6454

Seattle

Bank of America Tower 701 Fifth Avenue Seattle, WA 98104 (206) 344-5870

93

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Locations Worldwide

(continued)

Toronto

Milan

The Exchange Tower P.O. Box 444 130 King Street West Toronto ON M5X 1E4 416-955-1900

Piazza Del Carmine 4 20121 Milan, Italy 390-272-1581

Washington, D.C.

800 Connecticut Avenue NW Washington, D.C. 20006 (202) 452-4700

Munich

Funf Hofe Am Eisbach 3 80538 Munich, Germany 49-89-3782-8818 Paris

Wilmington

Lehman Brothers Bank, FSB 921 North Orange Street Wilmington, DE 19801 (302) 654-6179

21 Rue de Balzac 75406 Paris, Cedex 08, France 331-5389-3000 Rome

EUROPE & THE MIDDLE EAST

Piazza di Spagna 00187 Rome, Italy 390-667-5231

Regional Headquarters - London

Stockholm

One Broadgate London EC2M 7HA England 44-207-601-0011

17 Vastra Tradgardsgatan 111 86 Stockholm, Sweden 46-8796-2200

Amsterdam

Tel Aviv

Rembrandt Tower Amstelplein 1 1096 HA Amsterdam The Netherlands 312-0561-2800

Asia House 4 Weizman Street Tel Aviv, Israel 972-3696-6122 Zurich

Frankfurt

Lehman Brothers Bankhaus AG Gruneburgweg #18 60322 Frankfurt, Germany 496-915-3070 Madrid

Paseo de la Castellana 40-9 28046 Madrid, Spain 349-1426-2180

94

Talstrasse 82 8021 Zurich, Switzerland 411-287-8842

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ASIA PACIFIC Regional Headquarters – Tokyo

Ark Mori Building 12-32 Akasaka 1 Chome Minato-ku, Tokyo 107, Japan 813-5571-7000 Bangkok

Lehman Brothers (Thailand) Limited M. Thai Tower, All Seasons Place 87 Wireless Road Phatumwan, Bangkok 10330 Thailand 662-654-0667 Beijing

Seoul

Oriental Chemical Building 50 Sokong Dong Chung Ku Seoul, Korea 822-775-3600 Singapore

No. 5 Temasek Boulevard Suntec City Tower Singapore 0103 65-433-6288 Taipei

205 Tun Hua North Road Taipei, Taiwan Republic of China 8862-2545-7900

China World Trade Center No. 1 Jianguomenwai Avenue Beijing, The Peoples Republic of China 8610-6505-0301 Hong Kong

38/F, One Pacific Place 88 Queensway, Hong Kong 852-2869-3000 Jakarta

Bapindo Plaza Tower 2 JL Jend Sudirman Kav 54-55 Jakarta 12190, Indonesia 622-1527-8201 Melbourne

Lehman Brothers Australia Pty. Limited 140 William Street Melbourne, Australia 3000 613-9607-8498

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Other Stockholder Information Common Stock

Ticker Symbol: LEH The common stock of Lehman Brothers Holdings Inc. is listed on the New York Stock Exchange and on the Pacific Exchange. As of January 30, 2001, there were 22,554 holders of record of the Company’s common stock. On January 31, 2001, the last reported sales price of Lehman Brothers’ common stock was $82.28. Annual Meeting

Lehman Brothers’ annual meeting of stockholders will be held on Tuesday, April 3, 2001 at 10:30 a.m. at 3 World Financial Center, 26th Floor, 200 Vesey Street, New York, New York 10285.

Registrar and Transfer Agent for Common Stock

Questions regarding dividends, transfer requirements, lost certificates, changes of address, direct deposit of dividends, the direct purchase and dividend reinvestment plan, or other inquiries should be directed to: The Bank of New York Shareholders Services Department P.O. Box 11258 Church Street Station New York, New York 10286-1258 Telephone: (800) 824-5707 (U.S.) (610) 312-5303 (non.U.S.) E-mail:[email protected] Website: http://www.stockbny.com Direct Purchase and Dividend Reinvestment Plan

Dividends

Effective January 2001, Lehman Brothers’ Board of Directors increased the fiscal 2001 dividend rate to $0.28 per common share from an annual dividend rate of $0.22 per share in fiscal 2000. The dividend rate reflects Lehman Brothers’ two-for-one stock split on October 20, 2000. Dividends on the Company’s common stock are generally payable, following declaration by the Board of Directors, on the last business day of February, May, August and November.

