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Good Monday Afternoon - Comments From The Local Guys! We're back! We are also lost for words to describe our thoughts about last weeks attack. We may have more to say over time. At this stage, we would like to refer our readers to the Lehman Brothers website for a message from Richard Fuld, the Chairman & Chief Executive Officer of Lehman Brothers. http://www.lehman.com/ Lehman's Research. IMPACT CALLS Portfolio Strategy Jeffrey Applegate After September 11, 2001 The dreadful events of this week will probably push the U.S. economy and profits further down to a 'V' bottom; the profits recession will now also be deeper than our forecast of -12% with a trough in third quarter. The dreadful events of this week will probably push the U.S. economy and profits further down to a 'V' bottom; the profits recession will now also be deeper than our forecast of -12% with a trough in third quarter. But the vicious nature of the attack has prompted a vigorous monetary and fiscal policy response at a time when the S&P 500 is more than 30% below fair value; we expect that the stock market will rally on primarily cyclical leadership. Banks Update The expectation of aggressive rate cuts by the Federal Reserve Board and SEC actions to ease share repurchase restrictions should help many large cap bank stocks. We highlight BAC, C, FITB, FBF, JPM and WFC. Following Tuesday's tragedy, the U.S. government took steps to increase liquidity to the financial system and provide additional sources of support for stocks. The Federal Reserve provided liquidity and is expected to reduce rates aggressively, while the SEC took actions "to Facilitate Reopening of Fair and Orderly Equities Markets". The ramifications of these actions should include wider net interest margins, increased mortgage refinance activity, and an acceleration of share repurchase activity. Some of the companies that would seem to benefit immediately from these actions include BAC, C, FBF, FITB, JPM and WFC. q Our strategist, Jeff Applegate, recommends almost a double weighting of financial stocks - 32% vs. a market weighting of 18%. Mid Cap Banks We expect the Fed to aggressively lower interest rates during the remainder of year. We view NFB and SOTR, both of which are down 17% over the last two trading weeks, as liability sensitive plays. FTN, MTB and BBT should benefit from large mortgage banking operations. The recent weakness in bank stocks and the easing of restrictions should cause companies to increase share repurchase activity. Companies in this camp include CBSS, FMBI, HBAN, NFB, and TCB. Our 1 rated stocks are CYN, CBSS, CFR, NFB, TCB and ZION. We view MTB and SOTR as trading buys at current levels. Mid-cap banks tend to do well in a low inflation, low interest rate environment which our forecast calls for. The wildcard however continues to be the economy. Electric Utilities CT DPUC Draft Draws a Blank CT DPUC releases draft decision that denies FCEL 26MW project entirely. Reducing shares of FCEL to Market Perform from Strong Buy due to lack of material catalysts and potential downside to $8/share. Late Wednesday, the CT DPUC issued a draft decision that denied funding to an ENE/CRRA proposal that would have resulted in a 26MW order for FuelCell Energy. While the draft decision could be adjusted to provide funding in a final decision (early October), the wording of the order appears to point the companies towards additional state funding vehicles, which would likely take multiple months to tap and would be speculative at this point. We believe the disappointing CT DPUC draft decision leaves shares vulnerable to the downside ($8/share) and likely caught in a lower trading range until sub MW and MW "launch size" order flow can be generated. That said, FCEL's $7/share of fully diluted cash and leadership in carbonate technology should limit downside even in the current market environment. Electric Utilities Gray Growing Weaker in Round 10 The CA Senate failed to reach agreement on a revised SB78XX and therefore failed to call a vote at the end of the legislative session. We maintain our Market Perform rating on shares of EIX. The CA Senate failed to reach a compromise on a bill to avert bankruptcy for EIX's utility (SCE) in the wee hours of the session. Although the major terms of a revised deal were intact, the Senate lacked the votes to bring a successful vote. Gov Davis has called for a third extraordinary session in early October to try to force a compromise bill through both the Assembly and Senate. As anticipated, consumer opposition remained the sticking point but surprisingly Gov Davis lacked the political might to force the measure through the Senate. We maintain our Market Perform rating on shares of EIX as we continue to believe the near-term earnings and valuation are limited even if a bill ultimately passes. Major Pharmaceuticals Charles Butler Timing of Xigris Panel ? Restrictions ? We are raising our peak sales estimate for Lilly's sepsis drug Xigris to $2.6 billion from $2.0 billion. The Lilly sepsis drug Xigris was scheduled to be reviewed at an FDA