Jefferies Financial Group Inc. quarterly report, Q3 FY2011

Business context and reporting period

This is Leucadia National Corporation’s Form 10-Q for the quarter and nine months ended September 30, 2011. The supplied filing is for Leucadia, not Jefferies Financial Group; Leucadia reported Jefferies as an associated-company investment and owned approximately 28% of Jefferies at quarter-end. Unless noted otherwise, amounts below are in millions of dollars.

Key financial results and position

• Nine-month operating cash flow was $23.0, versus $45.9 in 2010; investing activities used $112.8 and financing activities used $45.3. Cash declined to $306.3 from $441.3 at December 31, 2010.
• At September 30, total assets were $8,215.1, total liabilities $2,186.7, and total equity $6,028.4. Current assets were $1,419.4 and current liabilities $659.3.
• Long-term debt was $1,471.3; debt due within one year was $1.1. Repurchase-agreement liabilities were $500.0, generally maturing through November 2011 and collateralized by investments.
• Management identified $2,608.0 of available liquidity, excluding $768.2 of investments considered unavailable because of collateral, restrictions, non-public status, or subsidiary limitations. This is management’s liquidity measure, not cash alone.
• Net deferred tax assets were $1,686.1. Leucadia said approximately $4.0 billion of future U.S. pre-tax income would be needed to realize the net deferred tax asset fully.

Material changes versus the prior comparable period

• Results swung to losses, principally reflecting fair-value losses on associated-company investments. The nine-month pre-tax loss from associated companies was $728.4, compared with income of $145.9 in 2010; Jefferies accounted for a reported $751.3 loss for the 2011 period, including unrealized fair-value losses.
• Revenue and other income increased, but comparisons were significantly affected by portfolio activity and unusual gains. Nine-month 2011 included $527.4 of gains on Fortescue share sales and an $81.8 gain from forgiveness of Myrtle Beach project debt.
• Accumulated other comprehensive income fell to $824.2 from $1,687.4, primarily as net unrealized investment gains declined. Leucadia reported a $864.3 after-tax reduction in unrealized investment gains during the nine months.
• Cash from operations decreased year over year, while investment activity included $408.6 invested in Mueller, $150.2 in Jefferies, and the $86.0 Seghesio winery acquisition. Fortescue share sales generated $609.2 in net proceeds.

Outlook, commentary, risks, and unusual items

• No numerical consolidated earnings or revenue guidance is provided. Management warned that interim results are not necessarily indicative of full-year results and that market volatility can materially affect securities values, equity, and earnings.
• Leucadia said weaker economic conditions could pressure its operating businesses, including housing-sensitive manufacturing and real estate. It cited risks from housing and commercial property markets, commodity and raw-material prices, drilling activity, consumer spending, and capital-market liquidity.
• Litigation with Fortescue and FMG concerns whether additional notes could dilute Leucadia’s contractual 4% interest in specified iron-ore revenue. An adverse outcome could materially reduce future cash flows and results; future interest receipts also depend on production volumes and prices.
• Leucadia’s approximately 27.5% Mueller stake was subject to a standstill agreement through September 2013 that restricts certain sales and further acquisitions. The filing added this as a risk because it may limit rapid access to liquidity.
• The large deferred tax asset depends on uncertain future taxable income and investment gains; management said further valuation-allowance adjustments are possible. Other notable items include the Myrtle Beach debt-forgiveness gain, Fortescue sale gains, and share-based compensation related to executive warrants.
• Management stated that current litigation was not expected to materially adversely affect consolidated financial position, results, or liquidity, while acknowledging that payments above recorded reserves could be significant to a period’s results. The accrual for contingent losses was not significant.

Important facts for investors to verify

1. Confirm the filing identity: this is Leucadia National Corporation’s 10-Q, not a Jefferies standalone filing; separately assess Jefferies’ own reported results and the timing and basis of Leucadia’s investment valuation.
2. Review the drivers and measurement of the $751.3 nine-month Jefferies-associated loss and the resulting sensitivity of Leucadia’s earnings and equity to market prices.
3. Assess the liquidity calculation, including which securities are pledged, restricted, or otherwise unavailable, and the near-term maturity profile of repurchase agreements and debt.
4. Monitor the Fortescue/FM G litigation, contractual interest receipts, and the potential effect of any dilution on future cash flows.
5. Evaluate the assumptions supporting realization of the $1,686.1 deferred tax asset, including the stated need for approximately $4.0 billion of future U.S. pre-tax income.