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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission file number 1-6817

Lehman Brothers Inc.
(Exact name of registrant as specified in its charter)

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1)(a) AND (b) OF FORM 10-Q AND THEREFORE IS FILING THIS FORM WITH THE REDUCED DISCLOSURE PERMITTED THEREBY.

        As of October 15, 2002, 1,006 shares of the Registrant's Common Stock, par value $0.10 per share, were outstanding.

LEHMAN BROTHERS INC. and SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED AUGUST 31, 2002

INDEX

AVAILABLE INFORMATION

        Lehman Brothers Inc. ("LBI") files annual, quarterly and current reports and other information with the Securities and Exchange Commission ("SEC"). You may read and copy any document LBI files with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. LBI's electronic SEC filings are available to the public at http://www.sec.gov.

        LBI's public internet site is http://www.lehman.com. LBI makes available free of charge through its internet site, via a link to the SEC's internet site at http://www.sec.gov, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC.

        In addition, LBI currently makes available on http://www.lehman.com its most recent annual report on Form 10-K and its quarterly reports on Form 10-Q for the current fiscal year, although in some cases these documents are not available on that site as soon as they are available on the SEC's site. You will need to have on your computer the Adobe Acrobat Reader software to view these documents, which are in the.PDF format. If you do not have Adobe Acrobat, a link to Adobe's internet site, from which you can download the software, is provided.

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LEHMAN BROTHERS INC. and SUBSIDIARIES

PART I—FINANCIAL INFORMATION

ITEM 1    Financial Statements

LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions)

See notes to consolidated financial statements.

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LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions)

See notes to consolidated financial statements.

5

LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION
(Unaudited)
(In millions)

See notes to consolidated financial statements.

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LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION—(Continued)
(Unaudited)
(In millions)

See notes to consolidated financial statements.

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LEHMAN BROTHERS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS
(Unaudited)
(In millions)

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)

        Interest paid totaled $6,275 and $10,869 for the nine months ended August 31, 2002 and August 31, 2001, respectively.

        Income taxes paid totaled $256 and $571 for the nine months ended August 31, 2002 and August 31, 2001, respectively.

See notes to consolidated financial statements

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LEHMAN BROTHERS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS

1.    Basis of Presentation:

        The consolidated financial statements include the accounts of Lehman Brothers Inc., a registered broker-dealer ("LBI") and subsidiaries (collectively, the "Company"). LBI is a wholly-owned subsidiary of Lehman Brothers Holding Inc. ("Holdings"). (Holdings and its subsidiaries are collectively referred to as "Lehman Brothers".) The Company is one of the leading global investment banks serving institutional, corporate, government and high-net-worth individual clients and customers. The Company's worldwide headquarters in New York are complemented by offices in additional locations in North America, Europe, the Middle East, Latin America and the Asia Pacific Region. The Company is engaged primarily in providing financial services. All material intercompany accounts and transactions have been eliminated in consolidation. The Company's financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q and reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Pursuant to such rules and regulations, certain footnote disclosures which are normally required under generally accepted accounting principles have been omitted. It is recommended that these consolidated financial statements be read in conjunction with the audited consolidated financial statements included in LBI's Annual Report on Form 10-K for the twelve months ended November 30, 2001 (the "Form 10-K"). The Consolidated Statement of Financial Condition at November 30, 2001 was derived from the audited financial statements.

        The nature of the Company's business is such that the results of any interim period may vary significantly from quarter to quarter and may not be indicative of the results to be expected for the fiscal year. Certain prior period amounts reflect reclassifications to conform to the current period's presentation.

Consolidation Accounting Policies

Operating Companies

        The Company follows Statement of Financial Accounting Standards ("SFAS") No. 94, "Consolidation of All Majority-Owned Subsidiaries", and consolidates operating entities when the Company has a controlling financial interest over the business activities of such entities. Non-controlled operating entities are accounted for under the equity method when the Company is able to exercise significant influence over the business activities of such entities. The cost method is applied when the ability to exercise significant influence is not present.

Special Purpose Entities

        For those entities which do not meet the definition of conducting a business, often referred to as special purpose entities ("SPE's"), the Company follows the accounting guidance under SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities—a replacement of FASB No. 125," and Emerging Issues Task Force ("EITF") Topic D-14, "Transactions Involving Special-Purpose Entities," to determine whether or not such SPE's are required to be consolidated. The majority of the Company's involvement with SPE's relates to securitization transactions meeting the SFAS 140 definition of a qualifying special purpose entity ("QSPE"). A QSPE can generally be described as an entity with significantly limited powers which are intended to limit it to passively holding financial assets and distributing cash flows based upon predetermined criteria. Based upon the guidance in SFAS 140, the Company does not consolidate such QSPE's. Rather, the Company accounts for its involvement with such QSPE's under a financial components approach in which the Company recognizes only its retained involvement with the QSPE. The Company accounts for such retained interests at fair value.

