UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-21342
---------------------------------------------
Lehman Brothers First Trust Income Opportunity Fund
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(Exact name of registrant as specified in charter)
399 Park Ave., New York, NY 10022
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(Address of principal executive offices) (Zip code)
Bradley Tank, Chief Executive Officer of Lehman Brothers Asset Management Inc.
399 Park Ave., New York, NY 10022
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(Name and address of agent for service)
Registrant's telephone number, including area code: (212) 526-7000
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Date of fiscal year end: 12/31/2005
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Date of reporting period: 12/31/2005
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ITEM 1. REPORTS TO STOCKHOLDERS.
The annual report for the period January 1, 2005 through December 31, 2005
is filed herewith.
ANNUAL REPORT 2005
LEHMAN BROTHERS
FIRST TRUST INCOME
OPPORTUNITY FUND
[GRAPHIC]
LEHMAN BROTHERS
CONTENTS
Chairman's and President's Letter 2
Portfolio Manager's Report 3
Fund Overview 4
Schedule of Investments 5
Notes to Schedule of Investments 15
Statement of Assets and Liabilities 16
Statement of Operations 17
Statements of Changes in Net Assets 18
Financial Highlights 19
Notes to Financial Statements 20
Shareholder Voting Results 25
Report of Independent Registered Public Accounting Firm 26
Dividend Reinvestment Plan (Unaudited) 27
Trustees and Officers Table (Unaudited) 28
CHAIRMAN AND PRESIDENT'S LETTER
Dear Shareholder:
We are pleased to present to you the 2005 annual report of the Lehman Brothers
First Trust Income Opportunity Fund. The report includes portfolio commentary, a
listing of the Fund's investments, and its financial statements for the
reporting period.
The high yield market was volatile over the course of 2005, with changes in
interest rates being the primary source of the volatility. With fears of higher
inflation, a spike in Treasury rates, and Federal Reserve Chairman Alan
Greenspan's comments about a bond market "conundrum," high yield bonds declined
in value. While interest rates were the main culprit, a modest increase in
spreads over the year also contributed to price declines. However, the
attractive coupon levels associated with high yield securities more than offset
any price declines and resulted in a positive overall return for the market.
The Fund's investment objective is to seek high total return through income plus
capital appreciation. The Fund pursues this investment objective by investing
primarily in high yield debt securities*. Its performance is dependent on
several factors, including the rate of interest received on securities held by
the Fund, the interest cost of Money Market Cumulative Preferred Shares issued
by the Fund, and the results of interest rate hedges used by the Fund in seeking
to manage short-term interest rate costs.
Portfolio Manager Ann H. Benjamin and her team of seasoned investment
professionals at Lehman Brothers Asset Management LLC manage the portfolio. The
team takes a proactive approach to high yield asset management, integrating
detailed security and industry analysis within the context of a global economic
outlook. Ann's portfolio co-managers and research analysts are industry
specialists who carry out independent primary research on companies and
industries. In addition to seeking value from specific issue selections, they
also implement strategies seeking to take advantage of valuation opportunities
across industry sectors and credit quality tiers.
We thank you for the trust you have placed in us by investing in the Lehman
Brothers First Trust Income Opportunity Fund. We will continue to do our best to
earn it.
Sincerely,
/s/ Kurt A. Locher /s/ Brad Tank
Kurt A. Locher Brad Tank
CHAIRMAN AND TRUSTEE PRESIDENT
----------
* Portfolios that invest in bonds and other fixed income securities can provide
regular income and have historically been less volatile than most stock
funds. However, they are subject to risks including credit risk, default on
principal or interest payments and interest rate fluctuations. High-yield
bonds, also known as "junk bonds," are subject to additional risks such as
the increased risk of default.
LEHMAN BROTHERS FIRST TRUST INCOME OPPORTUNITY FUND ANNUAL REPORT 2005
PORTFOLIO MANAGER'S REPORT
For the annual reporting period ended December 31, 2005, the Lehman Brothers
First Trust Income Opportunity Fund (NYSE: LBC) returned 3.63% on a Net Asset
Value (NAV) basis and 5.40% on a Market Value basis.
For the year, the high yield bond market* produced modest returns that were
driven by higher interest rates, despite historically low default levels and a
relatively benign credit environment. While most sectors in the high yield
market performed fairly well, three sectors in particular weighed on the
market's overall performance. These sectors included the Autos, which were
affected by credit downgrades of both General Motors and Ford, and Forest and
Paper Products. Automotive suppliers in particular were hurt by cost pressures
from GM and Ford. In general, credit spreads were only modestly wider for the
year, but returns were dampened primarily by the rise in interest rates.
The portfolio's relative outperformance came from a number of market sectors.
For example, an overweight in the strongly performing gaming sector helped
results. We purposefully maintained an underweight position in the weak paper
sector, which helped our returns relative to the broad market. In the Media
sector, the Fund's strong performance was mostly the result of good security
selection. Other areas that did well included Wireless and Health Care. In the
Wireless segment, we enjoyed favorable security selection and benefited from an
overweight, as the sector as a whole was strong. In Health Care, the portfolio
also benefited from positive security selection. The majority of our alpha
generation came from security selection.
Looking ahead, there are a number of factors that we believe bode well for the
high yield market. First, we anticipate that the Federal Reserve Board's
tightening cycle is going to end sometime in the first part of 2006. Second,
although default rates among lower quality bonds may experience a slight uptick,
they are still low relative to historical standards. Third, the economy
generally appears to be doing well.
Our strategy is to stay focused on intermediate duration bonds in the BB area of
the market, where we are seeing the best value. The spread conversion between B-
and BB-rated bonds is extremely narrow, so there is little to gain from taking
on the excess risk in the B-rated segment of the market. We therefore expect to
continue to move up the credit quality spectrum (within the non-investment grade
category) as our lower quality bonds mature and are called or tendered. In
addition, we continue to focus on industries with stable cash flows, such as
Cable, Media, Health Care and Gaming.
We also plan to underweight the cyclical segment of the market. From a valuation
perspective, cyclical components are trading similarly to more defensive
industries and, to us, appear fully valued. Over the past year, we began
lowering our cyclical weighting and we plan to maintain a significant
underweight until valuations in this area of the market start to look more
attractive.
Sincerely,
/s/ Ann H. Benjamin
Ann H. Benjamin
PORTFOLIO MANAGER
----------
Past performance is not indicative of future results.
* Portfolios that invest in bonds and other fixed income securities can provide
regular income and have historically been less volatile than most stock
funds. However, they are subject to risks including credit risk, default on
principal or interest payments and interest rate fluctuations. High-yield
bonds, also known as "junk bonds," are subject to additional risks such as
the increased risk of default.
3
LEHMAN BROTHERS FIRST TRUST INCOME OPPORTUNITY FUND
FUND OVERVIEW (AS OF 12/31/05)(1)
PERFORMANCE HIGHLIGHTS(2)
3 MONTHS 6 MONTHS
ENDED ENDED YEAR ENDED CUMULATIVE TOTAL RETURN
INCEPTION DATE 12/31/05 12/31/05 12/31/05 SINCE INCEPTION(3)
NAV 07/28/03 1.28% 2.54% 3.63% 30.82%
Market Price 07/28/03 2.62% 8.00% 5.40% 34.46%
FUND FACTS
Ticker NYSE: LBC
Market Price (12/31/2005) $ 15.61
Net Asset Value (NAV) $ 14.51
Premium / (Discount) 7.58%
Shares outstanding: 12,247,538
CUSIP number: 525178 10 9
Inception Date: 7/28/03
PORTFOLIO CHARACTERISTICS
Portfolio Turnover 96.18%
Expense Ratio 1.53%
Wtd. Avg. Maturity 7.98 Years
Average Coupon 8.14%
Average Credit Quality B
Portfolio Composition - % High Yield 89.1%
CAPITAL STRUCTURE AND LEVERAGE ($ MM)
Total Net Assets $ 267.9
Net Assets Attributable to Common Shares $ 177.7
Net Assets Attributable to Preferred Shares $ 90.2
Net Assets Attributable to Other Borrowings -
Leverage (% of total net assets) 33.7%
[CHART]
CREDIT QUALITY BREAKDOWN (% OF TOTAL INVESTMENTS AND CASH)
Cash (AAA) 2.0%
BBB 7.0%
BB 43.0%
A 0.5%
B 38.4%
CCC 7.7%
Not Rated 1.4%
[CHART]
MARKET PRICE AND NAV PERFORMANCE
PRICE ($) NAV ($) PREMIUM/DISCOUNT (%)
7/29/2003 $ 15.00 $ 14.30 0.049000