panel last Wednesday. Due to the tragedies in both New York and Washington the panel did not convene. However, documents were made available on the FDA website regarding Lilly's presentation and the FDA's interpretation. Some have interpretated from the FDA documents that while Xigris will be approved, it may have a more restricted label, thus reducing potential demand. q We spoke with two members of the Xigris team on Friday and have concluded that we do not believe a restricted label for the product will occur. Leisure Felicia Rae Kantor A Mixed Bag We fully expect the leisure segment to be under pressure in the first few days of trading. Fears of travel coupled with economic concerns do not bode well for the industry in general. In this note, we offer, sub-sector by sub-sector, a rational and logical snapshot of our universe with the hopes of helping investors reassemble the pieces of the puzzle after the terrible tragedy that occurred on 9/11. PC Software Neil Herman Software sector in light of last week The events of last week increase the risk that potential customers will delay software purchases near-term , but should help longer-term as companies increase software spending, particularly as they likely increase their focus on disaster recovery as well as reliable, scalable, and redundant systems. q Veritas likely biggest beneficiary as about of its revenue is associated with data backup and recovery. Advent's dependence on the financial community puts it at risk near-term. q Inability to travel last week likely negatively impacted consultants' billing time. Enterprise Software/Internet Software Neil Herman Details of the Quarter On Thursday afternoon, Oracle reported EPS of $0.09, slightly exceeding our EPS estimate of $0.08 and $0.08 reported in the first quarter of the previous year. The company reported total revenue of $2.242 billion, which fell 0.9% from $2.261.9 million in the same quarter a year ago. Oracle was able to deliver from an operating margin perspective, with the operating margin rising to an amazing 33.3% from 29.1% in the fiscal first quarter of 2001. Autos & Auto Parts Nicholas Lobaccaro Auto Stocks Likely Among Hardest Hit GM and Ford Could Drop at least 25 to 30% based on DaimlerChrysler's stock price reaction, which fell by 23.5% last week. Industry fundamentals, already weak, will likely deteriorate significantly in the near term, with sales and production likely to be disrupted. GM and Ford, hampered by low level of profitability and weak balance sheets before the tragic events of last week, are vulnerable from a financial standpoint with access to credit likely to be more difficult than anticipated. Aggressive monetary and fiscal policy, as well as military action, could set the stage for an eventual economic recovery, perhaps as soon as late 2002. In the mean time, business is likely to be extremely difficult. Based on the stock price action during the Gulf War, we expect a significant near term drop in stock prices with the prices not bottoming out for some time, perhaps as long as 18 months. Wireless Services John Bensche Cell Phones In Unwanted Spotlight Wireless services networks were stressed to the limit by last week's WTC-Pentagon disaster by enormous traffic levels. While some facilities were damaged, companies predicted no material impact to overall business conditions as a direct result. The utility of wireless service showed itself in a very dramatic fashion in multiple situations, and we may see some above average activation levels in the short run. The impact of a sustained war on consumer spending and air travel is likely to be the largest factor for carriers over the longer term. NOTES FROM TODAY Paper & Forest Products Peter Ruschmeier Impact of Terrorist Attacks on Paper Ind Last week's tragic events put a cloud over near-term relative performance of paper/forest product stocks but long term prospects remain favorable. Within our universe, we maintain confidence in our Strong Buy ratings on WY, MEA, and SPP. Leveraged producers such as GP and SSCC may be vulnerable. We would add to several Buy-rated stocks that should benefit from a flight to quality, especially BOW, IP, and W. The prospect of war combined with a likely drop in consumer confidence and a potentially deep recession will likely lead to near-term underperformance of shares of paper companies. Longer term, we believe numerous positive factors as highlighted in this note will allow shares to outperform. We expect a "flight to quality" within the group. Companies with the highest EBITDA margins (TGP, BOW, WLL, SPP), the cleanest balance sheets (MEA, WLL, WY, SPP), the greatest exposure to timberlands (TGP, WY, WLL, TIN), and the lowest valuations based on EV/mid-cycle EBITDA (SPP, BOW, LPX, BCC) should benefit. Entertainment Stuart Linde Some Initial Thoughts The Entertainment industry may remain volatile in the wake of the most significant catastrophe in US history. Advertising will undoubtedly be affected as will travel to destination parks. Neither should be more than a reaction to this unprecedented tragedy and do not represent long term secular