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        Certain special purpose entities do not meet the QSPE criteria due to their permitted activities not being sufficiently limited, or because the assets are not deemed qualifying financial instruments (e.g., real estate). In the limited instances in which the Company is either the sponsor of or transferor of assets to a non-qualifying SPE, the Company follows the accounting guidance provided by EITF Topic D-14 to determine whether consolidation is required. Under this guidance, the Company would not consolidate such SPE if a third party investor made a substantial equity investment in the SPE (minimum of 3%), was subject to first dollar risk of loss of such SPE, and had a controlling financial interest.

Transfers of Financial Assets

        The Company accounts for transfers of financial assets in accordance with SFAS 140. In accordance with this guidance the Company recognizes the transfer of financial assets as sales provided that control has been relinquished. Control is deemed to be relinquished only when all of the following conditions have been met: i) the assets have been isolated from the transferor even in bankruptcy or other receivership (true sale opinions are required), ii) the transferee has the right to pledge or exchange the assets received and iii) the transferor has not maintained effective control over the transferred assets (e.g., a unilateral ability to repurchase a unique or specific asset).

Revenue Recognition Policies

Principal Transactions

        Securities and other financial instruments owned and securities and other financial instruments sold but not yet purchased (both of which are recorded on a trade date basis) 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, or if liquidating the Company's position is reasonably expected to affect market prices, fair value is determined based on broker quotes, internal valuation pricing models which take into account time value and volatility factors underlying the financial instruments, or management's estimate of the amounts that could be realized under current market conditions, assuming an orderly liquidation over a reasonable period of time.

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.

Commissions

        Commissions primarily include fees from executing and clearing client transactions on stock, options and futures markets worldwide. These fees are recognized on a trade date basis.

Interest Revenue/Expense

        The Company recognizes contractual interest on securities and other financial instruments owned and securities and other financial instruments sold but not yet purchased on an accrual basis as a component of Interest and Dividends revenues and Interest Expense, respectively. Interest flows on the Company's derivative transactions are included as part of the Company's mark-to-market valuation of these contracts within Principal Transactions and are not recognized as a component of interest revenue/expense.

        The Company accounts for its secured financing activities, and short and long-term borrowings on an accrual basis with related interest recorded as interest revenue or interest expense, as applicable.

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2.    Events of September 11, 2001:

        As a result of the September 11, 2001 terrorist attack, the Company's leased facilities in the World Trade Center were destroyed and its leased and owned facilities in the World Financial Center complex (including the 3 World Financial Center building owned jointly with American Express) were significantly damaged.

        During the fourth quarter of 2001, the Company recognized a pretax special charge of $51 million ($29 million after-tax) associated with the net losses stemming from the events of September 11, 2001. This charge was comprised of charges and costs of $291 million, less estimated insurance recoveries of $240 million.

        During the first nine months of 2002, the Company incurred additional costs resulting from the September 11, 2001 terrorist attack of approximately $22 million, primarily related to technology restoration and other costs associated with unusable facilities, which were fully offset by estimated insurance recoveries.

        In addition, during the first nine months of 2002, the Company incurred costs of approximately $16 million to repair damage incurred to the core and shell of the Company's 3 World Financial Center facility, which were fully offset by estimated insurance recoveries. Such costs are anticipated to be fully recoverable under the Company's insurance policy.

        During the third quarter of 2002, the Company sold its interest in the 3 World Financial Center building to Holdings for book value.

        For further information regarding the special charge associated with the events of September 11, 2001 recognized during 2001, refer to Note 2 to the Consolidated Financial Statements included in the Form 10-K.

3.    Capital Requirements:

        As a registered broker-dealer, LBI is subject to SEC Rule 15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined. At August 31, 2002, LBI's regulatory net capital, as defined, of $1,664 million exceeded the minimum requirement by $1,572 million.

        As a clearing broker-dealer, the Company has elected to compute a reserve requirement for Proprietary Accounts of Introducing Broker-Dealer ("PAIB calculation"). The PAIB calculation is completed in order for each correspondent firm that uses the Company as its clearing broker-dealer to classify its assets held by the Company as allowable assets in the correspondent's net capital calculation. At August 31, 2002, the Company did not have a reserve requirement for PAIB, however the Company had $53 million of qualified securities or cash on deposit in a Special Reserve Bank Account as of August 31, 2002.

        The Company's "AAA" rated derivatives subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman Brothers Derivative Products Inc. ("LBDP"), have established certain capital and operating restrictions which are reviewed by various rating agencies. At August 31, 2002, LBFP and LBDP each had capital which exceeded the requirement of the most stringent rating agency by approximately $24 million and $13 million, respectively.

        Repayment of subordinated indebtedness and certain advances and dividend payments by LBI are restricted by the regulations of the SEC and other regulatory agencies. In addition, certain covenants governing the indebtedness of LBI contractually limit its ability to pay dividends.