8/8/2003 $ 15.00 $ 14.16 0.059300
8/15/2003 $ 15.10 $ 13.98 0.080100
8/22/2003 $ 14.56 $ 14.39 0.011800
8/29/2003 $ 14.45 $ 14.60 -0.010300
9/5/2003 $ 14.75 $ 14.75 0.000000
9/12/2003 $ 14.83 $ 14.93 -0.006700
9/19/2003 $ 14.82 $ 14.90 -0.005370
9/26/2003 $ 14.78 $ 14.92 -0.009380
10/3/2003 $ 14.93 $ 14.87 0.004035
10/10/2003 $ 15.14 $ 15.00 0.009330
10/17/2003 $ 15.10 $ 14.95 0.010000
10/24/2003 $ 15.23 $ 14.80 0.029054
10/31/2003 $ 15.25 $ 14.88 0.024900
11/7/2003 $ 15.27 $ 14.94 0.022100
11/14/2003 $ 15.48 $ 15.01 0.031300
11/21/2003 $ 15.14 $ 14.99 0.010000
11/28/2003 $ 15.26 $ 15.06 0.013300
12/5/2003 $ 15.36 $ 15.34 0.001300
12/12/2003 $ 15.32 $ 15.43 -0.007130
12/19/2003 $ 15.43 $ 15.60 -0.010900
12/26/2003 $ 15.49 $ 15.46 0.001940
12/31/2003 $ 15.91 $ 15.51 0.027800
1/9/2004 $ 15.79 $ 15.92 -0.008233
1/16/2004 $ 16.59 $ 15.98 0.038173
1/23/2004 $ 16.25 $ 15.95 0.018809
1/30/2004 $ 16.10 $ 15.60 0.032051
2/6/2004 $ 16.00 $ 15.31 0.045069
2/13/2004 $ 16.52 $ 15.49 0.066495
2/20/2004 $ 15.99 $ 15.22 0.050591
2/27/2004 $ 16.17 $ 15.17 0.065920
3/5/2004 $ 16.03 $ 15.27 0.049771
3/12/2004 $ 16.22 $ 15.25 0.063607
3/19/2004 $ 16.43 $ 15.12 0.086640
3/26/2004 $ 16.02 $ 14.98 0.069426
3/31/2004 $ 16.20 $ 15.09 0.073559
4/2/2004 $ 16.16 $ 15.06 0.073041
4/8/2004 $ 15.90 $ 15.16 0.048813
4/16/2004 $ 14.82 $ 15.17 -0.023617
4/23/2004 $ 14.90 $ 15.14 -0.016107
4/30/2004 $ 14.71 $ 15.02 -0.021074
5/7/2004 $ 14.39 $ 14.65 -0.018068
5/21/2004 $ 13.87 $ 14.35 -0.034607
5/28/2004 $ 14.94 $ 14.54 0.027510
6/4/2004 $ 14.95 $ 14.54 0.028198
6/10/2004 $ 14.98 $ 14.62 0.024624
6/18/2004 $ 14.95 $ 14.71 0.016315
6/25/2004 $ 14.75 $ 14.69 0.004084
6/30/2004 $ 14.85 $ 14.67 0.012270
7/2/2004 $ 14.94 $ 14.72 0.014946
7/9/2004 $ 15.00 $ 14.85 0.010101
7/16/2004 $ 15.20 $ 14.98 0.014686
7/23/2004 $ 15.18 $ 14.85 0.022222
7/30/2004 $ 15.15 $ 14.82 0.022267
8/13/2004 $ 15.44 $ 14.81 0.042539
8/20/2004 $ 15.55 $ 14.88 0.045027
8/27/2004 $ 15.49 $ 14.85 0.043098
8/31/2004 $ 15.58 $ 14.87 0.047747
8/13/2004 $ 15.44 $ 14.81 0.042539
8/20/2004 $ 15.55 $ 14.88 0.045027
8/27/2004 $ 15.49 $ 14.85 0.043098
8/31/2004 $ 15.58 $ 14.87 0.047747
9/3/2004 $ 15.53 $ 14.91 0.041583
9/10/2004 $ 15.73 $ 15.06 0.044489
9/17/2004 $ 15.85 $ 15.11 0.048974
9/24/2004 $ 15.67 $ 15.03 0.042582
10/1/2004 $ 15.75 $ 15.03 0.047904
10/15/2004 $ 16.29 $ 15.20 0.071711
10/22/2004 $ 16.13 $ 15.08 0.069629
10/29/2004 $ 15.86 $ 15.32 0.035248
11/5/2004 $ 16.30 $ 15.53 0.049581
11/12/2004 $ 16.10 $ 15.49 0.039380
11/19/2004 $ 16.35 $ 15.57 0.050096
11/26/2004 $ 16.34 $ 15.48 0.055556
12/3/2004 $ 16.40 $ 15.43 0.062865
12/10/2004 $ 16.10 $ 15.55 0.035370
12/17/2004 $ 16.48 $ 15.63 0.054383
12/23/2004 $ 16.26 $ 15.55 0.045659
12/31/2004 $ 16.48 $ 15.59 0.057088
1/7/2005 $ 15.98 $ 15.61 0.023700
1/14/2005 $ 16.30 $ 15.53 0.049600
1/21/2005 $ 16.00 $ 15.36 0.041700
1/28/2005 $ 15.91 $ 15.46 0.029100
1/31/2005 $ 15.91 $ 15.49 0.027100
2/4/2005 $ 15.84 $ 15.65 0.012100
2/11/2005 $ 15.99 $ 15.68 0.019800
2/18/2005 $ 15.73 $ 15.64 0.005800
2/25/2005 $ 15.53 $ 15.72 -0.012100
2/28/2005 $ 15.50 $ 15.75 -0.015900
3/4/2005 $ 15.44 $ 15.73 -0.018400
3/11/2005 $ 15.23 $ 15.69 -0.029300
3/18/2005 $ 15.05 $ 15.45 -0.025900
3/24/2005 $ 14.20 $ 15.02 -0.054600
3/31/2005 $ 14.85 $ 14.83 0.001300
4/1/2005 $ 14.78 $ 14.85 -0.004700
4/8/2005 $ 15.00 $ 15.03 -0.002000
4/15/2005 $ 14.58 $ 14.68 -0.006800
4/22/2005 $ 14.68 $ 14.66 0.001400
4/29/2005 $ 14.72 $ 14.38 0.023600
5/6/2005 $ 14.94 $ 14.45 0.033900
5/13/2005 $ 14.87 $ 14.27 0.042000
5/20/2005 $ 14.86 $ 14.16 0.049400
5/27/2005 $ 14.78 $ 14.56 0.015100
5/31/2005 $ 15.01 $ 14.65 0.024600
6/3/2005 $ 15.01 $ 14.94 0.004700
6/10/2005 $ 15.13 $ 14.87 0.017500
6/17/2005 $ 15.34 $ 14.95 0.026100
6/24/2005 $ 15.17 $ 14.84 0.022200
6/30/2005 $ 15.27 $ 14.95 0.021400
7/1/2005 $ 15.31 $ 14.96 0.023400
7/8/2005 $ 15.70 $ 14.98 0.048100
7/15/2005 $ 15.95 $ 15.16 0.052100
7/22/2005 $ 15.92 $ 15.04 0.058500
7/29/2005 $ 15.93 $ 15.15 0.051500
8/5/2005 $ 15.49 $ 15.06 0.028600
8/12/2005 $ 15.55 $ 15.10 0.029800
8/19/2005 $ 15.98 $ 15.17 0.053400
8/26/2005 $ 15.85 $ 15.10 0.049700
8/31/2005 $ 15.82 $ 15.05 0.051200
9/22/2005 $ 15.70 $ 15.02 0.045300
9/9/2005 $ 15.90 $ 15.06 0.055800
9/16/2005 $ 15.82 $ 15.01 0.054000
9/23/2005 $ 15.73 $ 14.72 0.068600
9/30/2005 $ 15.64 $ 14.73 0.061800
10/7/2005 $ 15.84 $ 14.68 0.079000
10/14/2005 $ 15.30 $ 14.50 0.055200
10/21/2005 $ 15.05 $ 14.61 0.030100
10/28/2005 $ 15.10 $ 14.45 0.045000
10/31/2005 $ 15.14 $ 14.48 0.045600
11/4/2005 $ 15.16 $ 14.51 0.044800
11/11/2005 $ 15.40 $ 14.50 0.062100
11/18/2005 $ 15.36 $ 14.32 0.072600
11/25/2005 $ 15.36 $ 14.38 0.068200
11/30/2005 $ 15.24 $ 14.45 0.054700
12/2/2005 $ 15.46 $ 14.50 0.066200
12/9/2005 $ 15.60 $ 14.53 0.073600
12/16/2005 $ 15.67 $ 14.59 0.074000
12/23/2005 $ 15.69 $ 14.46 0.085100
12/31/2005 $ 15.61 $ 14.51 0.075800
[CHART]
TOP INDUSTRIES (% OF TOTAL INVESTMENTS)
Media Broadcasting & Publishing 14.6%
Telephone Systems 7.4%
Entertainment & Leisure 9.2%
Electric Utilities 7.4%
Automotive 9.9%
Oil & Gas 10.0%
Health Care Providers 6.3%
Communications 2.6%
Commercial Services 6.7%
Retailers 4.1%
Other 21.8%
[CHART]
MATURITY BREAKDOWN (% OF TOTAL INVESTMENTS AND CASH)
< 1 Year 4.06%
1-3 Years 6.42%
3-5 Years 10.35%
5-7 Years 27.98%
7-10 Years 38.39%
10+ Years 12.80%
----------
1. Unless noted, data at or for twelve months ended December 31, 2005. High
yield securities, also known as "junk bonds," are subject to additional risks
such as the increased risk of default. Portfolio holdings are subject to
change.
2. Performance for NAV and Market Price assume reinvestment of all dividends and
capital gains. Shares of the Fund fluctuate in value. Fund performance
changes over time and currently may be different from that shown as of
12/31/05. Past performance is no guarantee of future results. More current
Fund performance information can be obtained by visiting the Fund's website
at www.lbftincomeopportunity.com.
3. Not annualized.
LEHMAN BROTHERS FIRST TRUST INCOME OPPORTUNITY FUND
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2005
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
ASSET BACKED SECURITIES -- 1.5%
AIRLINES -- 1.5%
$ 1,336,646 Continental Airlines, Inc., Pass-Through Certificates,
Series 2004-ERJ1, Class A
9.558%, 9/01/2019 BBB Ba NR $ 1,341,940
1,405,000 Delta Airlines, Inc., Pass-Through Certificates,
Series 2000-1, Class A2
7.570%, 11/18/2010 BB Ba B 1,384,338
TOTAL ASSET BACKED SECURITIES (IDENTIFIED COST $2,630,698) 2,726,278
CORPORATE DEBT -- 141.6%
ADVERTISING -- 0.7%
1,325,000 Lamar Media Corp., Senior Subordinated Note
6.625%, 8/15/2015 B Ba NR 1,329,969
AUTOMOTIVE -- 14.2%
2,000,000 Ford Motor Co., Global Note
7.450%, 7/16/2031 BB Ba BB 1,360,000
1,405,000 Ford Motor Credit Co., Global Note
6.875%, 2/01/2006 BB Baa BB 1,401,979
1,500,000 Ford Motor Credit Co., Global Note
7.875%, 6/15/2010 BB Baa BB 1,349,838
2,175,000 Ford Motor Credit Co., Global Note (FRN)
5.290%, 11/16/2006 BB Baa BB 2,111,838
4,000,000 Ford Motor Credit Co., Note
6.500%, 1/25/2007 BB Baa BB 3,869,880
3,070,000 Ford Motor Credit Co., Senior Note
4.950%, 1/15/2008 BB Baa BB 2,750,702
1,355,000 General Motors Acceptance Corp., Global Note
6.125%, 2/01/2007 BB Ba BB 1,293,547
4,145,000 General Motors Acceptance Corp., Global Note
6.875%, 9/15/2011 BB Ba BB 3,780,012
2,690,000 General Motors Acceptance Corp., Note
8.000%, 11/01/2031 BB Ba BB 2,576,700
5,155,000 General Motors Acceptance Corp., Senior Note
7.000%, 2/01/2012 BB Ba BB 4,675,204
25,169,700
BEVERAGES, FOOD & TOBACCO -- 0.6%
1,000,000 Del Monte Corp., Senior Subordinated Note
8.625%, 12/15/2012 B B BB 1,062,500
See accompanying notes to financial statements.
5
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
BUILDING MATERIALS -- 0.8%
$ 1,460,000 Nortek, Inc., Senior Subordinated Note
8.500%, 9/01/2014 CCC Caa NR $ 1,408,900
CHEMICALS -- 3.3%
1,155,000 Equistar Chemicals, LP/Equistar Funding Corp., Senior Note
10.625%, 5/01/2011 BB B B 1,270,500
1,645,000 Methanex Corp., Senior Note
8.750%, 8/15/2012 BBB Ba BBB 1,830,062
2,000,000 Millennium America, Inc., Senior Note
9.250%, 6/15/2008 BB B BB 2,157,500
610,000 PQ Corp., Senior Subordinated Note, 144A
7.500%, 2/15/2013 B B NR 567,300
5,825,362
COAL -- 1.6%
1,350,000 Massey Energy Co., Senior Note
6.625%, 11/15/2010 BB B NR 1,371,937
1,500,000 Massey Energy Co., Senior Note, 144A
6.875%, 12/15/2013 BB B NR 1,513,125
2,885,062
COMMERCIAL SERVICES -- 9.6%
1,905,000 Allied Waste North America, Inc., Senior Secured Note
8.875%, 4/01/2008 BB B B 2,009,775
1,400,000 Allied Waste North America, Inc., Senior Note
7.250%, 3/15/2015 BB B B 1,414,000
2,300,000 Cardtronics, Inc., Senior Subordinated Note, 144A
9.250%, 8/15/2013 B Caa NR 2,288,500
1,014,000 Coinmach Corp., Senior Note
9.000%, 2/01/2010 CCC B NR 1,062,165
2,945,000 Knowledge Learning Corp., Inc., Senior Subordinated Note, 144A
7.750%, 2/01/2015 B B NR 2,797,750
3,105,000 Language Line, Inc., Note
11.125%, 6/15/2012 CCC Caa NR 2,887,650
3,105,000 Monitronics International, Inc., Senior Subordinated Note
11.750%, 9/01/2010 B B NR 3,066,187
1,595,000 Service Corp. International/US, Senior Note, Step Up,144A
0.000%/7.000%, 6/15/2017 (c) BB Ba NR 1,583,037
17,109,064
See accompanying notes to financial statements.
