Jefferies Financial Group Inc. annual report, FY2010

Business context and reporting period

This is Leucadia National Corporation’s Form 10-K for the fiscal year ended December 31, 2010, not a Jefferies Financial Group filing or a standalone fourth-quarter report. Leucadia was a diversified holding company with operating businesses, investments, and a roughly 28% stake in Jefferies. Its results combine operating performance with investment valuation changes and gains on asset sales.

Financial results and liquidity

Cash and investments included $3.025 billion management considered available to meet Parent liquidity needs; $1.514 billion was pledged, restricted, non-public, or otherwise unavailable for those needs. Indebtedness, including current maturities, was reported as $2.092 billion; this includes $401.1 million of repurchase agreements. Balance-sheet debt was $1.691 billion, excluding those repos. Parent long-term debt principal outstanding was $1.552 billion. Contractual cash obligations totaled $2.878 billion, including estimated interest.

Leucadia reported a $1.157 billion deferred tax benefit from reversing part of its valuation allowance, the principal driver of the unusually high 2010 net income. The net deferred tax asset was $1.176 billion at year-end, supported by approximately $5.400 billion of federal NOL carryforwards. Consolidated operating margins are not a useful standalone measure given the company’s diverse businesses and substantial investment-related income.

Material changes versus 2009

• Net income attributable to common shareholders rose to $1.939 billion from $550.3 million, substantially reflecting the tax valuation allowance reversal and investment-related gains; the reported increase should not be read as equivalent growth in recurring operating earnings.
• 2010 corporate results included a $383.4 million gain on selling the remaining Las Cruces interest, $179.5 million in net securities gains, and a $143.3 million unrealized gain on Jefferies shares. Jefferies’s year-end fair value was $1.314 billion.
• Leucadia sold its AmeriCredit shares for $830.6 million cash consideration, sold its remaining Las Cruces interest for $150 million cash plus Inmet shares, and divested LPH, ResortQuest, and STi Prepaid. The Inmet shares held at year-end were valued at $862.5 million.
• Operating cash flow improved by $564.7 million year over year, reflecting, among other items, the AmeriCredit sale proceeds, Fortescue interest receipts, and increased distributions from associated companies. Investing activities used $208.7 million; financing activities provided $64.7 million.
• Cash dividends of $0.25 per share were paid in 2010; none were paid in 2009.

Outlook, commentary, risks, and unusual items

• No consolidated earnings or revenue guidance was provided. Management said future acquisitions, divestitures, investments, and changes in the business mix are possible, and noted results and cash flows may be irregular due to transaction timing.
• Management described modest improvement in some businesses but continued pressure from weak housing and real estate markets, low natural-gas prices and rig oversupply, competitive conditions, and higher raw-material costs. Keen reported a $13.9 million pretax loss; domestic real estate lost $54.9 million before tax.
• Leucadia recorded a $47.1 million 2010 impairment on its Myrtle Beach property, in addition to a $67.8 million 2009 impairment. The property was acquired through foreclosure in January 2011 for $19.3 million; release of $81.2 million of remaining loan liability was expected to be recognized as income in first-quarter 2011.
• Leucadia is litigating Fortescue’s claim that additional notes could dilute interest on the $100 million FMG note. An adverse outcome could materially reduce future note cash flows. The company also noted volatility in its large Fortescue, Inmet, and Jefferies positions.
• The STi Prepaid buyer stopped scheduled payments and sought deferral; $17.8 million remained due. Leucadia said future recoveries would be recognized when received.
• Premier recorded an $11.2 million charge, including interest, for a bankruptcy-court award to former bondholders; its appeal was pending. Hurricane exposure remains, with named-storm coverage sublimited to $100 million and a $5 million deductible.
• Sangart’s trauma-patient trial supported a larger Phase II study that could begin in the first half of 2011, but further trials and substantial funding would be required before possible approval or revenue. Leucadia expected to fund Sangart through 2011 but had no obligation to do so.
• Management reported effective disclosure controls and internal control over financial reporting. The independent auditor gave an unqualified opinion on the consolidated financial statements and internal controls.

Important facts for investors to verify

• Confirm the filing identity and period: the supplied filing is Leucadia’s 2010 annual report, despite the request metadata naming Jefferies and 2010 Q4.
• Separate recurring business performance from the $1.157 billion tax benefit, asset-sale gains, market-value gains, and other one-off items; review the deferred-tax asset assumptions and NOL availability.
• Reconcile reported indebtedness with balance-sheet debt and repurchase agreements, and assess the Parent’s usable liquidity against maturities and contractual obligations.
• Track the Fortescue note litigation, Inmet merger and trading restrictions, STi buyer payments, and the realized proceeds and subsequent value of major investments.
• Assess segment-level operating trends and downside risks, particularly real estate, Keen, Sangart, and Premier’s litigation and catastrophe exposure.