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4.    Derivative Financial Instruments:

        In the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end-user. The Company's derivative activities (both trading and end-user) are recorded at fair value on the Company's Consolidated Statement of Financial Condition. As an end user, the Company utilizes derivatives to modify the market risk exposures of certain assets and liabilities. In this regard, the Company primarily enters into fair value hedges utilizing interest rate swaps to convert a substantial portion of the Company's fixed rate long-term debt and certain term fixed rate secured financing activities to a floating interest rate. The ineffective portion of the fair value hedges were included in "Interest Expense" on the Consolidated Statement of Income and were immaterial for the three and nine months ended August 31, 2002 and 2001.

        Market or fair value for derivative instruments is generally determined by either quoted market prices (for exchange-traded futures and options) or pricing models (for over-the-counter swaps, forwards and options). Pricing models utilize a series of market inputs to determine the present value of future cash flows, with adjustments, as required, for credit risk and liquidity risk. Further valuation adjustments may be recorded, as deemed appropriate for new or complex products or for positions with significant concentrations. These adjustments are integral components of the mark-to-market process. Credit-related valuation adjustments represent estimates of expected losses which incorporate business and economic conditions, historical experience, concentrations, and the character, quality and performance of credit sensitive financial instruments.

        Unrealized gains and losses on derivative contracts are recorded on a net basis in the Consolidated Statement of Financial Condition for those transactions with counterparties executed under a legally enforceable master netting agreements and are netted across products when such provisions are stated in the master netting agreement. Listed in the following table is the fair value of the Company's derivative activities. Assets and liabilities represent net unrealized gains (amounts receivable from counterparties) and net unrealized losses (amounts payable to counterparties), respectively.

*

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

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        Assets included in the table above represent the Company's net receivable/payable for derivative financial instruments before consideration of collateral held by the Company. Included within the $8,832 million fair value of assets at August 31, 2002 was $8,475 million related to swaps and other over-the-counter ("OTC") contracts and $357 million related to exchange-traded option and warrant contracts. Included within the $6,727 million fair value of assets at November 30, 2001 was $6,239 million related to swaps and other OTC contracts and $488 million related to exchange-traded option and warrant contracts.

        With respect to OTC contracts, the Company views its net credit exposure to be $7,138 million at August 31, 2002, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral. Presented below is an analysis of the Company's net credit exposure at August 31, 2002 for OTC contracts based upon actual ratings made by external rating agencies or by equivalent ratings established and utilized by the Company's Credit Risk Management Department.

        The Company is also subject to credit risk related to its exchange-traded derivative contracts. Exchange-traded contracts, including futures and certain options, are transacted directly on the exchange. To protect against the potential for a default, all exchange clearinghouses impose net capital requirements on their members. Additionally, exchange clearinghouses require counterparties to futures contracts to post margin upon the origination of the contracts and for any changes in the market value of the contracts on a daily basis (certain foreign exchanges provide for settlement within three days). Therefore, the potential for losses from exchange-traded products is limited.

        For a further discussion of the Company's derivative related activities, refer to the Notes to the Consolidated Financial Statements included in the Form 10-K.

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5.    Securitizations:

        The Company is a market leader in mortgage- and asset-backed securitizations and other structured financing arrangements. In connection with these activities, the Company utilizes special purpose entities principally for (but not limited to) the securitization of commercial and residential mortgages, home equity loans, government and corporate bonds, and lease and trade receivables. The Company derecognizes financial assets transferred in securitizations provided that the Company has relinquished control over such assets. For further information regarding the accounting for securitization transactions, refer to Note 1, Basis of Presentation—Consolidation Accounting Policies—Transfers of Financial Assets. The Company may retain an interest in the financial assets it securitizes ("Retained Interests") which may include assets in the form of residual interests in the special purpose entities established to facilitate the securitization. Any Retained Interests are included in Securities and Other Financial Instruments Owned (principally Mortgages and Mortgage-Backed) within the Company's Consolidated Statement of Financial Condition. During the first nine months of 2002, the Company securitized approximately $98 billion of financial assets including: $71 billion of residential mortgages, $7 billion of commercial mortgages and $20 billion of other asset-backed financial instruments.

        As of August 31, 2002 and November 30, 2001, the Company held approximately $1.2 billion and $1.4 billion, respectively, of non-investment grade Retained Interests from its securitization activities (principally a junior security interest in securitizations) including $0.6 billion and $0.9 billion of commercial mortgages, $0.4 billion and $0.3 billion of residential mortgages, and $0.2 billion and $0.2 billion of other asset-backed financial instruments, respectively. The Company records its trading assets on a mark-to-market basis, including those assets held prior to securitization, as well as any retained interest post securitization. Mark-to-market gains or losses are recorded as a component of "Principal Transactions" in the Consolidated Statement of Income. Fair value is determined based upon listed market prices, if available. When listed market prices are not available, fair value is determined based on other relevant factors, including broker or dealer price quotations and valuation pricing models which take into account time value and volatility factors underlying the financial instruments among other factors.

