Jefferies Financial Group Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended May 31, 2019. Jefferies changed its fiscal year-end to November 30 in 2018; the 2018 comparison uses June 30 periods, and Jefferies Group’s prior-year results were reported with a one-month lag. Comparisons therefore are not fully aligned.
Business context and financial results
The company operates through Jefferies Group (capital markets and asset management), Merchant Banking and Corporate. Amounts below are in millions except per-share data.
| Metric | Q2 2019 | Comparable 2018 period | First half 2019 | Comparable 2018 period |
|---|---|---|---|---|
| Total revenues | $1,510.4 | $1,243.8 | $2,705.4 | $2,404.9 |
| Net revenues | $1,101.7 | $911.2 | $1,930.1 | $1,806.6 |
| Income from continuing operations before tax | $183.5 | $37.5 | $232.8 | $75.3 |
| Income from continuing operations | $672.3 | $27.9 | $719.3 | $114.1 |
| Net income attributable to common shareholders | $670.8 | $725.5 | $715.6 | $850.1 |
| Diluted EPS | $2.14 | $2.03 | $2.25 | $2.33 |
Q2 net revenues rose about 21%, while pretax income from continuing operations increased to $183.5 million. Reported continuing-operations income includes a nonrecurring $544.6 million tax benefit from selling the remaining available-for-sale securities portfolio; management said the benefit shifted amounts between retained earnings and accumulated other comprehensive income and did not increase total equity. The prior-year net income comparison includes National Beef discontinued-operation income and a $643.9 million after-tax disposal gain.
Key metrics, liquidity and balance sheet
- Revenue mix: Q2 principal transactions revenue was $240.2 million versus $53.8 million; investment banking revenue was $430.1 million versus $500.3 million. First-half investment banking revenue fell to $715.7 million from $940.3 million.
- Expenses: Q2 expenses were $940.3 million versus $907.0 million. Compensation was 53.0% of net revenues, compared with 54.0% a year earlier. First-half expenses were $1,746.8 million versus $1,796.8 million.
- Cash flow: First-half operating activities used $1,440.4 million; investing activities provided $1,202.8 million and financing activities provided $167.8 million. Cash, cash equivalents and restricted cash ended at $5,939.0 million, down $73.7 million from the beginning of the period.
- Balance sheet at May 31: Assets were $48,523.9 million, liabilities $38,502.6 million and total equity $9,877.4 million. Cash and cash equivalents were $5,393.7 million.
- Debt: Short-term borrowings were $510.4 million and long-term debt $7,861.0 million. Parent-company debt was approximately $990.7 million. Jefferies Group’s $644.8 million principal amount of 8.5% notes matured in July 2019.
- Liquidity and capital: Parent-level readily convertible cash and investments totaled $1,327.4 million, above the stated $562.6 million minimum reserve target. Jefferies Group reported $5,701.0 million in cash and other liquidity sources and $1,290.1 million of excess regulatory net capital.
- Capital returns: The company repurchased 17.35 million shares for $344.5 million in the first half and paid $74.6 million in dividends. $155.5 million remained under the then-current repurchase authorization at May 31.
Material changes and management commentary
- Jefferies Group’s Q2 net revenues rose to $901.9 million from $822.6 million. Equities and fixed income improved with greater activity and better market conditions; investment banking declined, with lower capital-markets and advisory revenue.
- First-half investment banking was affected by the December market downturn and five-week U.S. government shutdown, which dampened issuance activity; management also cited a lagged effect on Q2 advisory results.
- Merchant Banking reported Q2 pretax income of $51.2 million, versus a $50.1 million loss. Results included $34.9 million of National Beef equity-method income and an $11.3 million mark-to-market decline in Spectrum Brands. First-half Merchant Banking pretax income was $71.3 million.
- On July 1, 2019, after quarter-end, Jefferies completed its merger with HomeFed, issued 9.3 million common shares and authorized repurchases of 9.25 million shares to offset the issuance.
- No quantified earnings or revenue guidance is provided in the filing. Management emphasizes that Jefferies Group revenues are inherently variable and sensitive to financial markets, economic conditions and its positions.
Risks, contingencies and unusual items
- Market, credit, liquidity, operational, legal and regulatory risks are inherent in the businesses. Jefferies Group reported average daily VaR of $8.70 million in Q2; no daily trading loss exceeded its 95% one-day VaR estimate during the quarter. VaR has stated modeling limitations and does not capture all stress or tail risks.
- A downgrade below investment grade could trigger collateral demands. The filing estimates up to $119.5 million of additional collateral under specified agreements; separate derivative provisions indicate $59.9 million of return/additional collateral in the event of a downgrade.
- The company reported $8,055.2 million of maximum commitments, including substantial forward-starting repos and reverse repos. It also disclosed legal and regulatory matters that management did not expect to materially affect consolidated financial position or liquidity, while payments could significantly affect results in a period.
- Unrecognized tax benefits, including interest, totaled $260.0 million. Tax examinations are ongoing; resolution could materially affect earnings in the period resolved, though the company did not expect a significant balance-sheet effect.
- Jefferies Group’s next scheduled debt maturity was the $644.8 million 8.5% notes in July 2019. In July, the company announced a potential issuance of five-to-ten-year euro-denominated senior unsecured notes, subject to market conditions.
Important facts for investors to verify
- How much of reported earnings and EPS depends on the $544.6 million one-time tax benefit, versus recurring operating performance.
- Whether the improvement in trading revenues and markets persists, and how investment banking issuance and advisory activity develop.
- Refinancing or repayment of the July 2019 notes and any subsequent euro-note issuance, including its terms and effect on funding costs.
- The financial and share-count effects of the HomeFed merger and the authorized offsetting repurchases.
- Exposure to market-sensitive and less-liquid investments, including Spectrum Brands, WeWork, FXCM and Level 3 fair-value assets, as well as the potential impact of commitments and contingencies.