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
COMMUNICATIONS -- 3.8%
$ 1,305,000 Dycom Industries, Inc., Senior Subordinated Note, 144A
8.125%, 10/15/2015 B Ba NR $ 1,305,000
3,365,000 Intelsat Bermuda, Ltd., Senior Note, 144A
8.625%, 1/15/2015 B B B 3,398,650
1,000,000 L-3 Communications Corp., Senior Subordinated Note
7.625%, 6/15/2012 BB Ba BB 1,052,500
1,345,000 PanAmSat Holding Corp., Senior Note, Step-Up
0.000%/10.375%, 11/01/2014 (c) B B NR 941,500
6,697,650
COMPUTERS -- 0.9%
1,630,000 Sungard Data Systems, Inc., Senior Note, 144A
9.125%, 8/15/2013 B B B 1,687,050
CONTAINERS & PACKAGING -- 3.5%
3,645,000 Crown Americas, Inc., Guaranteed Senior Note, 144A
7.750%, 11/15/2015 B B NR 3,772,575
2,345,000 Owens-Brockway Glass Container, Senior Secured Note
8.750%, 11/15/2012 BB B BB 2,520,875
6,293,450
COSMETICS & PERSONAL CARE -- 1.6%
1,985,000 Playtex Products, Inc., Senior Secured Note
8.000%, 3/01/2011 B B NR 2,114,025
655,000 Playtex Products, Inc., Senior Subordinated Note
9.375%, 6/01/2011 CCC Caa NR 686,112
2,800,137
ELECTRIC UTILITIES -- 10.5%
4,305,000 AES Corp. (The), Senior Secured Note, 144A
8.750%, 5/15/2013 B Ba BB 4,687,069
2,505,000 CMS Energy Corp., Senior Note
7.750%, 8/01/2010 B B BB 2,627,119
440,000 Edison Mission Energy Corp., Senior Note
9.875%, 4/15/2011 B B B 513,150
1,785,000 Midwest Generation LLC, Senior Secured Note
8.750%, 5/01/2034 B B B 1,965,731
740,000 Mirant North America LLC, Senior Note, 144A
7.375%, 12/31/2013 B B BB 748,325
1,410,000 Mission Energy Holding Co., Senior Secured Note
13.500%, 7/15/2008 CCC B B 1,635,600
See accompanying notes to financial statements.
7
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
ELECTRIC UTILITIES -- CONTINUED
$ 1,910,000 Reliant Energy, Inc., Senior Secured Note
9.500%, 7/15/2013 B B BB $ 1,914,775
3,000,000 TECO Energy, Inc., Note
7.500%, 6/15/2010 BB Ba BB 3,195,000
1,500,000 TXU Corp., Series Q, Senior Note
6.500%, 11/15/2024 BB Ba BBB 1,424,058
18,710,827
ELECTRONICS -- 2.3%
2,130,000 Freescale Semiconductor, Inc., Senior Note
7.125%, 7/15/2014 BB Ba BB 2,268,450
1,720,000 Xerox Corp., Note
7.625%, 6/15/2013 BB Ba BB 1,814,600
4,083,050
ENTERTAINMENT & LEISURE -- 13.2%
2,400,000 AMF Bowling Worldwide, Inc., Senior Subordinated Note
10.000%, 3/01/2010 CCC Caa NR 2,379,000
1,770,000 Blockbuster, Inc., Senior Subordinated Note, 144A
9.000%, 9/01/2012 CCC Caa CC 1,557,600
1,150,000 Choctaw Resort Development Enterprise, Senior Note, 144A
7.250%, 11/15/2019 BB B NR 1,168,687
2,790,000 Chukchansi Economic Development Authority, Note, 144A
8.000%, 11/15/2013 BB B NR 2,863,237
2,000,000 Chumash Casino & Resort Enterprise, Senior Note, 144A
9.000%, 7/15/2010 BB Ba NR 2,125,000
490,000 Majestic Star Casino LLC/Majestic Star Casino Cap, Senior Note
9.500%, 10/15/2010 BB B NR 515,725
910,000 Majestic Star Casino LLC/Majestic Star Casino Capital Corp. II,
Senior Secured Note, 144A
9.750%, 1/15/2011 B B NR 916,825
1,090,000 Marquee, Inc., Series B, Senior Note
8.625%, 8/15/2012 B B NR 1,139,050
1,400,000 Mohegan Tribal Gaming Authority, Senior Subordinated Note
7.125%, 8/15/2014 B Ba NR 1,433,250
665,000 Penn National Gaming, Inc., Senior Subordinated Note
6.875%, 12/01/2011 B B NR 671,650
790,000 Royal Caribbean Cruises, Ltd., Senior Note
7.500%, 10/15/2027 BB Ba NR 846,287
See accompanying notes to financial statements.
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
ENTERTAINMENT & LEISURE -- CONTINUED
$ 1,815,000 San Pasqual Casino, Senior Note, 144A
8.000%, 9/15/2013 B B NR $ 1,842,225
3,510,000 Station Casinos, Inc., Senior Subordinated Note
6.875%, 3/01/2016 B Ba NR 3,588,975
3,475,000 WMG Holdings Corp., Senior Note, Step-Up
0.000%/9.500%, 12/15/2014 (c) B B NR 2,432,500
23,480,011
FINANCIAL SERVICES -- 2.6%
500,000 American Real Estate Partners, LP, Senior Note
8.125%, 6/01/2012 BB Ba NR 518,750
1,340,000 American Real Estate Partners, LP, Senior Note 144A
7.125%, 2/15/2013 BB Ba NR 1,340,000
2,650,000 Arch Western Finance LLC, Guaranteed Senior Note
6.750%, 7/01/2013 BB Ba NR 2,699,687
4,558,437
FOREST PRODUCTS & PAPER -- 0.3%
500,000 Georgia-Pacific Corp., Note
7.750%, 11/15/2029 BB Ba B 456,250
HEALTH CARE PROVIDERS -- 8.9%
1,510,000 HCA, Inc., Note
7.500%, 11/06/2033 BB Ba BB 1,559,099
2,100,000 Rural/Metro Corp., Senior Subordinated Note, 144A
9.875%, 3/15/2015 CCC Caa NR 2,142,000
1,350,000 Select Medical Corp., Senior Note, 144A, (FRN)
9.933%, 9/15/2015 B Caa NR 1,356,750
2,485,000 Spheris, Senior Subordinated Note, 144A
11.000%, 12/15/2012 CCC Caa NR 2,199,225
500,000 Tenet Healthcare Corp., Senior Note, 144A
9.250%, 2/01/2015 B B B 496,250
4,165,000 US Oncology Holdings, Inc., Senior Note, (FRN)
9.264%, 3/15/2015 B Caa NR 4,144,175
2,500,000 US Oncology, Inc., Senior Note
9.000%, 8/15/2012 B B NR 2,675,000
1,330,000 Ventas Realty, LP/Ventas Capital Corp. REIT, Note, 144A
6.500%, 6/01/2016 BB Ba NR 1,336,650
15,909,149
See accompanying notes to financial statements.
9
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
HEAVY MACHINERY -- 1.6%
$ 1,040,000 Mueller Group, Inc., Senior Subordinated Note
10.000%, 5/01/2012 B Caa NR $ 1,105,000
2,280,000 Mueller Holdings, Inc., Senior Note, Step-Up
0.000%/14.750%, 4/15/2014 (c) B NR NR 1,715,700
2,820,700
HOME CONSTRUCTION, FURNISHINGS & APPLIANCES -- 2.8%
1,900,000 Beazer Homes USA, Inc., Senior Note
8.625%, 5/15/2011 BB Ba BB 1,985,500
560,000 K Hovnanian Enterprises, Inc., Senior Note
8.000%, 4/01/2012 BB Ba BB 578,404
1,255,000 Simmons Bedding Co., Senior Subordinated Note
7.875%, 1/15/2014 B Caa NR 1,160,875
1,255,000 Standard-Pacific Corp., Senior Note
7.750%, 3/15/2013 BB Ba BB 1,228,331
4,953,110
MEDIA - BROADCASTING & PUBLISHING -- 20.9%
2,005,000 CCH I Holdings LLC, Guaranteed Senior Note, 144A
10.000%, 5/15/2014 CCC Ca CCC 1,137,837
1,613,000 CCH I LLC, Guaranteed Senior Secured Note, 144A
11.000%, 10/01/2015 CCC Caa CCC 1,354,920
1,845,000 Charter Communications Operating LLC/Charter
Communications Capital Corp., Senior Note, 144A
8.000%, 4/30/2012 B B B 1,835,775
1,000,000 Charter Communications Operating LLC/Charter
Communications Capital Corp., Senior Note, 144A
8.375%, 4/30/2014 B B B 995,000
2,525,000 CSC Holdings, Inc., Series B, Senior Note
8.125%, 8/15/2009 B B BB 2,550,250
2,960,000 Dex Media, Inc., Note
8.000%, 11/15/2013 B B CCC 3,019,200
650,000 DirecTV Holdings LLC, Senior Note
6.375%, 6/15/2015 BB Ba BB 635,375
550,000 DirecTV Holdings LLC/DirecTV Financing Co., Senior Note
8.375%, 3/15/2013 BB Ba BB 591,250
1,400,000 Echostar DBS Corp., Senior Note
6.625%, 10/01/2014 BB Ba BB 1,342,250
960,000 Entercom Radio LLC/Entercom Capital, Inc., Senior Subordinated Note
7.625%, 3/01/2014 B Ba NR 962,400
See accompanying notes to financial statements.
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
MEDIA - BROADCASTING & PUBLISHING -- CONTINUED
$ 1,915,000 Houghton Mifflin Co., Senior Note
8.250%, 2/01/2011 B B B $ 1,977,237
1,000,000 Liberty Media Corp., Senior Note
8.500%, 7/15/2029 BB Ba BB 990,326
585,000 LIN Television Corp., Series B, Senior Subordinated Note
6.500%, 5/15/2013 B NR NR 560,869
910,000 Mediacom Broadband LLC, Senior Note, 144A
8.500%, 10/15/2015 B B B 842,887
610,000 Mediacom LLC/Mediacom Capital Corp., Senior Note
9.500%, 1/15/2013 B B B 595,512
7,300,000 Ono Finance Plc, Note
14.000%, 2/15/2011 CCC B B 7,874,875
2,050,000 Paxson Communications Corp., Senior Note, 144A, (FRN)
10.777%, 1/15/2013 CCC B NR 1,970,562
1,665,000 Primedia, Inc., Senior Note
8.000%, 5/15/2013 B B NR 1,409,006
1,185,000 Primedia, Inc., Senior Note
8.875%, 5/15/2011 B B NR 1,093,163
325,000 RH Donnelley Inc., Senior Subordinated Note
10.875%, 12/15/2012 B B NR 366,438
605,000 Rogers Cable, Inc., Senior Secured Note
7.875%, 5/01/2012 BB Ba BB 649,619
1,355,000 Rogers Cable, Inc., Senior Secured Note
8.750%, 5/01/2032 BB Ba BB 1,558,250
1,300,000 Shaw Communications, Inc., Senior Note
7.200%, 12/15/2011 BB Ba NR 1,355,250
775,000 Young Broadcasting, Inc., Senior Subordinated Note
8.750%, 1/15/2014 CCC Caa NR 682,969
775,000 Young Broadcasting, Inc., Senior Subordinated Note
10.000%, 3/01/2011 CCC Caa NR 725,594
37,076,814
MEDICAL SUPPLIES -- 1.3%
3,785,000 CDRV Investors, Inc., Senior Note, Step-Up
0.000%/9.625%, 1/01/2015 (c) B Caa NR 2,318,313
See accompanying notes to financial statements.