        The tables below outline the key economic assumptions used in measuring the fair value of retained interests:

At August 31, 2002:

At November 30, 2001:

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        The tables below outline the sensitivity of the fair value of the retained interests to immediate 10% and 20% adverse changes in the above assumptions (dollars in millions):

        The sensitivity analysis in the preceding table is hypothetical and should be used with caution as the above stresses are performed without consideration of the impact of hedges which serve to reduce the Company's actual risk. In addition, these results are calculated by stressing a particular economic assumption independent of changes in any other assumption (as required by U.S. GAAP); in reality changes in one factor often result in changes in another (for example changes in discount rates will often impact expected prepayment speeds). Further, changes in the fair value based upon a 10% or 20% variation in an assumption should not be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.

        The following table summarizes cash flows from securitization trusts for the quarter ended August 31,2002:

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6.    Financial Instruments:

        Securities and other financial instruments owned and securities and other financial instruments sold, but not yet purchased are recorded at fair value, and were comprised of the following:

7.    Securities Pledged as Collateral:

        The Company enters into secured borrowing and lending transactions to finance trading inventory positions, obtain securities for settlement, and meet customers' needs. The Company primarily receives collateral in connection with resale agreements, securities borrowed transactions, customer margin loans and certain other loans. The Company is generally permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements, enter into securities lending transactions or deliver to counterparties to cover short positions. The Company carries secured financing agreements for financial reporting purposes on a net basis when permitted under the provisions of Financial Accounting Standards Board Interpretation No. 41 ("FIN 41").

        At August 31, 2002 and November 30, 2001, the fair value of securities received as collateral and securities owned that have not been sold, repledged or otherwise encumbered totaled approximately $13 billion and $9 billion, respectively. At August 31, 2002 and November 30, 2001, the gross fair value of securities received as collateral where the Company was permitted to sell or repledge the securities was approximately $263 billion and $190 billion, respectively. Of this collateral, approximately $258 billion and $183 billion at August 31, 2002 and November 30, 2001, respectively, has been sold or repledged, generally as collateral under repurchase agreements or to cover securities and other financial instruments sold but not yet purchased.

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        The Company also pledges its own assets, principally to collateralize certain financing arrangements. These pledged securities, where the counterparty has the right, by contract or custom, to rehypothecate the financial instruments are classified as securities and other financial instruments owned, pledged as collateral on the Company's Consolidated Statement of Financial Condition as required by SFAS 140.

        In addition, the carrying value of securities and other financial instruments owned that have been pledged to counterparties where those counterparties do not have the right to sell or repledge were approximately $37 billion and $40 billion at August 31, 2002 and November 30, 2001, respectively.

8.    Other Commitments and Contingencies:

        As of August 31, 2002 and November 30, 2001, the Company was contingently liable for $0.7 billion and $0.9 billion, respectively, of letters of credit, primarily used to provide collateral for securities and commodities borrowed and to satisfy margin deposits at option and commodity exchanges.

        In connection with its financing activities, the Company had outstanding commitments under certain lending arrangements of approximately $1.5 billion at both August 31, 2002 and November 30, 2001, respectively. These commitments require borrowers to provide acceptable collateral, as defined in the agreements, when amounts are drawn under the lending facilities. Advances made under the above lending arrangements are typically at variable interest rates and generally provide for over-collateralization based upon the borrowers' creditworthiness. At August 31, 2002, the Company had commitments to enter into forward starting secured financing transactions including reverse repurchase agreements and repurchase agreements of approximately $54.1 billon and $36.0 billion, respectively, as compared to $43.6 billion and $21.5 billion, respectively, at November 30, 2001. In addition, the Company had other guarantees of approximately $2.0 billion at August 31, 2002. These other guarantees, which are principally overcollateralized with investment grade collateral, consist of liquidity facilities and default protection to investors.

        In addition, the Company, through its high grade and high yield sales, trading and underwriting activities, makes commitments to extend credit in loan syndication transactions. The Company utilizes various hedging and funding strategies to actively manage its market, credit and liquidity exposures on these commitments. In addition, total commitments are not indicative of actual risk or funding requirements, as the commitments may not be drawn or fully utilized. These commitments and any related draw downs of these facilities typically have fixed maturity dates and are contingent upon certain representations, warranties and contractual conditions applicable to the borrower.

        At August 31, 2002 and November 30, 2001, the Company had lending commitments to investment grade borrowers of approximately $6.6 billion and $4.3 billion, respectively. However, these commitments are not indicative of the Company's actual risk as the Company reduced its credit risk through the use of hedges and has utilized funding facilities to mitigate liquidity risk. The Company views its credit risk for investment grade commitments (after consideration of hedges) to be $3.0 billion and $3.2 billion at August 31, 2002 and November 30, 2001, respectively. Lending commitments to non-investment grade borrowers totaled approximately $1.0 billion at both August 31, 2002 and November 30, 2001. The Company had available undrawn borrowing facilities with third parties of approximately $2.6 billion and $2.9 billion at August 31, 2002 and November 30, 2001, respectively, which can be drawn upon to provide funding for these commitments. These funding facilities contain limits for certain concentrations of counterparty, industry or credit ratings of the underlying loans.

