Jefferies Financial Group Inc. annual report, FY2015

Business context and reporting period

Leucadia National Corporation (now Jefferies Financial Group Inc.) filed this Form 10-K for the fiscal year ended December 31, 2015. It is a diversified holding company; Jefferies, its wholly owned investment-banking and capital-markets business, is its largest investment. Results reflect a broad portfolio spanning financial services, beef processing, manufacturing, energy, real estate, and other investments. Jefferies reports on a November 30 fiscal year and is consolidated with a one-month lag.

Financial results and key metrics

Net revenue declined about 5.2%; pre-tax income fell about 6.5%, while common-shareholder net income rose about 36.9%. Income from continuing operations before tax was approximately 3.3% of net revenues. Cash and cash equivalents were $3.639 billion at year-end, down from $4.277 billion. Leucadia reported $613.8 million of available parent-company liquidity against a stated minimum liquidity reserve of $426.1 million. Parent-company debt was approximately $988.6 million; consolidated debt includes substantial subsidiary and financial-services borrowings.

Jefferies generated $2.476 billion of net revenues and $119.2 million of pre-tax income, versus $2.986 billion and $358.4 million in 2014. National Beef generated $7.402 billion of revenue and a $123.9 million pre-tax loss, versus $7.832 billion and a $40.3 million loss. Other financial-services businesses and investments reported $504.8 million of pre-tax income, including the FXCM-related gain described below.

Material changes versus the prior period

• Jefferies fixed-income revenue fell sharply amid weak liquidity, market volatility, energy-sector deterioration, and distressed-market losses. Its equities revenue increased, and investment banking revenue was $1.439 billion, down from $1.527 billion; record advisory and equity-capital-markets revenue partly offset weaker debt-capital-markets results.
• National Beef’s revenue fell about 5%, reflecting lower cattle processing volumes and lower average selling prices. Lower volumes and tighter margins contributed to a larger pre-tax loss.
• Leucadia recorded $491.3 million of realized and unrealized gains, interest income, and fees associated with its FXCM investment. The investment was valued at $625.7 million at year-end, including a $192.7 million loan balance; the valuation is Level 3 and depends materially on assumptions.
• Operating cash use narrowed from 2014, but remained substantial. The filing attributes cash-flow variability to trading-balance movements, investment activity, distributions, and the mix of businesses.
• Year-end assets declined by $6.3 billion, partly reflecting changes in Jefferies financial instruments and segregated regulatory cash. Long-term debt declined by $1.1 billion, including repayment of Leucadia’s $458.6 million 8.125% notes at maturity.

Outlook, risks, contingencies, and unusual items

• Management provides no specific earnings or revenue guidance. It cautions that the portfolio’s results are not predictable from period to period and that business mix may change through acquisitions and dispositions.
• Jefferies substantially exited its Bache futures business in 2015, transferring client accounts to Société Générale and other brokers. Exit costs were $73.1 million pre-tax, including $28.7 million of non-cash costs; approximately $3.1 million of further exit costs were expected in 2016.
• National Beef’s results are exposed to cattle prices, beef spreads, volumes, seasonality, disease, food-safety events, export conditions, environmental compliance, and union labor. Its 2015 results included $52.9 million of revenue reductions associated with hedging derivatives and a $4.7 million impairment related to its closed Brawley facility.
• Other unusual items included a $40.7 million WilTel pension settlement charge, partly offset by a $20.1 million insurance recovery of previously expensed legal fees, and $20.3 million of oil-and-gas asset impairment at Juneau Energy.
• Leucadia’s $1.575 billion net deferred tax asset and approximately $1.6 billion of consolidated federal net operating losses depend on future taxable income and remain subject to utilization limits and uncertainty.
• Contingencies include a settlement in the Sykes consumer-debt litigation submitted for preliminary court approval, and a guarantee to reimburse Berkshire Hathaway for up to half of losses under a $2.5 billion Berkadia commercial-paper support arrangement; $2.47 billion was outstanding. Management stated it did not believe current litigation would materially adversely affect consolidated financial position, results, or liquidity.
• Principal risks include market and trading losses, funding and liquidity stress, ratings downgrades, regulatory change, operational and cyber incidents, counterparty credit risk, valuation uncertainty, and volatility in FXCM, HRG, oil-and-gas, and other investments. Jefferies’ year-end firmwide one-day 95% VaR was $7.73 million; the filing notes that VaR does not capture all potential losses.
• The board’s intended annual dividend rate was $0.25 per share, subject to board discretion. Leucadia repurchased 5.95 million shares for $125.8 million in 2015.

Important facts for investors to verify

• Review the FXCM valuation methodology, rights to future distributions, payment and restructuring discussions, and sensitivity to FXCM’s share price, volatility, and time to a liquidity event.
• Assess Jefferies’ ability to recover revenue and profitability after the fixed-income downturn and Bache exit, including remaining restructuring costs and upcoming debt maturities.
• Track National Beef’s cattle-to-beef margins, processing volumes, hedging results, and labor, food-safety, and environmental exposures.
• Reconcile operating cash use and the reported parent liquidity reserve with cash availability at regulated subsidiaries, contractual commitments, and debt maturities.
• Evaluate realization of the deferred tax asset and NOLs, and monitor the Berkadia commercial-paper guarantee and Sykes settlement approval and final resolution.