changes. The Entertainment industry remains in strong financial shape with all large diversified entities having investment grade balance sheets. Regulatory changes from the FCC are forthcoming which could further accelerate consolidation long-term. Changes in programming have been put in place due to the events of last week such as the timing of certain sporting events, a delay for TV season premieres and also for certain film releases. Networks and TV stations have also continued commercial free news to assist their viewers in learning of continuous updates which will impact 3Q results. In times of crisis, certain segments of the Entertainment industry will outperform such as regional and in home entertainment. Movie and home video rental/sales as well as TV viewership will permit an escape from the crisis at hand. Banks Jason Goldberg North Fork Bk Return to share Repurchase We rate NFB 1-Strong Buy. With over 85% of its revenues derived from spread income and projected aggressive Fed actions in the nearterm, we expect solid results to continue, despite disruption in the Manhattan marketplace. We expect NFB to increase its share repurchase program by 5MM shares, bringing its authorized repurchase to 8MM shares. This represents 5% of its outstanding shares and 14 days of average trading volumes We also expect NFB to continue growing de novo in Manhattan and anticipate the Commercial Bank of New York acquisition to close in 4Q01. Pro forma, 3 of its 20 Manhattan branches are below 14th Street, one of which maybe consolidated after the acquisition closes. NFB should benefit from its diverse lending portfolio. We do not expect systems issues to hamper customer service or hurt results. Satellite Communications William Kidd Sector - Economic Exposure is Moderate In light of a looming global recession, we wanted to stress our expectation for the satellite equity group to hold up relatively well. In the group, DBS companies are likely hardest hit by a weakening economy, while FSS companies should be relatively insulated. DARS: XM is still waiting for an FCC decision on its repeater license. However, XM equipment and service are now being sold. Internet Infrastructure Services Harry Blount Update from Attack This past Tuesday, Akamai experienced a tragic loss and announced a major new agreement. Co-founder and CTO Danny Lewin was lost in the WTC tragedy. Earlier that morning, Akamai had announced the establishment of a significant new agreement with Compaq. Akamai co-founder and CTO, Danny Lewin was lost in the first airplane that crashed into the World Trade Center. We continue to rate Akamai 2-Buy. David C. Morris Sr. VP Lehman Brothers 713-652-7112/800-227-4537 dcmorris@lehman.com Disclosure Legend: A-Lehman Brothers Inc. managed or co-managed within the past three years a public offering of securities for this company. B-An employee of Lehman Brothers Inc. is a director of this company. C-Lehman Brothers Inc. makes a market in the securities of this company. Key to Investment Rankings: This is a guide to expected total return (price performance plus dividend) relative to the total return of the stock's local market over the next 12 months. 1 = Strong Buy (expected to outperform the market by 15 or more percentage points); 2=Buy (expected to outperform the market by 5-15 percentage points); 3=Market Perform (expected to perform in line with the market, plus or minus 5 percentage points); 4=Market Underperform (expected to underperform the market by 5-15 percentage points); 5=Sell (expected to underperform the market by 15 or more percentage points). This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates ("Lehman Brothers") and has been approved by Lehman Brothers International (Europe), regulated by the Securities and Futures Authority, in connection with its distribution in the European Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. We do not represent that this information is accurate or complete and it should not be relied upon as such. It is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein are subject to change without notice. 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In addition, Lehman Brothers, its shareholders, directors, officers and/or employees, may from time to time have long or short positions in such securities or in options, futures, or other derivative instruments based thereon. One or more directors, officers, and/or employees of Lehman Brothers may be a director of the issuer of the securities mentioned in this document. Lehman Brothers may have managed or co-managed a public offering of securities for any issuer mentioned in this document within the last three years, or may, from time to time perform investment banking or other services for, or solicit investment banking or other business from any company mentioned in this document. Unless otherwise permitted by law, you must contact a Lehman Brothers entity in your home jurisdiction if you want to use our services in effecting a transaction in any security mentioned in this document. ? 2001 Lehman Brothers. 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