        At August 31, 2002 and November 30, 2001, the Company had commitments to invest up to $182 million and $169 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.

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        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, established reserves and the advice of counsel, in the opinion of the Company such litigation will not, in the aggregate, have a material adverse effect on the Company's consolidated financial position or cash flows, but may be material to the Company's operating results for any particular period, depending on the level of income for such period.

        As a leading global investment bank, risk is an inherent part of all of the Company's businesses and activities. The extent to which the Company properly and effectively identifies, assesses, monitors and manages each of the various types of risks involved in its trading (including derivatives), brokerage, and investment banking activities is critical to the success and profitability of the Company. The principal types of risks involved in the Company's activities are market, credit or counterparty, liquidity, legal and operational risks. Management has developed a control infrastructure throughout the Company to monitor and manage these risks on a global basis. For further discussion of these matters, refer to the Risk Management section of Management's Analysis of Results of Operations included in the Form 10K.

9.    Segments

        The Company operates in three segments: Investment Banking, Capital Markets and Client Services.

        The Investment Banking Division provides advice to corporate, institutional and government clients throughout the world on mergers, acquisitions and other financial matters. The Division also raises capital for clients by underwriting public and private offerings of debt and equity securities.

        The Capital Markets Division includes the Company's institutional sales, trading, research and financing activities in equity and fixed income cash and derivatives products. Through the Division, the Company is a global market-maker in numerous equity and fixed income products, including U.S., European and Asian equities, government and agency securities, money market products, corporate high grade, high yield, emerging market securities, mortgage- and asset-backed securities, municipal securities, bank loans, foreign exchange and derivatives products. The Division also includes the Company's risk arbitrage and secured financing businesses, as well as realized and unrealized gains and losses related to the Company's direct private equity investments. The financing business manages the Company's equity and fixed income matched book activities, supplies secured financing to institutional clients and customers, and provides secured funding for the Company's inventory of equity and fixed income products.

        Client Services revenues reflect earnings from the Company's private client and private equity businesses. Private Client revenues reflect the Company's high-net-worth retail customer flow activities as well as asset management fees earned from these clients. Private Equity revenues include the management and incentive fees earned in the Company's role as general partner for thirty-three private equity partnerships.

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        The Company's segment information for the three and nine months ended August 31, 2002 and August 31, 2001 is prepared utilizing the following methodologies:

•

Revenues and expenses directly associated with each segment are included in determining pre-tax earnings.



•

Expenses not directly associated with specific segments are allocated based upon the most relevant measures applicable, including each segment's revenues, headcount and other factors.



•

Net revenues include allocations of interest income and interest expense to securities and other positions in relation to the cash generated by, or funding requirements of, the underlying positions.



•

Segment assets include an allocation of indirect corporate assets which have been fully allocated to the Company's business segments, generally based on each segment's respective headcount figures.

Segments (Three Months Ended):

(1)

Before dividends on preferred securities.

(1)

Before dividends on preferred securities.

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Segments (Nine Months Ended):

(1)

Before dividends on preferred securities.

(1)

Before dividends on preferred securities.

        The following are net revenues by geographic region:

10.  Related Parties:

        In the normal course of business, the Company engages in various securities trading, investment banking and financial activities with Holdings and many of its subsidiaries (the "Related Parties"). Various charges, such as compensation and benefits, occupancy, administration and computer processing are allocated between the Related Parties, based upon specific identification and allocation methods.

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LEHMAN BROTHERS INC. and SUBSIDIARIES

ITEM 2. MANAGEMENT'S ANALYSIS of RESULTS of OPERATIONS

Forward-Looking Statements

        Some of the statements contained in this Management's Analysis of Results of Operations, including those relating to the Company's strategy and other statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as "expects," "anticipates," "intends," "plans," "believes," "estimates" and similar expressions, are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements are not historical facts but instead represent only the Company's expectations, estimates and projections regarding future events. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict, which may include market, credit or counterparty, liquidity, legal and operational risks. Market and liquidity risks include changes in interest and foreign exchange rates and securities and commodities valuations, the availability and cost of capital and credit, changes in investor sentiment, global economic and political trends, concerns about possible military action and terrorist activity and industry competition. Legal risks include legislative and regulatory developments in the U.S. and throughout the world. The Company's actual results and financial condition may differ, perhaps materially, from the anticipated results and financial condition in any such forward-looking statements and, accordingly, readers are cautioned not to place undue reliance on such statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Results of Operations
For the Three Months Ended August 31, 2002 and August 31, 2001

        The Company reported net income of $143 million for the quarter ended August 31, 2002, an increase of 34% from the third quarter of 2001. These results reflect an improvement in the Company's investment banking activities offsetting the difficult market conditions experienced in Capital Markets activities.