Lehman Brothers’ Direct Purchase and Dividend Reinvestment Plan provides both existing stockholders and first-time investors with an alternative means of purchasing the Company’s stock. The plan has no minimum stock ownership requirements for eligibility and enrollment. Plan participants may reinvest all or a portion of cash dividends and/or make optional cash purchases up to a maximum of $175,000 per year without incurring commissions or service charges. Additional information and enrollment forms can be obtained from the Company’s Transfer Agent listed above.

Annual Report and Form 10-K

Lehman Brothers will make available upon request copies of this Annual Report and the Annual Report on Form 10-K as filed with the Securities and Exchange Commission. Requests may be directed to: Jeffrey A. Welikson Corporate Secretary Lehman Brothers Holdings Inc. 1 World Financial Center, 27th Floor New York, New York 10281 Telephone: (646) 836-2250 Independent Auditors

Ernst & Young LLP 787 Seventh Avenue New York, New York 10019 Telephone: (212) 773-3000 Investor Relations

(212) 526-8381 Media Relations

(212) 526-4379 Website Address

http://www.lehman.com

PRICE RANGE OF COMMON STOCK Three months ended

2000

96

1999

Nov. 30

Aug. 31

May 31

Feb. 29

Nov. 30

Aug. 31

May 31

Feb. 28

High

$80.0000

$72.5117

$51.7188

$47.5000

$41.9375

$31.2813

$33.7500

$29.9375

Low

$49.5000

$40.8125

$36.2500

$31.0625

$26.6563

$24.1250

$25.0313

$20.4375

1842/cover mechanical 2/13/01 7:45 AM Page 2

Lehman Brothers. The Mission. Our Firm. We are a rapidly growing global institutional investment bank with a heritage of over 150 years of success. As a growth company in a growth industry, our atmosphere is charged with entrepreneurial energy. We are a culture of “we’s”, not “I’s”, with a commitment to access and teamwork. The hallmark of our success will be our reputation as a firm that generates and supports exceptional levels of opportunity and initiative.

Our One-Firm culture allows us to team up and bring together the best of Lehman Brothers to meet our clients’ most important needs. We do this by taking the initiative to reach out to our clients; by listening carefully to understand their needs; by developing innovative and tailored solutions; and by delivering the full resources and strength of the Firm to provide superb execution of those solutions. The hallmark of our success will be that our clients look to us first as their lead investment bank.

Our People. Our success depends on the strength of our people. Our goal is to attract and develop exceptionally talented people who share our passion for individual excellence and our commitment to teamwork. We do this by attracting the best person to fill every role within the Firm; by developing everyone to reach their full potential; by fostering the mindset that finishing second is unacceptable; and by working together in an environment of integrity, respect and trust as One Firm. The hallmark of our success will be our wide recognition as a unique firm in which exceptional people build rewarding careers.

Our Shareholders. As employees, we are all shareholders of Lehman Brothers and are deeply committed to building the value of the Firm. Our goal is to deliver superior returns to all of our shareholders. We do this by committing to opportunities that offer exceptional returns; by focusing on productivity, expense discipline and profitability; by managing our risks and maintaining our financial strength; and by preserving our reputation. The hallmark of our success will be the strength of our long-term record of value creation for our shareholders.

TABLE OF CONTENTS Financial Highlights Letter to Stockholders and Clients Creating Opportunity Building Value Delivering Performance Business Review Financial Review Board Members and Officers Locations Worldwide Other Stockholder Information

1 2 6 10 22 26 36 89 92 96

Design: Russell Design Associates Photography: Shonna Valeska, Joe McNally, Neal Wilson, Patrick Lucero, Paul Hu / Liaison Agency

Our Clients.

1842/revised cover (2/15/01) 2/18/01 8:37 AM Page 1

LEHMAN BROTHERS ANNUAL REPORT 2000

3 WORLD FINANCIAL CENTER, NEW YORK, NY 10285 WWW.LEHMAN.COM

Where Vision Gets Built

ANNUAL REPORT 2000

SM