11
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
OIL & GAS -- 14.3%
$ 670,000 Chesapeake Energy Corp., Senior Note
6.875%, 1/15/2016 BB Ba BB $ 686,750
2,380,000 Chesapeake Energy Corp., Senior Note
7.000%, 8/15/2014 BB Ba BB 2,463,300
2,300,000 Dynegy Holdings, Inc., Senior Note, 144A
10.125%, 7/15/2013 B B B 2,599,000
2,650,000 El Paso Corp., Note, 144A
7.750%, 6/15/2010 NR NR NR 2,703,000
920,000 El Paso Corp., Senior Note, 144A
9.625%, 5/15/2012 NR NR NR 1,014,300
1,970,000 El Paso Natural Gas Co., Note
8.375%, 6/15/2032 B B NR 2,224,991
1,095,000 El Paso Natural Gas Co., Senior Note
7.625%, 8/01/2010 B B NR 1,151,479
840,000 Forest Oil Corp., Senior Note
7.750%, 5/01/2014 BB Ba NR 871,500
1,710,000 Forest Oil Corp., Senior Note
8.000%, 12/15/2011 BB Ba NR 1,868,175
1,820,000 Kerr-McGee Corp., Note
6.950%, 7/01/2024 BB Ba BB 1,930,441
500,000 Newfield Exploration Co., Senior Note
7.625%, 3/01/2011 BB Ba BB 535,000
3,000,000 Newfield Exploration Co., Senior Subordinated Note
8.375%, 8/15/2012 BB Ba BB 3,210,000
435,000 Southern Natural Gas Co., Note
8.000%, 3/01/2032 B B NR 476,983
1,420,000 Targa Resources, Inc., Senior Note, 144A
8.500%, 11/01/2013 B B NR 1,455,500
1,965,000 Transcontinental Gas Pipe Line Corp., Note
7.250%, 12/01/2026 B Ba BB 2,146,763
25,337,182
PHARMACEUTICALS -- 2.4%
3,015,000 Athena Neurosciences Finance LLC, Senior Note
7.250%, 2/21/2008 B B NR 2,943,394
1,330,000 Biovail Corp., Senior Subordinated Note
7.875%, 4/01/2010 BB B NR 1,378,213
4,321,607
See accompanying notes to financial statements.
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
RETAILERS -- 5.9%
$ 2,330,000 Amscan Holdings, Inc., Senior Subordinated Note
8.750%, 5/01/2014 CCC B NR $ 1,963,025
1,415,000 Dollarama Group, LP, Senior Subordinated Note, 144A
8.875%, 8/15/2012 B B NR 1,386,700
2,045,000 JC Penney Corp., Note
8.125%, 4/01/2027 BB Ba BBB 2,142,138
2,325,000 Jean Coutu Group, Inc., Senior Subordinated Note
8.500%, 8/01/2014 B Caa NR 2,127,375
2,755,000 Movie Gallery, Inc., Senior Note
11.000%, 5/01/2012 CCC B NR 2,148,900
730,000 Stripes Acquisition LLC/Susser Finance Corp., Senior Note, 144A
10.625%, 12/15/2013 B B NR 740,950
10,509,088
TELEPHONE SYSTEMS -- 10.6%
640,000 American Cellular Corp., Series B, Senior Note
10.000%, 8/01/2011 B B NR 694,400
1,759,645 Calpoint Receivables Structured Trust 2001, Note, 144A
7.440%, 12/10/2006 NR B CCC 1,764,044
2,635,000 Centennial Cellular Operating Co./Centennial Communications
Corp., Guaranteed Senior Note
10.125%, 6/15/2013 CCC B NR 2,865,563
35,000 Dobson Cellular Systems, Senior Note
8.375%, 11/01/2011 B B NR 37,144
2,740,000 Dobson Communications Corp., Senior Note
8.875%, 10/01/2013 CCC Caa NR 2,733,150
1,300,000 Nextel Communications, Inc., Series E, Senior Note
6.875%, 10/31/2013 A Baa BBB 1,356,178
725,000 Qwest Corp., Note
7.875%, 9/01/2011 BB Ba BB 781,188
5,530,000 Qwest Corp., Note
8.875%, 3/15/2012 BB Ba BB 6,235,075
665,000 Rogers Wireless Communications, Inc., Senior Secured Note
7.500%, 3/15/2015 BB Ba BB 718,200
1,490,000 Time Warner Telecom Holdings, Inc., Senior Note
9.250%, 2/15/2014 CCC B NR 1,571,950
18,756,892
See accompanying notes to financial statements.
13
PRINCIPAL S&P MOODY'S FITCH
AMOUNT DESCRIPTION RATINGS* RATINGS* RATINGS* VALUE (a)
CORPORATE DEBT -- CONTINUED
TEXTILES, CLOTHING & FABRICS -- 0.6%
$ 1,075,000 Quiksilver, Inc., Senior Note
6.875%, 4/15/2015 BB B NR $ 1,034,688
TRANSPORTATION -- 2.8%
2,640,000 Grupo Transportacion Ferroviaria Mexicana SA de CV, Note, 144A
9.375%, 5/01/2012 B B B 2,890,800
175,000 Stena AB, Note
9.625%, 12/01/2012 BB Ba NR 190,094
2,055,000 Stena AB, Senior Note
7.000%, 12/01/2016 BB Ba NR 1,880,325
4,961,219
TOTAL CORPORATE DEBT (IDENTIFIED COST $248,149,537) 251,556,181
TOTAL INVESTMENTS -- 143.1%
(IDENTIFIED COST $250,780,235) (b) 254,282,459
Other Assets, Less Liabilities -- 7.7% 13,558,476
Money Market Cumulative Preferred Shares plus cumulative unpaid
dividends (50.8%) (90,182,360)
TOTAL NET ASSETS APPLICABLE TO COMMON SHAREHOLDERS -- 100% $ 177,658,575
See accompanying notes to financial statements.
LEHMAN BROTHERS FIRST TRUST INCOME OPPORTUNITY FUND
NOTES TO SCHEDULE OF INVESTMENTS
* Ratings of issues shown are unaudited.
(a) See Note 2a of Notes to Financial Statements.
(b) Federal Tax Information:
At December 31, 2005, the net unrealized appreciation on investments
based on cost of $251,265,051 for federal income tax purposes was as
follows:
Aggregate gross unrealized appreciation for all investments in which there is an excess of value over tax cost $ 7,045,228
Aggregate gross unrealized depreciation for all investments in which there is an excess of tax cost over value (4,027,820)
Net unrealized appreciation $ 3,017,408
(c) Denotes a step-up bond: a zero coupon bond that converts to a fixed rate
of interest at a designated future date.
FRN Floating rate note. Rate shown is rate in effect at December 31, 2005.
144A Securities exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may be resold in transactions exempt from
registration, normally to qualified institutional buyers under Rule 144A,
and have been deemed by the adviser to be liquid. At the period end, the
value of 144A securities amounted to $66,384,105 or 37.4% of net assets
applicable to common shareholders.
Quality Profile (unaudited)
The quality ratings of securities in the fund as of December 31, 2005
were as follows:
PERCENT OF
TOTAL INVESTMENTS
S&P RATING/MOODY'S RATING/FITCH RATING AND CASH**
A/A/A 0.5%
BBB/Baa/BBB 7.0
BB/Ba/BB 43.0
B/B/B 38.4
CCC/Caa/CCC 7.7
NR (Not Rated)*** 1.4
Cash 2.0
100.0%
** Percentages compiled using the highest rating for each security.
*** Securities not rated are of quality that is permitted to be invested in by
the fund.
See accompanying notes to financial statements.
15
LEHMAN BROTHERS FIRST TRUST INCOME OPPORTUNITY FUND
STATEMENT OF ASSETS & LIABILITIES
DECEMBER 31, 2005
ASSETS
Investments at cost $ 250,780,235
Net unrealized appreciation 3,502,224
INVESTMENTS AT VALUE 254,282,459
Cash 5,250,485
Receivable for securities sold 6,019,561
Interest receivable 5,401,735
Interest rate swap contracts, at market value 1,402,642
Prepaid expenses 53,700
------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS 272,410,582
LIABILITIES
Payable for securities purchased 3,071,167
Management fees payable 136,421
Payable for collateral on interest rate swap contracts 1,226,000
Other accrued expenses 136,059
------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 4,569,647
MONEY MARKET CUMULATIVE PREFERRED SHARES (3,600 SHARES ISSUED AND OUTSTANDING)
AT LIQUIDATION VALUE PLUS CUMULATIVE UNPAID DIVIDENDS 90,182,360
------------------------------------------------------------------------------------------------------------------------------
NET ASSETS APPLICABLE TO COMMON SHARES $ 177,658,575
==============================================================================================================================
NET ASSETS CONSIST OF:
Common Shares, no par value; unlimited number of shares authorized, 12,247,538 shares issued and outstanding $ 173,824,127
Accumulated net realized gain on investments (1,070,418)
Net unrealized appreciation of investments and interest rate swap contracts 4,904,866
------------------------------------------------------------------------------------------------------------------------------
NET ASSETS APPLICABLE TO COMMON SHARES $ 177,658,575
COMPUTATION OF NET ASSET VALUE PER COMMON SHARE:
NET ASSETS $ 177,658,575
COMMON SHARES ISSUED AND OUTSTANDING 12,247,538
NET ASSET VALUE PER SHARE $ 14.51
MARKET VALUE (CLOSING PRICE PER SHARE ON THE NEW YORK STOCK EXCHANGE) $ 15.61
See accompanying notes to financial statements.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2005
INVESTMENT INCOME
Interest $ 23,709,909
Expenses
Management fee 1,636,931
Investor service fee 136,411
Trustees' fees and expenses 109,346
Custodian fee 312,318
Audit and tax services 51,550
Legal fee 130,608
Shareholder reports 54,812
Preferred shares auction 232,002
Insurance expense 85,416
Miscellaneous 40,843
-------------------------------------------------------------------------------------------------
TOTAL EXPENSES 2,790,237
NET INVESTMENT INCOME 20,919,672
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Realized gain (loss) on:
Investments -- net (707,367)
Interest rate swap contracts -- net 591,395
Change in unrealized appreciation (depreciation) of:
Investments -- net (11,744,400)
Interest rate swap contracts -- net 322,642
-------------------------------------------------------------------------------------------------
Net realized and unrealized loss on investments and interest rate swap contracts (11,537,730)
-------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 9,381,942
=================================================================================================
LESS DISTRIBUTIONS TO PREFERRED SHAREHOLDERS FROM NET INVESTMENT INCOME (2,993,978)
=================================================================================================
NET INCREASE IN NET ASSETS APPLICABLE TO COMMON SHARES RESULTING FROM OPERATIONS $ 6,387,964
=================================================================================================
See accompanying notes to financial statements.
17
STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED YEAR ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
FROM OPERATIONS:
Net investment income $ 20,919,672 $ 21,013,341
Net realized gain (loss) on investments and interest rate swap contracts (115,972) 222,124
Net change in unrealized appreciation (depreciation) of investments and interest
rate swap contracts (11,421,758) 1,240,507
Dividends to preferred shareholders from net investment income (2,993,978) (1,380,048)
---------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS APPLICABLE TO COMMON SHARES RESULTING FROM OPERATIONS 6,387,964 21,095,924
LESS DISTRIBUTIONS TO COMMON SHAREHOLDERS
Net investment income (19,265,627) (19,016,408)
Net realized gain on investments (235,064) (1,173,302)
Return of capital (49,045) --
---------------------------------------------------------------------------------------------------------------------------
(19,549,736) (20,189,710)
INCREASE (DECREASE) IN NET ASSETS DERIVED FROM COMMON SHARE TRANSACTIONS: 120,786 128,713
Offering costs and underwriting discounts on preferred shares -- 1,000
---------------------------------------------------------------------------------------------------------------------------
TOTAL NET INCREASE (DECREASE) IN NET ASSETS APPLICABLE TO COMMON SHARES (13,040,986) 1,035,927
NET ASSETS APPLICABLE TO COMMON SHARES
Beginning of period 190,699,561 189,663,634
End of period $ 177,658,575 $ 190,699,561
See accompanying notes to financial statements.