Revenues

        Net revenues were $828 million for the third quarter of 2002 as compared to $674 million for the third quarter of 2001, an increase of 23%. Despite the difficult market conditions experienced in the third quarter of 2002, the Company's strategy, of building a diversified set of high margin global businesses while maintaining strong discipline around expenses, liquidity and risk management, has resulted in improved market positions in a number of key areas such as mergers and acquisitions ("M&A"), debt and equity underwriting.

Principal Transactions, Commissions and Net Interest Revenues

        The Company measures the performance of its Capital Markets and Client Services activities in the aggregate, including Principal Transactions, Commissions and Net Interest. Decisions relating to these activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction, including any associated commissions, and the interest income or expense associated with financing or hedging the Company's positions. Therefore, the Company views net revenues from principal transactions, commissions and interest, offset by related interest expense, in the aggregate, because the revenue classifications, when analyzed individually, are not always indicative of the performance of the Company's overall Capital Markets and Client Services activities.

        Principal Transactions, Commissions and Net Interest revenues increased 10% to $419 million for the third quarter of 2002 as compared to $381 million for the third quarter of 2001. Despite the negative market conditions, customer flow activity remained relatively strong.

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        Within these amounts, Principal Transactions revenues decreased to a loss of $98 million for the third quarter of 2002 as compared to a loss of $81 million in the third quarter of 2001. Commissions revenues were $304 million for the third quarter of 2002 as compared to $206 million for the third quarter of 2001. Interest and Dividend revenues were $2,271 million for the third quarter of 2002 as compared to $3,149 million for the third quarter of 2001. Interest expense was $2,058 million for the third quarter of 2002 as compared to $2,893 million for the third quarter 2001. The Company measures the performance of its Capital Markets and Client Services business in the aggregate, including Principal Transactions, Commissions and Net Interest. Decisions relating to these activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction, including any associated commissions, and the interest income or expense associated with financing or hedging the Company's positions; therefore caution should be utilized when analyzing revenue categories individually.

        The decrease in Principal Transactions revenues in 2002 resulted from poor market conditions for both fixed income and equity products. In addition, Principal Transactions revenues in 2002 decreased as a result of the transition to a commission-based revenue structure on certain NASDAQ trades whereas in the prior year, the Company's NASDAQ trades for substantially all of its institutional customers were transacted on a spread basis (with related revenues classified within Principal Transactions).

        Commissions revenues increased as compared to the prior year's level principally due to the transition to a commission-based revenue structure on certain NASDAQ trades.

        Interest and dividend revenues and interest expense are a function of the level and mix of total assets and liabilities, principally financial instruments owned and secured financing activities, the prevailing level of interest rates, as well as the term structure of the Company's financings. Interest and dividends revenues and interest expense are integral components of the Company's overall customer flow activities. The decline in interest revenue and interest expense from the previous year is principally due to a substantial decline in interest rates over the period. The decrease in net interest income for the third quarter of 2002 was primarily due to a change in the asset mix to generally higher quality assets, which usually produce lower yields.

Investment Banking

        Investment Banking revenues were $402 million for the third quarter of 2002 as compared to $278 million for the third quarter of 2001. Investment Banking revenues result mainly from fees earned by the Company for underwriting public and private offerings of fixed income and equity securities, and advising clients on M&A activities and other services. Investment Banking revenues increased 45% from the third quarter of 2001, primarily due to the Company's role as joint lead manager on the largest initial public offering in the third quarter of 2002 as well as strong M&A activities in the third quarter of 2002.

Segments

        The Company is segregated into three business segments (each of which is described below): Investment Banking, Capital Markets and Client Services. Each segment represents a group of activities and products with similar characteristics. These business activities result in revenues from both institutional and high-net-worth retail clients, which are recognized across all revenue categories contained in the Company's Consolidated Statement of Income. (Net revenues also contain certain internal allocations, including funding costs, which are centrally managed.)

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Segment Results—Three Months Ended August 31, 2002 and August 31, 2001

(1)

Before dividends on preferred securities

        The following discussion provides an analysis of the Company's net revenues results by segment for the periods above.

        In assessing the performance of Capital Markets and Client Services, the Company measures Principal Transactions, Commissions and Net Interest revenues in the aggregate. Decisions relating to capital markets and client services activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction including any associated commissions, and the interest income or expense associated with financing or hedging the Company's positions. Therefore, the Company views net revenues from principal transactions, commissions and interest, offset by related interest expense, in the aggregate, because the revenue classifications, when analyzed individually, are not always indicative of the performance of the Company's Capital Markets and Client Services activities.

