Jefferies Financial Group Inc. (then Leucadia National Corporation) — 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2013. The filing is by Leucadia National Corporation, which acquired Jefferies Group LLC on March 1, 2013. Jefferies is consolidated from the acquisition date using a one-month reporting lag; reported comparisons with 2012 therefore do not represent equivalent businesses.
Financial results and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net revenues | $2.705 billion (2012: $1.746 billion) | $5.032 billion (2012: $4.505 billion) |
| Net income attributable to common shareholders | $52.6 million (2012: loss of $197.3 million) | $357.7 million (2012: $293.6 million) |
| Basic EPS | $0.14 (2012: loss of $0.81) | $1.12 (2012: $1.20) |
| Operating cash flow | $447.5 million for the six months (2012: $63.2 million) |
- At June 30, total assets were $46.18 billion, total liabilities $35.81 billion, and total equity $10.03 billion. Cash and cash equivalents were $3.55 billion; long-term debt was $7.56 billion.
- Management reported $2.62 billion of available corporate liquidity. Of approximately $6.2 billion in cash and available-for-sale securities, about $3.6 billion was pledged, held by subsidiaries with debt, or otherwise restricted.
- Jefferies’ second-quarter segment results: net revenues of $651.5 million and pretax income of $77.6 million. Compensation was 57.4% of net revenues.
- Cash from investing activities was $3.76 billion, including $3.02 billion of cash acquired with Jefferies. Financing activities used $792.8 million.
Material changes and business drivers
- The acquisition substantially expanded the balance sheet and added investment banking and capital markets operations. Leucadia issued approximately 119.4 million common shares and $125 million of mandatorily redeemable convertible preferred shares; preliminary purchase accounting recorded $1.70 billion of Jefferies goodwill.
- Reported revenue and earnings comparisons are materially affected by the acquisition. On an unaudited pro forma basis assuming Jefferies was acquired January 1, 2012, second-quarter 2013 net revenues were $2.705 billion and common-shareholder net income was $56.6 million, versus $2.814 billion and $78.9 million in 2012. Pro forma six-month net income was $253.6 million versus $376.0 million.
- Jefferies described stronger core equity trading and investment banking, offset by a slowdown in fixed income activity early in the quarter and inventory write-downs amid market volatility. Its investment banking activity included 138 debt financings totaling $54.4 billion and 38 public equity financings totaling $8.4 billion.
- National Beef revenue was broadly unchanged, but higher cattle costs and lower processed volume reduced profitability. Pretax income was $27.3 million in the quarter versus $46.9 million; first-half pretax income was $6.8 million versus $29.3 million.
- Reported first-half security gains were $239.4 million, including a $227.6 million gain on exchanging Inmet shares for First Quantum shares and cash. First-half 2012 security gains were $427.5 million, including a $417.9 million Fortescue share-sale gain.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided. Management stated an intention to continue dividends at an annual rate of $0.25 per share, paid quarterly; the board declared a $0.0625 dividend payable September 27, 2013, subject to board discretion and applicable restrictions.
- Jefferies’ business and results are sensitive to market activity, interest rates, credit spreads, equity and commodity prices, client flows, funding access, and credit ratings. Management reported sufficient excess liquidity under its stress scenarios; approximately 72% of Jefferies trading assets were readily financeable at haircuts of 10% or less.
- Jefferies had $6.1 billion of long-term debt, excluding $75 million outstanding under a revolving facility; its next scheduled note maturity was $250 million in June 2014. Jefferies reported compliance with its credit-facility covenants. A downgrade below investment grade could trigger additional collateral demands; management estimated $88.4 million of potential additional collateral under relevant arrangements.
- Key exposures include fair-value estimation and Level 3 assets, counterparty and market risk, regulatory capital constraints, litigation, and the recoverability of deferred tax assets. The company said approximately $4.6 billion of future U.S. pretax income, in addition to reversal of certain deferred tax liabilities, would be needed to realize its net deferred tax asset.
- Seven lawsuits challenge the Jefferies merger; defendants moved to dismiss, and the company could not estimate a reasonably possible loss. A separate consumer class action has a recorded $20 million reserve; the company received permission to appeal class certification.
- Other notable items: $14.8 million of Berkadia income in the quarter related to prior periods; a $12.3 million state deferred-tax-asset reserve charge was recorded in the first half; and the $197 million Crimson Wine Group spin-off was recorded as a distribution to shareholders. Acquisition-related costs were $15.6 million for the first half.
- Sangart’s Phase 2 MP4OX trial did not meet its primary efficacy goal. Further trials would require substantial funding, and the company is not committed to provide it. National Beef is seeking replacement business after Walmart discontinued its case-ready business; full replacement of related cash flow is uncertain.
Most important facts for investors to verify
- Use pro forma results, not reported year-over-year growth alone, to assess the post-acquisition earnings trend.
- Review Jefferies’ revenue mix, compensation ratio, fixed-income inventory marks, liquidity and funding profile, debt maturities, and collateral sensitivity to ratings changes.
- Assess how much of reported earnings reflects investment gains, tax effects, and the Berkadia prior-period adjustment versus recurring operating performance.
- Track progress on replacing National Beef’s lost case-ready business, Sangart’s funding and trial plans, and the outcomes of the disclosed litigation.
- Monitor deferred-tax-asset realizability, acquisition purchase-accounting estimates, and the company’s stated liquidity and leverage principles.