FINANCIAL HIGHLIGHTS
FOR THE PERIOD
JULY 28, 2003
YEAR ENDED DECEMBER 31, THROUGH
------------------------------- DECEMBER 31,
2005 2004 2003*
NET ASSET VALUE, BEGINNING OF PERIOD (COMMON SHARES) $ 15.58 $ 15.51 $ 14.33(a)
------------------------------------------------------------------------------------------------------------------------
Net Investment Income (b) 1.71 1.72 0.64
Net Realized and Unrealized Gain (Loss) on Investments (0.94) 0.11 1.31
Dividends to Preferred Shareholders from Net Investment Income (0.24) (0.11) (0.02)
------------------------------------------------------------------------------------------------------------------------
TOTAL FROM INVESTMENT OPERATIONS APPLICABLE TO COMMON SHAREHOLDERS 0.53 1.72 1.93
Less Distributions to Common Shareholders
From Net Investment Income (1.58) (1.55) (0.60)
From Net Realized Gains (0.02) (0.10) (0.02)
From Return of Capital (0.00)(g) -- --
------------------------------------------------------------------------------------------------------------------------
TOTAL DISTRIBUTIONS TO COMMON SHAREHOLDERS (1.60) (1.65) (0.62)
Common Shares Offering Costs Charged to Paid-in Capital -- -- (0.03)
Preferred Shares Underwriting Commissions and Offering Costs
Charged to Paid in Capital -- -- (0.10)
NET ASSET VALUE, END OF PERIOD (COMMON SHARES) $ 14.51 $ 15.58 $ 15.51
========================================================================================================================
MARKET VALUE - END OF PERIOD (COMMON SHARES) $ 15.61 $ 16.48 $ 15.91
========================================================================================================================
Total Return on Net Asset Value (Common Shares) (%) 3.63 11.99 12.73(c)
------------------------------------------------------------------------------------------------------------------------
Total Return on Market Value (Common Shares) (%) 5.40 15.48 10.47(d)
------------------------------------------------------------------------------------------------------------------------
Ratio of Expenses (excluding interest expense) to Average Net Assets
Applicable to Common Shares (%) (f) 1.53 1.48 1.42(e)
Ratio of Interest Expense to Average Net Assets Applicable to
Common Shares (%) (f) -- -- 0.19(e)
Ratio of Net Investment Income to Average Net Assets Applicable to
Common Shares (%) (f) 11.44 11.36 10.00(e)
Portfolio Turnover Rate (%) 96.18 106.76 32.08
------------------------------------------------------------------------------------------------------------------------
Net Assets Applicable to Common Shares, End of Period (000) $ 177,659 $ 190,700 $ 189,644
------------------------------------------------------------------------------------------------------------------------
MONEY MARKET CUMULATIVE PREFERRED SHARES
Preferred Shares Outstanding, End of Period (000) 90,000 90,000 90,000
Asset Coverage Per Share $ 74,350 $ 77,975 $ 77,675
Involuntary Liquidation Preference Per Share $ 25,000 $ 25,000 $ 25,000
Approximate Market Value Per Share $ 25,000 $ 25,000 $ 25,000
* Commencement of operations.
(a) Net asset value at beginning of period reflects the deduction from the
$15.00 offering price of the sales load of $0.675 per share paid by the
shareholder.
(b) Calculated using average shares outstanding during the period.
(c) Total return on net asset value is calculated assuming a purchase at the
offering price of $15.00 less the sales load of $0.675 paid by the
shareholder on the first day and a sale at the ending net asset value per
share and is not annualized.
(d) Total return on market value is calculated assuming a purchase at the
offering price of $15.00 on the first day and a sale at the current market
price on the last day of the period and is not annualized.
(e) Annualized.
(f) Expense and net investment income ratios include accumulated and unpaid
dividends.
(g) Rounds to less than $0.01.
See accompanying notes to financial statements.
19
LEHMAN BROTHERS FIRST TRUST INCOME OPPORTUNITY FUND
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2005
NOTE 1 -- ORGANIZATION
Lehman Brothers First Trust Income Opportunity Fund (the "Fund") was organized
as a statutory trust under the laws of the state of Delaware on April 8, 2003,
and is registered under the Investment Company Act of 1940, as amended (the
"1940 Act"), as a diversified, closed-end management investment company. Lehman
Brothers Asset Management Inc. (the "Adviser") is investment adviser to the
Fund. Lehman Brothers Asset Management LLC (formerly Lincoln Capital Fixed
Income Management Company, LLC) is the sub-adviser to the Fund. The Fund's
common shares are listed on the New York Stock Exchange under the symbol LBC.
The Fund's investment objective is to seek high total return (income plus
capital appreciation). The Fund will pursue its investment objective by
investing its assets primarily in high yield debt securities.
NOTE 2 -- SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in accordance with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of income and expenses
during the reporting period. Actual results could differ from those estimates.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
a) VALUATION: Debt securities are valued using an independent pricing service
approved by the Board of Trustees, which utilizes closing market prices, market
quotations and transactions, quotations from dealers and various relationships
among securities in determining value. Securities for which closing market
prices or market quotations are not available or are not considered by the
Adviser to be reflective of a security's market value, are valued at fair value
as determined in good faith under consistently applied procedures established by
and applied under the supervision of the Board of Trustees. Criteria considered
in making this determination may include, but are not limited to, a review of
other securities by the same issuer for which market quotations are available,
recent bid and ask prices for the security, the issuer's position in and
economic outlook of the industry and, if necessary, a review of similar
securities in similar industries. Securities with remaining maturities of 60
days or less are valued at amortized cost. This method involves valuing a
portfolio security initially at its cost and thereafter assumes a constant
amortization to maturity of any discount or premium.
b) SECURITY TRANSACTIONS AND RELATED INVESTMENT INCOME: Security transactions
are recorded on a trade date basis. Dividend income is recorded on the
ex-dividend date. Interest income, including amortization of premium and
accretion of discount on securities, is recorded on the accrual basis. Realized
gains and losses on investments are recorded on the basis of identified cost.
c) FEDERAL INCOME TAXES: It is the policy of the Fund to continue to comply with
the requirements of Subchapter M of the Internal Revenue Code applicable to
regulated investment companies and distribute all of its net taxable income,
including any net realized gains on investments, to its shareholders. Therefore,
no federal income tax provision is required.
d) REVERSE REPURCHASE AGREEMENTS: The Fund is permitted to enter into reverse
repurchase agreements with banks or securities firms deemed creditworthy by the
Adviser. A reverse repurchase agreement involves the sale of a security by the
Fund, with an agreement to repurchase the same or substantially similar security
at an agreed upon price and date. Securities purchased subject to repurchase
agreements must have an aggregate market value greater than or equal to the
repurchase price plus accrued interest at all times. Reverse repurchase
agreements involve the risk that the market value of the securities purchased
with the proceeds from the sale of securities received by the Fund may decline
below the price of the securities that the Fund is obligated to repurchase.
There were no reverse repurchase agreements outstanding at December 31, 2005.
e) INTEREST RATE SWAP CONTRACTS: The Fund may enter into interest rate swap
transactions. A swap is an agreement to exchange the return generated by one
instrument for the return generated by another instrument. The Fund may enter
into interest rate swap agreements to manage its exposure to interest rate risk.
Interest rate swap contracts involve the exchange by the Fund with another party
of their respective commitments to pay or receive interest. Swaps are marked to
market daily based upon quotations from market makers and the change in value,
if any, is recorded as unrealized gain or loss in the Statement of Operations.
Net payments of interest on interest rate swap contracts are included as part of
realized gain or loss. Entering into these agreements involves, to varying
degrees, elements of credit and market risk in excess of the amounts recognized
on the Statement of Assets and
Liabilities. Such risks involve the possibility that there will be no liquid
market for these agreements, that the counterparty to these agreements may
default on its obligation to perform and that there may be unfavorable changes
in interest rates. At December 31, 2005, the Fund had the following open swap
agreements:
NET UNREALIZED
NOTIONAL AMOUNT EXPIRATION DATE DESCRIPTION APPRECIATION
------------------------------------------------------------------------------------------------------------------
$ 22,500,000 03/15/06 Agreement with Citibank N.A. dated 03/11/04 to pay the $ 149,499
notional amount multiplied by 1.78% and to receive
the notional amount multiplied by the 1 month U.S.
Dollars -- London Interbank Offered Rate -- British
Bankers Association (USD -- LIBOR -- BBA).
$ 22,500,000 03/15/07 Agreement with Citibank N.A. dated 03/11/04 to pay the $ 677,612
notional amount multiplied by 2.27% and to receive the
notional amount multiplied by the 1 month U.S. Dollars --
London Interbank Offered Rate -- British Bankers Association
(USD -- LIBOR -- BBA).
$ 22,500,000 09/28/07 Agreement with Citibank N.A. dated 09/24/04 to pay the $ 575,531
notional amount multiplied by 3.22% and to receive the
notional amount multiplied by the 1 month U.S. Dollars --
London Interbank Offered Rate -- British Bankers Association
(USD -- LIBOR -- BBA).
Periodically, the Fund receives from or deposits, with the counter party, a
specific amount of cash equal to the market value of the interest rate swap
contracts. At December 31, 2005, the Fund had $1,226,000 payable for collateral
on interest rate swap contracts under this arrangement.
NOTE 3 -- FEES AND TRANSACTIONS WITH RELATED PARTIES
The Fund pays all expenses incurred in connection with the operations of the
Fund. These expenses, among others, include custodian and fund accounting and
administrative fees, legal and audit fees, fees and expenses of the
disinterested Trustees, registration fees, and printing expenses.
The Fund pays the Adviser a monthly fee computed at an annual rate of 0.60% of
the Fund's average daily "Managed Assets" (net assets, including assets
attributable to any outstanding preferred shares, plus the aggregate principal
amount of any borrowings). The Adviser is responsible for developing,
implementing and supervising the Fund's investment program and providing certain
administrative services to the Fund. The Adviser has retained Lehman Brothers
Asset Management LLC ("LBAM LLC") to serve as the sub-adviser of the Fund and to
manage the Fund's investment portfolio. The Adviser compensates LBAM LLC for its
services as sub-adviser. The Adviser pays LBAM LLC a monthly sub-advisory fee
calculated at the following annual percentage rates of the Fund's average daily
Managed Assets: 0.55% on the Fund's first $25 million of Managed Assets, 0.45%
on the next $25 million of Managed Assets, 0.35% on the next $50 million of
Managed Assets, and 0.30% on Managed Assets that are in excess of $100 million.
The Adviser and LBAM LLC are wholly owned subsidiaries of Lehman Brothers
Holdings Inc., a publicly traded corporation.
First Trust Portfolios L.P. ("First Trust") serves as the Fund's distribution
and marketing agent, and investor servicing agent. As the Fund's distribution
and marketing agent, First Trust provides certain distribution and marketing
services for the Fund's common shares including preparing marketing materials
and presentations, developing contacts with brokers whose clients may have an
interest in acquiring Fund shares and replying to information requests from
prospective investors. In consideration for these services, First Trust receives
a fee paid by the Adviser.