        Investment Banking    This segment's earnings result from fees earned by the Company for underwriting public and private offerings of fixed income and equity securities, and advising clients on M&A activities and other services.

        Investment Banking pre-tax earnings of $128 million increased significantly from the third quarter of 2001, as net revenues increased 57%. The increase was primarily due to an increase in equity underwriting, and to a lesser extent, M&A advisory and fixed income underwriting activity.

        Debt underwriting revenues totaled $201 million for the third quarter 0f 2002, an increase of 10% from the third quarter of 2001, due to the continued strength in U.S. investment grade debt underwriting driven by a favorable interest rate environment.

INVESTMENT BANKING NET REVENUES

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        Equity underwriting revenues increased substantially to $111 million in the third quarter of 2002 from $29 million in the third quarter of 2001. Although industry-wide equity market volumes decreased during the third quarter of 2002 compared to the third quarter of 2001, the Company's quarterly volume increased. The results for the third quarter of 2002 reflect the Company's participation as joint lead-manager for the largest initial public offering transaction in the quarter.

        M&A advisory fees for the third quarter of 2002 were $89 million, up from $44 million in the third quarter of 2001, principally due to an increase in the Company's market share in the U.S.

        Capital Markets    This segment's earnings reflect institutional customer flow activities and secondary trading and financing activities related to fixed income and equity products. These products include a wide range of cash, derivative, secured financing and structured instruments.

        Capital Markets pre-tax earnings of $3 million decreased slightly from the third quarter of 2001. Capital Markets non-interest expenses increased 9% during the quarter to $232 million from $212 million in the third quarter of 2001, primarily due to an increase in compensation and benefits associated with higher revenues, as well as an increase in nonpersonnel expenses, particularly occupancy costs associated with increased headcount levels, technology spending in order to enhance the Company's trading platforms and technology infrastructure and a slight increase in brokerage and clearance costs due to higher volumes in certain fixed income structured products.

CAPITAL MARKETS NET REVENUES

        Capital Markets' net revenues were $235 million for the third quarter of 2002, up 5% from the third quarter of 2001, despite the extremely difficult market environment.

        Net revenues from the fixed income component of Capital Markets in the third quarter of 2002 decreased by 36% from the third quarter of 2001. Revenues from fixed income products were adversely affected by price deterioration associated with widening credit spreads, particularly in the investment grade and high yield sectors. The weakness in the secondary markets was driven by historically high levels of downgrades as well as investor uncertainty due to corporate governance issues, geopolitical risks and continued global economic weakness.

        Net revenues from the equities component of Capital Markets were $121 million in the third quarter of 2002, up 157% from the third quarter of 2001. 2002 net revenues were positively impacted by reduced financing costs associated with the lower interest rate environment and by the Company's ability to increase its market share in the listed and NASDAQ markets. In addition, the increase reflects higher revenues from institutional trading, as in 2002 there was a change to commission-based pricing on certain NASDAQ trades to compensate for the compressed spreads (reflected within Principal Transactions) caused by decimalization, which had resulted in historically low revenue levels from NASDAQ customer flow activities in 2001. The increase was partially offset by a decline in convertible revenues as a result of spreads widening in the underlying bonds, as well as lower levels of secondary trading volumes consistent

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with the decrease in origination activity. In addition, the Company recorded mark-to-market losses on certain private equity investments in 2002 to reflect decreased valuations.

        Client Services    Client Services earnings reflect earnings from the Company's Private Client and Private Equity businesses. Private Client net revenues reflect the Company's high-net-worth retail customer flow activities as well as asset management fees. Private Equity net revenues include the management and incentive fees earned in the Company's role as general partner for thirty-three private equity banking partnerships.

        Client Services pre-tax earnings of $42 million decreased from $60 million in the third quarter of 2001, primarily due to an incentive fee recognized in Private Equity in 2001 as well as an increase in non-interest expenses, including occupancy and compensation.

        Client Services net revenues were $192 million in the third quarter of 2002 virtually flat versus the third quarter of 2001. Private Client net revenues increased 12%, from $171 million in the third quarter of 2001 to $191 million in the third quarter of 2002 as customers remained invested during the difficult market environment by repositioning their portfolios to fixed income products.

CLIENT SERVICES REVENUES

        Private equity net revenues declined substantially in the third quarter of 2002 from the third quarter of 2001 primarily due to an incentive fee recognized from the Company's general partner interest in a single Merchant Banking investment in the third quarter of 2001.

        Non-Interest Expenses    Non-interest expenses were $655 million for the third quarter of 2002 compared to $550 million for the third quarter of 2001. Compensation and benefits expense of $421 million in the third quarter of 2002 increased 22% from $344 million in the third quarter of 2001, consistent with the increase in net revenues.

        Nonpersonnel expenses were $234 million for the third quarter of 2002, up 14% compared to the third quarter of 2001. The increase is mainly attributable to higher management fees and occupancy expenses, driven by the increase in space, and technology costs required for the increase in headcount. Technology and communications, Business development and Professional fees decreased from the third quarter of 2001, due to lower discretionary spending in response to the current market environment.