First Trust, as the investor servicing agent, developed and maintains a website
for the Fund, assists in the review of shareholder materials, assists in the
dissemination of the Fund's net asset value and market price, provides ongoing
shareholder and account maintenance services, replies to information requests
from shareholders and aids in secondary market support. In consideration for
these services, the Fund pays First Trust a monthly fee computed at the annual
rate 0.05% of the Fund's average daily Managed Assets. For the year ended
21
December 31, 2005, the Fund paid First Trust, as the investor servicing agent, a
fee equal to $136,411.
The Fund pays no compensation to its officers or to its Trustees who are
interested Trustees of the Adviser or its affiliates.
NOTE 4 -- INVESTMENT IN SECURITIES
For the year ended December 31, 2005, purchases and sales of investments, other
than short-term securities, aggregated $251,964,596 and $258,950,264,
respectively.
NOTE 5 -- MONEY MARKET CUMULATIVE PREFERRED SHARES
The Fund is authorized to issue 3,750 Money Market Cumulative Preferred Shares
("MMP"), each without par value. On October 22, 2003, the Fund issued 3,600 MMP
with proceeds of $90,000,000 in a public offering. The underwriting commissions
and offering costs of $1,236,545 were incurred in connection with the offering
and were charged directly to paid-in capital of the common shares. Distributions
to preferred shareholders are cumulative at a rate which was established at the
offering and is reset every twenty-eight days based on the results of an
auction. The Fund pays commissions to certain broker-dealers at the end of each
auction at an annual rate of 0.25%. For the year ended December 31, 2005, Lehman
Government Securities, Inc., an affiliate of the Adviser, earned $225,000 in
commissions.
The MMP are redeemable at the option of the Fund at a redemption price equal to
$25,000 per share, plus accumulated and unpaid dividends, on any dividend
payment date. The MMP are also subject to mandatory redemption at a redemption
price equal to $25,000 per share, plus accumulated and unpaid dividends, if the
Fund defaults on its asset maintenance requirements with respect to the MMP and
fails to cure such a default within the time permitted. If the dividends on the
MMP shall remain unpaid in an amount equal to two full years' dividends, the
holders of the MMP, as a class, have the right to elect a majority of the Board
of Trustees. In general, the holders of the MMP and the common shares have equal
voting rights of one vote per share, except that the holders of the MMP, as a
separate class, have the right to elect at least two members of the Board of
Trustees and to vote under certain other circumstances specified in the Fund's
Amended By-Laws. The MMP have a liquidation preference of $25,000 per share,
plus accumulated and unpaid dividends. The Fund is required to maintain certain
asset coverage with respect to the MMP as defined in the Fund's Amended By-Laws
and the 1940 Act.
NOTE 6 -- DISTRIBUTIONS TO SHAREHOLDERS
The Fund intends to make monthly distributions of net investment income to
common shareholders, after payments of any dividends on outstanding MMP.
Distributions to common shareholders are recorded on the ex-dividend date.
Distributions to preferred shareholders are recorded daily and are payable at
the end of each dividend period. Each dividend payment period for the MMP is
generally twenty-eight days. For the year ended December 31, 2005, the dividend
rates for MMP ranged from 2.41% to 4.35%. The dividend rate for MMP on December
31, 2005 was 4.35%. In addition, at least annually, the Fund intends to
distribute net capital gains, if any. The timing and characterization of certain
income and capital gains distributions are determined in accordance with federal
tax regulations which may differ from U.S. generally accepted accounting
principles. Permanent differences between book and tax accounting relating to
distributions are reclassified to paid-in capital.
NOTE 7 -- SHARES OF BENEFICIAL INTEREST
The Fund's Declaration of Trust authorizes the Trustees to issue an unlimited
number of common shares for the Fund, each without par value. Transactions in
common shares were as follows:
YEAR ENDED YEAR ENDED
DECEMBER 31, 2005 DECEMBER 31, 2004
--------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT
--------- --------- --------- ---------
Shares issued pursuant to the Fund's 8,148 $ 120,786 8,448 $ 128,713
dividend reinvestment plan
----- --------- ----- ---------
Increase derived from capital share transactions 8,148 $ 120,786 8,448 $ 128,713
===== ========= ===== =========
NOTE 8 -- CONCENTRATION OF CREDIT RISK
The Fund will normally invest at least 80% of its Managed Assets in investments
offering high current income, which generally will be in the lower rating
categories of recognized rating agencies. These investments are regarded as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligations and will generally
involve more credit risk than securities in the higher rating categories. In
addition, the trading market for high yield investments may be relatively less
liquid than the market for higher-rated investments.
NOTE 9 -- RISK ASSOCIATED WITH THE USE OF LEVERAGE
The Fund's use of leverage through the issuance of preferred shares and
borrowings, as well as the economic leverage inherent in certain derivatives,
including credit default swaps, creates risks for holders of common shares.
There is no assurance that the Fund's leveraging strategies will be successful.
If the Fund issues preferred shares or borrows money to make additional
investments and the income and capital appreciation from those investments
exceed the dividends payable on the preferred shares or the costs of borrowing,
the Fund's investment return will be greater than if leverage had not been used.
However, if the dividends payable on the preferred shares or the costs of
borrowing exceed the income and capital appreciation from the additional
investments, the Fund would lose money and its investment return will be lower
than if leverage had not been used. Leverage creates risks which may adversely
affect the return for holders of common shares, including:
(a) the likelihood of greater volatility of net asset value and market price of
the Fund's common shares;
(b) the possibility either that common share income will fall if the preferred
share dividend rate rises or the Fund's borrowing costs increase, or that
common share income will fluctuate because of changes in the preferred
share dividend rates or borrowing costs.
NOTE 10 -- INDEMNIFICATIONS
In the ordinary course of business, the Fund enters into contracts that contain
a variety of indemnifications. The Fund's maximum exposure under these
arrangements is unknown. However, the Fund has not had prior claims or losses
pursuant to these contracts and expects the risk of loss to be remote.
NOTE 11 -- FEDERAL INCOME TAX INFORMATION
For the years ended December 31, 2005 and December 31, 2004, the tax character
of distributions paid was $21,925,912 and $21,569,758 of ordinary income,
respectively. For the year ended December 31, 2005 the tax character of
distributions for long term capital gains and return of capital was $568,757 and
$49,045, respectively.
As of December 31, 2005, the components of accumulated earnings on a tax basis
were as follows:
Capital and other losses $ (585,602)
Unrealized gains 4,420,050*
-----------------------------------------------------------
TOTAL ACCUMULATED EARNINGS $ 3,834,448
* The difference between book-basis and tax-basis net unrealized gains is
attributed primarily to wash sales.
A permanent difference incurred during the period ended December 31, 2005,
resulting from differences in book and tax accounting due to the tax treatment
for paydown gains and losses on mortgage backed securities, the tax treatment
for swaps and return of capital distributions, and a redesignation of
distributions paid, has been reclassified at year end by increasing
undistributed net income by $1,388,978, decreasing undistributed realized gain
by $1,339,933 and decreasing paid in capital by $49,045.
At December 31, 2005 the Fund elected to defer post October 31 net capital
losses by $585,602.
NOTE 12 -- SUBSEQUENT EVENT (UNAUDITED)
At its meeting held on February 15, 2006, the Board of Trustees of the Fund (the
"Board") nominated for election as trustees of the Fund (at the annual meeting
of the shareholders of the Fund scheduled to be held on April 19, 2006) the
following individuals: John Cannon, Faith Colish, C. Anne Harvey, Barry Hirsch,
Robert A. Kavesh, Howard A. Mileaf, Edward I. O'Brien, Jack L. Rivkin, William
E. Rulon, Cornelius T. Ryan, Tom D. Seip, Candace L. Straight, Peter E. Sundman
and Peter P. Trapp. These individuals currently serve as the trustees/directors
of the Neuberger Berman family of funds ("NB Trustees"). This family of funds is
advised by an affiliate of Lehman Brothers Asset Management Inc. ("LBAM"), the
Fund's investment adviser. The current members of the Board have determined not
to continue serving as Trustees of the Fund upon the election of the NB
23
Trustees as Trustees of the Fund. This determination was based on the Board's
and the nominating committee's consideration of management's recommendation that
the board oversight of the Fund be transitioned to the NB Trustees.
Specifically, following thorough review of the matter, and based on
representations from LBAM and representatives from NBMI (the investment adviser
to the Neuberger Berman family of funds), the Board agreed that transitioning
the Fund's governance to the NB Trustees would likely result in the realization
of cost savings and operational efficiencies for the Fund and its shareholders.
To accomplish this transition, and consistent with management's recommendation,
the Board voted to nominate all of the NB Trustees for election as Trustees of
the Fund.
OTHER INFORMATION
SHAREHOLDER VOTING RESULTS (UNAUDITED)
The annual meeting of the Trust's shareholders was held on May 25, 2005 at which
shareholders considered and approved the following proposals. The voting results
were the following:
With respect to the election of Stephanie E. Dolan as a Trustee of the Fund:
11,799,430.812 shares of Common Shares and MMP Shares, voting together as a
single class, or 99.514% of shares cast, in the affirmative, with 57,670 shares,
or 0.486% of shares cast, withheld;
With respect to the election of Scott Hall as a Trustee of the Fund:
11,803,145.812 shares of Common Shares and MMP Shares, voting together as a
single class, or 99.545% of shares cast, in the affirmative, with 53,955 shares,
or 0.455% of shares cast, withheld; and
With respect to the election of Michael M. Knetter as a Trustee of the Fund:
1,917 MMP shares, or 100% of shares cast, in the affirmative, with 0 shares or
0% of shares cast withheld.
25
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Trustees
Lehman Brothers First Trust Income Opportunity Fund
We have audited the accompanying statement of assets and liabilities of Lehman
Brothers First Trust Income Opportunity Fund (the "Fund"), including the
schedule of investments, as of December 31, 2005, and the related statement of
operations for the year then ended, the statements of changes in net assets for
each of the two years in the period then ended, and the financial highlights for
the each of the periods indicated therein. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. We were
not engaged to perform an audit of the Fund's internal control over financial
reporting. Our audits included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Fund's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. Our procedures included confirmation of
securities owned as of December 31, 2005, by correspondence with the custodian
and brokers or by other appropriate auditing procedures where replies from
brokers were not received. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Lehman
Brothers First Trust Income Opportunity Fund, at December 31, 2005, the results
of its operations for the year then ended, the changes in its net assets for
each of the two years in the period then ended, and the financial highlights for
each of the periods indicated therein, in conformity with U.S. generally
accepted accounting principles.
/s/ Ernst & Young LLP
Boston, Massachusetts
February 10, 2006
DIVIDEND REINVESTMENT PLAN
The Fund has a Dividend Reinvestment Plan (the "Plan") commonly referred to as
an "opt-out" plan. Each common shareholder will have all distributions of
dividends and capital gains automatically reinvested in additional common shares
by Investors Bank & Trust Company, as agent for shareholders pursuant to the
Plan (the "Plan Agent"), unless the shareholder elects to receive cash or unless
the shares are registered in the name of a broker-dealer or other nominee (that
is, in "street name") and the respective nominee does not participate in the
Plan. For Plan participants, the Plan Agent will either (i) effect purchases of
common shares under the Plan in the open market or (ii) distribute newly issued
common shares of the Fund. Shareholders who elect not to participate in the Plan
will receive all distributions in cash paid by check mailed directly to the
shareholder of record (or if the shares are held in street or other nominee
name, then to the nominee) by the Plan Agent, as dividend disbursing agent.
Certain broker-dealers and nominees do not permit their clients to participate
in dividend reinvestment plans. Shareholders whose common shares are held in the
name of a broker or nominee should contact the broker or nominee to determine
whether and how they may participate in the Plan.
The Plan Agent serves as agent for the shareholders in administering the Plan.