        Income Taxes    The Company's income tax provision was $30 million for the third quarter of 2002 versus $17 million for the third quarter of 2001. The effective tax rate was 17.3% for the third quarter of 2002 versus 13.7% for the third quarter of 2001. The effective tax rate for 2002 is higher than for 2001 primarily due to a decrease in tax benefits attributable to income subject to preferential tax treatment coupled with higher pretax income.

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Results of Operations
For the Nine Months Ended August 31, 2002 and August 31, 2001

        The Company reported net income of $677 million for the nine months ended August 31, 2002, a decrease of 10% from the nine months ended August 31, 2001. These results reflect the difficult market conditions experienced throughout 2002, led by a decline in equity capital markets and M&A activities. However, during this nine month period, the Company was generally able to continue to execute its strategy of building market share while maintaining a strict discipline with regard to its expenses, capital and liquidity.

Revenues

        Net revenues were $3,217 million for the fist nine months of 2002 compared to $3,478 million for the first nine months of 2001. Revenues declined 8% as compared to the prior year's levels, reflecting the impact of the difficult market conditions throughout the current fiscal year.

Principal Transactions, Commissions and Net Interest Revenues

        The Company measures the performance of its Capital Markets and Client Services activities in the aggregate including Principal Transactions, Commissions and Net Interest. Decisions relating to these activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction, including associated commissions, and the interest income or expense associated with financing or hedging the Company's positions. The Company views these revenues in the aggregate, because the revenue classifications, when analyzed individually, are not always indicative of the performance of the Company's Capital Markets and Client Services activities.

        Principal Transactions, Commissions and Net Interest revenues were $2,056 million for the first nine months of 2002 as compared to $2,394 million for the first nine months of 2001. Principal Transactions, Commissions and Net Interest revenues decreased 14% from the first nine months of 2001 as a result of strong fixed income results being more than offset by weakness in the equity markets. Fixed income results were fueled by historically low interest rate levels and increased customer trading volumes, particularly in mortgage related products and investment grade debt, as investors rebalanced portfolios into fixed income products amid geopolitical and accounting uncertainties. The weakness in equity results were driven by declining equity indices and reduced customer flow, as investors had a bias against equity trading.

        Within these amounts, Principal Transactions revenue decreased to $608 million for the first nine months of 2002 from $1,198 for the first nine months of 2001. Commissions revenues were $806 million for the first nine months of 2002 as compared to $644 million for the first nine months of 2001. Interest and Dividends revenue were $6,905 million for the first nine months of 2002 as compared to $11,360 million for the first nine months of 2001. Interest Expense was $6,263 million for the first nine months of 2002 as compared to $10,808 million for the first nine months of 2001.

        The decrease in Principal Transactions revenues represents weakness in the equity markets resulting from the continued depressed levels of market volatility and declining equity indices offset by higher fixed income results, driven by historically low interest rate levels which led to increased customer flow activities. In addition, Principal Transaction revenues in 2002 decreased as a result of the transition to a commission-based revenue structure on certain NASDAQ trades. In the prior year, the Company's NASDAQ trades for substantially all of its institutional customers were transacted on a spread basis (with related revenues classified within Principal Transactions).

        Commissions revenues increased as compared to the prior year period primarily due to the migration to institutional commission-based pricing in the NASDAQ market.

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        Interest and Dividends revenues and Interest Expense are a function of the level and mix of total assets and liabilities, including financial instruments owned and secured financing activities, the prevailing level of interest rates, as well as the term structure and volatility of the Company's financings. Interest and Dividends revenues and Interest Expense are integral components of trading activities. The decline in interest income and interest expense from the previous year is principally due to a significant decline in interest rates over the period. The increase in net interest income was due in part to higher interest and dividend earning asset levels in the first nine months of 2002 as compared to the first nine months of 2001, as well as an increase in spreads earned as a result of lower financing costs, offset by a change in the asset mix during the third quarter of 2002.

Investment Banking

        Investment Banking revenues were $1,135 million for the first nine months of 2002 as compared to $1,054 million for the first nine months of 2001. Investment Banking revenues result mainly from fees earned by the Company for underwriting public and private offerings of fixed income and equity securities, and advising clients on M&A activities and other services. Investment Banking revenues increased 8% from the first nine months of 2001 primarily as a result of market share increases in fixed income and equity underwriting.

Segments

        The Company is segregated into three business segments (each of which is described below): Investment Banking, Capital Markets and Client Services. Each segment represents a group of activities and products with similar characteristics. These business activities result in revenues from both institutional and high-net-worth retail clients, which are recognized across all revenue categories contained in the Company's Consolidated Statement of Income. (Net revenues also contain certain internal allocations, including funding costs, which are centrally managed.)

Segment Results—Nine Months Ended August 31, 2002 and August 31, 2001