After the Fund declares a dividend or makes a capital gain distribution, the
Plan Agent will, as agent for the participants, either (i) receive the cash
payment and use it to buy common shares in the open market, on the New York
Stock Exchange or elsewhere, for the participants' accounts or (ii) distribute
newly issued common shares of the Fund on behalf of the participants. The Plan
Agent will receive cash from the Fund with which to buy common shares in the
open market if, on the determination date, the net asset value per share exceeds
the market price per share plus estimated brokerage commissions on that date.
The Plan Agent will receive the dividend or distribution in newly issued common
shares of the Fund if, on the determination date, the market price per share
plus estimated brokerage commissions equals or exceeds the net asset value per
share of the Fund on that date. The number of shares to be issued will be
computed at a per share rate equal to the greater of (i) the net asset value or
(ii) 95% of the closing market price per share on the payment date.
Participants in the Plan may withdraw from the Plan upon written notice to the
Plan Agent. Such withdrawal will be effective immediately if received not less
than ten days prior to a distribution record date; otherwise, it will be
effective for all subsequent dividend record dates. When a participant withdraws
from the Plan or upon termination of the Plan as provided below, certificates
for whole common shares credited to his or her account under the Plan will be
issued and a cash payment will be made for any fraction of a common share
credited to such account. In the alternative, upon receipt of the participant's
instructions, common shares will be sold and the proceeds sent to the
participant less brokerage commissions and any applicable taxes.
The Plan Agent maintains each shareholder's account in the Plan and furnishes
confirmations of all acquisitions made for the participant. Common shares in the
account of each Plan participant will be held by the Plan Agent on behalf of the
participant. Proxy material relating to shareholders' meetings of the Fund will
include those shares purchased as well as shares held pursuant to the Plan.
In the case of shareholders, such as banks, brokers or nominees, which hold
common shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of common shares certified from
time to time by the record shareholders as representing the total amount
registered in the record shareholder's name and held for the account of
beneficial owners who are participants in the Plan.
The Plan Agent's fees for the handling of reinvestment of dividends and other
distributions will be paid by the Fund. Each participant will pay a pro rata
share of brokerage commissions incurred with respect to the Plan Agent's open
market purchases in connection with the reinvestment of distributions. There are
no other charges to participants for reinvesting dividends or capital gain
distributions; however, the Fund reserves the right to amend the Plan to include
a service charge payable by the participants.
The automatic reinvestment of dividends and other distributions will not relieve
participants of any income tax that may be payable or required to be withheld on
such dividends or distributions.
The Fund and the Plan Agent reserve the right to amend or terminate the Plan.
All correspondence concerning the Plan should be directed to: Investors Bank &
Trust Company, 200 Clarendon Street, Mail Stop OPS22, Boston, MA 02116
(Telephone) 800-988-5196.
27
TRUSTEES AND OFFICERS TABLE
Set forth below is information about the Trustees. The address for each Trustee
is Lehman Brothers Asset Management Inc., 399 Park Avenue, New York, NY 10022.
INDEPENDENT TRUSTEES:
NUMBER OF
PORTFOLIOS
OVERSEEN IN OTHER
LEHMAN TRUSTEESHIPS
BROTHERS HELD OUTSIDE OF
ASSET LEHMAN
LENGTH OF MANAGEMENT BROTHERS ASSET
NAME AND POSITION TIME PRINCIPAL OCCUPATIONS FOR LAST FIVE FUNDS MANAGEMENT
DATE OF BIRTH WITH FUND SERVED YEARS COMPLEX FUNDS COMPLEX
------------------------------------------------------------------------------------------------------------------------------------
General James E. Dalton, Trustee Since June Formerly Vice President of Logicon Inc., a 1 Formerly, Director
(Retired) 2003 wholly-owned subsidiary of Northrop of Defense Group,
10/17/1930 Grumman (1985-1998); formerly, General Inc., a defense
Manager of Logicon's Defense Technology business (since
Group (1995-1998). 1999-2005);
formerly, Director,
Chair of the Audit
Committee at
William Lyon
Homes, a home
building business
(since 1991-2005);
formerly Director
of Finance
America, a
mortgage business
(2002-2004).
Margaret M. Eisen Trustee Since June Managing Director of Marketing, CFA 1 Director, Chair of
6/19/1953 2003 Institute, since 2005; formerly, Managing Compensation
Director and Chief Investment Officer of Committee, and
EAM International, LLC, an investment Member of the
banking and asset management firm Audit Committee of
(2003-2005); formerly, Managing Director Antigenics
of DeGuardiola Advisors, an investment Corporation, a
bank (2001-2002); formerly, Managing bio-pharmaceutical
Director of North American Equities of company (since
General Motors Investment Management 2003); Trustee of
Corporation (1995-2001). Columbia Acorn
family of mutual
funds of Wanger
Asset Management
(six portfolios
under management)
(since 2002).
NUMBER OF
PORTFOLIOS
OVERSEEN IN OTHER
LEHMAN TRUSTEESHIPS
BROTHERS HELD OUTSIDE OF
ASSET LEHMAN
LENGTH OF MANAGEMENT BROTHERS ASSET
NAME AND POSITION TIME PRINCIPAL OCCUPATIONS FOR LAST FIVE FUNDS MANAGEMENT
DATE OF BIRTH WITH FUND SERVED YEARS COMPLEX FUNDS COMPLEX
------------------------------------------------------------------------------------------------------------------------------------
Michael M. Knetter Trustee Since June Dean of the University of Wisconsin- 1 Director, Wausau
4/8/1960 2003 Madison School of Business (since 2002); Paper, since 2005;
formerly, Professor of International Director, Great
Economics and Associate Dean at the Amos Wolf Resorts
Tuck School of Business -- Dartmouth (since 2004).
College (1997-2002).
Eugene A. Matthews Trustee Since June President of Nintai, Incorporated, an 1 None
11/19/1958 2003 investment advisory firm (since 1997);
formerly, Senior Fellow of Asia Studies
for the Council of Foreign Relations (2001
2003); formerly, Asia Studies Project
Director for the Japan Economic Task Force
and Leader of Asia Roundtable (2001-
2003); Founding and General Partner of
Apax-Globis Japan, Inc., a private equity
investment firm (since 1998); formerly
Founder/President of Ashta International,
a Vietnamese investment firm (1989-1997).
George W. Morriss Trustee Since June Formerly, Executive Vice President and 1 None
9/24/1947 2003 Chief Financial Officer of People's Bank,
a financial services company (1991-2001).
29
INTERESTED TRUSTEES:*
NUMBER OF
PORTFOLIOS
OVERSEEN IN OTHER
LEHMAN TRUSTEESHIPS
BROTHERS HELD OUTSIDE OF
ASSET LEHMAN
LENGTH OF MANAGEMENT BROTHERS ASSET
NAME AND POSITION TIME PRINCIPAL OCCUPATIONS FOR LAST FIVE FUNDS MANAGEMENT
DATE OF BIRTH WITH FUND SERVED YEARS COMPLEX FUNDS COMPLEX
------------------------------------------------------------------------------------------------------------------------------------
Stephanie E. Dolan Trustee Since June Managing Director of Lehman Brothers Inc., 1 None
4/4/1963 2003 since January 2006; Senior Vice President
of Lehman Brothers Inc. (since 2000);
Controller of Lehman Brothers Asset
Management Inc. (since 2003).
Scott Hall Trustee Since June Managing Director of First Trust Advisors 1 None
1/12/1957 2003 L.P. and First Trust Portfolios L.P.
(since 1992).
Kurt A. Locher Trustee Since June Managing Director of Lehman Brothers 1 None
5/9/1966 2003 Inc. (since 1998); Managing Director of
Lehman Brothers Asset Management Inc.
(since 2003); formerly Director of BNC
Mortgage Inc. (2000-2004), Finance America
LLC (1999-2004), and TrueLink
Inc. (1999-2004); formerly, President of
Lehman Brothers Bank, F.S.B. (1999-2000);
formerly, Senior Vice President of Lehman
Brothers Inc. (1995-1998).
* Stephanie E. Dolan and Kurt A. Locher are "interested persons" of the Fund, as
such term is defined by the 1940 Act, by virtue of their officerships with
Lehman Brothers Asset Management Inc., the investment adviser to the Fund
("Lehman Brothers" or the "Adviser"). Scott Hall is an "interested person" of
the Fund, as such term is defined by the 1940 Act, by virtue of his employment
with First Trust Portfolios LP, the Fund's servicing agent and distribution and
marketing agent.
Set forth below is information about the officers of the Fund. Each officer
serves for a one-year term. The address for each officer is Lehman Brothers
Asset Management Inc., 399 Park Avenue, New York, NY 10022.
POSITION
NAME AND DATE OF BIRTH WITH FUND PRINCIPAL OCCUPATION FOR LAST FIVE YEARS
------------------------------------------------------------------------------------------------------------------------------------
Bradley Tank President Chief Executive Officer of Lehman Brothers Asset Management Inc.; Managing Director and
9/29/1957 Global Head of Fixed Income Asset Management for Lehman Brothers (since 2002); Chief
Exeutive Officer and Managing Director of Lehman Brothers Asset Management LLC;
formerly, Director of Fixed Income for Strong Capital Management in Menomonee Falls,
Wisconsin (1990-2002).
POSITION
NAME AND DATE OF BIRTH WITH FUND PRINCIPAL OCCUPATION FOR LAST FIVE YEARS
------------------------------------------------------------------------------------------------------------------------------------
Edward Grieb Treasurer Chief Financial Officer of Lehman Brothers Asset Management Inc.; Managing Director
9/22/1961 (since 2003) and Assistant Controller for Lehman Brothers (since 1997).
Stephanie E. Dolan Assistant Managing Director of Lehman Brothers Inc., since January 2006; Senior Vice President of
4/4/1963 Treasuer Lehman Brothers Inc. (since 2000); Controller of Lehman Brothers Asset Management Inc.
(since 2003).
Jonathan Morris Secretary Senior Vice President of Lehman Brothers Asset Management Inc.; Senior Vice President
3/1/1956 and General Counsel for Lehman Brother's Investment Management Division which includes
Lehman Brothers private investment management business and asset management and
investment advisory business (since 1997).
Rainer L.C. Frost Assistant Director and Counsel, Investors Bank & Trust Company (since 2005); Principal and General
3/5/1957 Secretary Counsel, Clarity Group (2000-2005); Chief Administrative Officer, Executive
Vice-President and General Counsel, GoldK, Inc. (2001-2002); Chief Executive Officer and
General Counsel, Norfox Software, Inc. (1999-2000).
Chamaine Williams Chief Vice President, Lehman Brothers Inc., since 2003; Chief Compliance Officer, fifteen
1/29/1971 Compliance registered investment companies for which Neuberger Berman acts as investment manager
Officer and administrator, since 2005; Chief Compliance Officer, Lehman Brothers Asset
Management Inc., since 2003; Chief Compliance Officer, Lehman Brothers Alternative
Investment Management LLC, since 2003; formerly, Vice President, UBS Global Asset
Management (U.S.) Inc. (formerly, Mitchell Hutchins Asset Management, a wholly-owned
subsidiary of Paine Webber Inc.), 1997-2003.
The Fund's Statement of Additional Information includes additional information
about the Trustees of the Fund and is available without charge, upon request, by
calling 1-800-988-5196 or visiting the Fund's website at
www.lbftincomeopportunity.com.
A description of the Fund's proxy voting policies and procedures is available
(1) without charge, upon request, by calling 1-800-988-5196, (2) on the Fund's
website at www.lbftincomeopportunity.com and (3) on the Commission's website at
www.sec.gov.
Information regarding how the Fund voted proxies relating to portfolio
securities during the most recent 12 month period ended June 30, 2005 is
available (1) on the Fund's website www.lbftincomeopportunity.com and (2) on the
Commission's website at www.sec.gov.
In accordance with Section 303A.12 (a) of the New York Stock Exchange Listed
Company Manual, the Fund's Annual CEO Certification certifying as to compliance
with NYSE's Corporate Governance Listing Standards was submitted to the Exchange
on June 13, 2005.
The Fund files a complete schedule of investments with the Commission for the
first and third quarters of its fiscal year on Form N-Q, which when filed will
be available on the Commission's website at www.sec.gov. The Fund's Form N-Q may
be reviewed and copied at the Commission's Public Reference Room, which may be
obtained by calling 1-800-SEC-0330.
31
LEHMAN BROTHERS
(C) 2005 Lehman Brothers Inc. All Rights Reserved. LB10183
ITEM 2. CODE OF ETHICS.
For the year ended December 31, 2005, there were no amendments to a provision of
the code of ethics, nor were there any waivers granted from a provision of the
code of ethics. A copy of the Registrant's code of ethics is filed with this
Form N-CSR under Item 12(a)(1).
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
The Registrant's Board of Trustees designated George Morriss as the Registrant's
Audit Committee Financial Expert. George Morriss is deemed "independent" for
purposes of this item because (i) he does not accept directly or indirectly any
consulting, advisory, or compensatory fee from the issuer (other than in his
capacity as a committee member or a member of the board of trustees); and (ii)
he is not an "interested person" of the Registrant as that term is defined in
Section 2(a)(19) of the Investment Company Act of 1940, as amended (the "1940
Act").
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) AUDIT FEES: The aggregate fees billed to the Registrant for
professional services rendered by its independent auditors, Ernst
& Young LLP, for the audit of the Registrant's annual financial
statements for the year ended 2005 and 2004 were $34,500, and
$36,400.
(b) AUDIT RELATED FEES: The aggregate fees billed to the Registrant
for professional services rendered by its independent auditors,
Ernst & Young LLP, for the the initial and year end agreed upon
procedures reporting for the preferred shares for the years ended
2005 and 2004 were $6,000 and $5,400, respectively.
(c) TAX FEES: The aggregate fees accrued for professional services
rendered by Ernst & Young LLP for tax compliance, tax advice, and
tax planning for the years ended 2005 and 2004 were $8,700 and
$4,250, respectively. Such services included the preparation of
the year-end tax provision and excise tax work.
(d) ALL OTHER FEES: The aggregate fees billed to the Registrant for
professional services rendered by its independent auditors, Ernst
& Young LLP, other than services reported in Audit Fees,
Audited-Related Fees, and Tax Fees for years ended 2005 and 2004
were $0 and $0, respectively.
(e) (1) The Registrant's Audit Committee pre-approved the provision
of audit and non-audit services by Ernst & Young LLP for the
fiscal years ended December 31, 2005 and December 31, 2004. The
Registrant has not delegated the pre-approval of audit and
non-audit services to a member of the audit committee. Rather,
any action of the audit committee with respect to the
pre-approval process requires the vote of a majority of the audit
committee members present, whether in person or otherwise, at the
meeting at which such action is considered. One member of the
audit committee shall constitute a quorum for the purpose of
taking any action.
(2) The percentage of services described in each of paragraphs
(b) through (d) of this Item that were approved by the audit
committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of
Regulation S-X are as follows:
(b) 100%
(c) 100%
(d) 100%
(f) Not applicable.
2
(g) Aggregate non-audit fees billed to the Registrant by the
Registrant's accountant for the fiscal years ended December 31,
2005 and 2004 were $14,700 and $9,650, respectively
Aggregate non-audit fees billed to the investment adviser or
sub-adviser by the Registrant's accountant were $165,450 and
$167,550 for the fiscal years ended December 31, 2005 and 2004,
respectively. In addition to the services outlined under "Tax
Fees" and "Audit-Related Fees", these services include AIMR
attestation work performed by our New York City Office for the
adviser.
(h) Non-audit services rendered to the Registrant's investment
adviser and any adviser affiliate that were not pre-approved
pursuant to Paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X
were considered by the Registrant's audit committee as to whether
they were compatible with maintaining the principal accountant's
independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
The Board of Trustees of the Registrant established an audit committee for the
purpose of overseeing the accounting and financial reporting processes of the
Registrant and audits of the financial statements of the Registrant in
accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act").
To be eligible to serve as a member of the Registrant's audit committee, a
trustee must be an "Independent Trustee," which term shall mean a Trustee (i)
who is not an "interested person," as that term is defined in Section 2(a)(19)
of the 1940 Act, as amended of the Registrant; and (ii) who has not accepted
directly or indirectly any consulting, advisory, or other compensatory fee from
the Registrant (other than fees for serving as a trustee or committee member).
The Registrant's Audit Committee Members are:
James E. Dalton
Margaret M. Eisen
Michael M. Knetter
Eugene A. Matthews
George Morriss
ITEM 6. SCHEDULE OF INVESTMENTS
Not applicable to this filing.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Board of the Registrant has delegated to the Registrant's sub-advisor (the
"Sub-Advisor") the authority to vote proxies on behalf of the Fund and has
approved the Sub-Advisor's proxy voting guidelines and procedures. A copy of the
Sub-Advisor's proxy voting procedures and guidelines are filed with this Form
N-CSR under Item 12(b).
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES
(a) Portfolio Managers of Closed-End Management Investment Companies is
attached
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable to this registrant.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
3
None.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The Registrant's Principal Executive Officer and Principal Financial
Officer concluded that the Registrant's disclosure controls and procedures
(as defined in Rule 30a-3(c) under the Investment Company Act of 1940) were
effective as of a date within 90 days prior to the filing date of this
report, based on their evaluation of the effectiveness of the Registrant's
disclosure controls and procedures as of the Evaluation Date.
(b) There were no significant changes in the Registrant's internal control
over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act)
that occurred during the second fiscal quarter of the period covered by
this report that has materially affected, or is reasonably likely to
materially affect, the Registrant's internal control over financial
reporting.
ITEM 12. EXHIBITS.
(a)(1) Sox Code of Ethics is attached
(a)(2) Section 302 Certification letters are attached
(b) Proxy voting procedures and guidelines are attached.
(c) Section 906 Certifications are attached.
Pursuant to the requirements of the Exchange Act and the 1940 Act, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Lehman Brothers First Trust Income Opportunity Fund
By: /S/ Bradley Tank
--------------------------------------------------
Bradley Tank, President/Chief Executive Officer
Date: 3/07/06
Pursuant to the requirements of the Exchange Act and the 1940 Act, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /S/ Bradley Tank
----------------------------------------------------------------
Bradley Tank, President/Chief Executive Officer
Date: 03/07/06
4
By: /S/ Edward Grieb
----------------------------------------------------------------
Edward Grieb, Treasurer/Chief Financial Officer
Date: 3/09/06
N-CSR EXHIBIT FOR ITEM 8(a): PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT
INVESTMENT COMPANIES
PORTFOLIO MANAGER INFORMATION
Lehman Brothers Asset Management Inc. serves as investment adviser to the Fund,
with overall responsibility for overseeing the Fund's management. Lehman
Brothers Asset Management LLC ("LBAM LLC") serves as investment sub-adviser to
the Fund and has day-to-day responsibility for managing the Fund's portfolio of
investments. Information relating to the portfolio managers for the Fund is
presented below.
Ann H. Benjamin has served as lead portfolio manager for the Fund since its
inception. She is the managing director and chief investment officer of high
yield for LBAM LLC. She serves as the lead portfolio manager for all of LBAM
LLC's high yield strategy accounts. Ann H. Benjamin has been with LBAM LLC since
March 1, 1997.
Thomas P. O'Reilly has served as portfolio and credit analyst for the Fund since
its inception. He is a senior vice president and portfolio manager for LBAM LLC.
He serves as portfolio and credit analyst for all of LBAM LLC's high yield
strategy accounts. Thomas P. O'Reilly has been with LBAM LLC since July 1, 1997.
OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS AS OF 12/31/05
The table below contains information about other accounts managed by the Fund's
primary portfolio managers.
ANN H. BENJAMIN THOMAS P. O'REILLY
--------------- ------------------
REGISTERED INVESTMENT COMPANIES
Total Accounts Managed 5 5
Total Assets Managed $1.1 billion $1.1 billion
Accounts with Performance Fees None None
Assets with Performance Fees None None
OTHER POOLED INVESTMENT VEHICLES
Total Accounts Managed 3 3
Total Assets Managed $0.1 billion $0.1 billion
Accounts with Performance Fees None None
Assets with Performance Fees None None
5
OTHER ACCOUNTS
Total Accounts Managed 31 31
Total Assets Managed $3.8 billion $3.8 billion
Accounts with Performance Fees 1 1
Assets with Performance Fees $86 million $86 million
TOTAL ACCOUNTS MANAGED 39 39
TOTAL ASSETS MANAGED $5.1 billion $5.1 billion
The Fund's portfolio managers may manage other accounts with investment
strategies similar to those of the Fund, which may suggest the potential for
conflicts of interest. LBAM LLC may charge varying fees to different accounts
managed by the portfolio managers. The Fund's portfolio managers may participate
personally in some pooled accounts, including the Fund. LBAM LCC may manage
accounts with variable fees based on performance. Theoretically, these features
could create an incentive for a portfolio manager to favor the higher or
variable fee accounts, or accounts in which he or she participates, which may
not include the Fund. However, the Fund does not anticipate that management by a
Fund portfolio manager of other accounts with a similar investment strategy
would conflict with the management of the Fund. LBAM LLC has a fundamental
policy to bundle trades for all accounts managed, which LBAM LLC believes
promotes best execution. LBAM LLC dedicates high yield trading personnel to
focus on purchasing bonds within the levels established by the portfolio
managers. LBAM LLC observes the following practices and policies as part of its
trading strategies: 1) adherence to the requirement that best execution is the
sole criterion for evaluating trades; 2) policies and procedures requiring fair
treatment of all clients; 3) professional conduct requirements mandating the
primacy of the best interests of clients; 4) a policy against directing soft
dollar credits to individual brokers on behalf of individual clients; 5) trading
positions for all portfolios or accounts together; 6) seeking competitive bids
for purchases and sales, to the extent possible; and 7) close attention to the
orderly handling of cash flows. LBAM LLC manages its various portfolios and
accounts without regard to management fees.
PORTFOLIO MANAGER COMPENSATION
All portfolio managers are employed and compensated by LBAM LLC, the investment
sub-adviser for the Fund. LBAM LLC evaluates the performance of portfolio
managers in light of LBAM LLC's success in meeting its clients stated goals and
objectives (i.e. the performance of a client's portfolio; while fees for most of
the high yield portfolios or accounts LBAM LLC manages are not based on
performance, the performance of a portfolio or account is relevant to the
portfolio manager's compensation). Based on this performance evaluation, each
portfolio manager earns annual compensation comprised of a salary and bonus. A
portion of bonuses may be paid through the Lehman Brothers Stock Award Program,
which includes restricted stock units or options with specific terms on vesting
and forfeiture.
In addition to the annual compensation and Lehman equity, a portfolio manager's
success is tied to the company's success through participation in the company's
Incentive Payment Pool (IPP). The IPP will be valued at a fixed multiple of
future earnings. Payouts will begin in 2007 and extend through 2009.
PORTFOLIO MANAGER BENEFICIAL OWNERSHIP OF SHARES OF THE FUND AS OF 12/31/05
NAME OF PORTFOLIO MANAGER DOLLAR RANGE OF SHARES IN THE FUND
------------------------- ----------------------------------
Ann H. Benjamin $50,001 to $100,000
Thomas P. O'Reilly $10,001 to $50,000
6