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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER: 1-11665
JEFFERIES GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 95-2848406
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
11100 SANTA MONICA BOULEVARD, 11TH FLOOR 90025
LOS ANGELES, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(310) 445-1199
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE (TITLE OF CLASS)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K, or any amendment to
this Form 10-K. [ ]
State the aggregate market value of the common stock held by nonaffiliates
of the registrant. $809,846,676 as of March 8, 1999.
Indicate the number of shares outstanding of the registrant's class of
common stock, as of the latest practical date. 23,961,913 shares as of the close
of business March 8, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
See list on following page.
LOCATION OF EXHIBIT INDEX
The index of exhibits is contained in Part IV herein on page 54.
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JEFFERIES GROUP, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
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PAGE
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Item 1. Business.................................................... 1
Item 2. Properties.................................................. 6
Item 3. Legal Proceedings........................................... 7
Item 4. Submission of Matters to a Vote of Security Holders......... 7
PART II
Market for the Registrant's Common Stock and Related
Item 5. Security Holder Matters..................................... 8
Item 6. Selected Financial Data..................................... 9
Management's Discussion and Analysis of Financial Condition
Item 7. and Results of Operations................................... 10
Item 8. Financial Statements and Supplementary Data................. 19
Item 9. Disagreements on Accounting and Financial Disclosure........ 46
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 46
Item 11. Executive Compensation...................................... 48
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................. 51
Item 13. Certain Relationships and Related Transactions.............. 54
PART IV
Exhibits, Financial Statements, Schedules and Reports on
Item 14. Form 8-K.................................................... 54
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Exhibit Index located on page 54 of this report.
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PART I
ITEM 1. BUSINESS.
Jefferies Group, Inc. is a holding company which, through its four primary
subsidiaries, Jefferies & Company, Inc. ("JEFCO"), Investment Technology Group,
Inc. ("ITGI"), Jefferies International Limited and Jefferies Pacific Limited, is
engaged in securities brokerage and trading, corporate finance and other
financial services. The term "Company" refers, unless the context requires
otherwise, to Jefferies Group, Inc., its subsidiaries, predecessor entities, and
W & D Securities, Inc. The Company was originally incorporated in 1973 as a
holding company for JEFCO and was reincorporated in Delaware on August 10, 1983.
The Company and its various subsidiaries maintain offices in Los Angeles, New
York, Short Hills, Jersey City, Chicago, Dallas, Boston, Atlanta, New Orleans,
Houston, San Francisco, Stamford, London, Hong Kong, Zurich and Tokyo.
As of December 31, 1998, the Company and its subsidiaries had 1,155
full-time employees, including 542 representatives registered with NASD
Regulation, Inc. ("NASDR"). The Company's executive offices are located at 11100
Santa Monica Boulevard, Los Angeles, California 90025, and its telephone number
is (310) 445-1199.
PROPOSED TRANSFERS, SPIN-OFF AND ITGI MERGER TRANSACTIONS
Transfers and Spin-Off. In March 1998, the Company announced an intention
to engage in a series of transactions designed to separate ITGI from the other
Company businesses. This separation would be achieved through the transfer of
all the Company's assets, except for the Company's approximately 80.5% interest
in the outstanding capital stock of ITGI, and all of the Company's liabilities,
other than liabilities of or related to ITGI (the "Transfers"), to a
wholly-owned Company subsidiary, JEF Holding Company, Inc. ("New JEF") or to
JEFCO, which will become a subsidiary of New JEF in connection with the
Transfers. Following the Transfers, the aforementioned separation would be
completed by means of a pro rata distribution to the Company's stockholders of
100% of the outstanding shares of common stock of New JEF (the "Spin-Off").
Completion of the Transfers is subject to the satisfaction of numerous
conditions precedent to the Spin-Off, including ITGI's payment of a special
$4.00 per share cash dividend to all of its stockholders (including the
Company), Company and ITGI stockholder approval of the ITGI Merger (as defined
below), and other conditions related to the Spin-Off and the ITGI Merger.
ITGI Merger. Following the Transfers and Spin-Off, ITGI will merge with and
into the Company (the "ITGI Merger") resulting in the issuance of shares of the
Company's common stock to the public, non-Company stockholders of ITGI (the
"ITGI Public Stockholders") in accordance with an exchange ratio formula that
will result in ITGI Public Stockholders owning the same proportionate common
stock ownership of the surviving corporation that they held in ITGI prior to the
ITGI Merger. The ITGI Merger will result in the stockholders of the Company
becoming direct stockholders in ITGI and in the Company no longer being ITGI's
parent company. The ITGI Merger will result in Company stockholders, as a group,
directly owning the same proportionate ownership interest in the surviving
corporation that the Company held in ITGI prior to the ITGI Merger. The ITGI
Merger will be completed to eliminate public ownership redundancies that would
otherwise arise after the Spin-Off. The ITGI Merger is necessary in order to
effectuate the desire to have only one publicly traded entity that owns the ITGI
business after the Spin-Off.
Name Changes Related to Spin-Off and ITGI Merger. In connection with the
ITGI Merger, the Company will be renamed Investment Technology Group, Inc. and
New JEF will change its name to Jefferies Group, Inc. New JEF common stock will
be publicly traded on the New York Stock Exchange ("NYSE") under the symbol
"JEF." ITGI has applied for the listing of the New ITGI common stock (following
the ITGI Merger) on the NYSE.
On March 12, 1999, Group received tax rulings from the Internal Revenue
Service (the "IRS") with the concurrence of the IRS concerning the tax-free
treatment of the Transfers and the Spin-Off for Group and its stockholders,
respectively. On March 17, 1999, Group's Board of Directors unanimously approved
the Transfers and the Spin-Off.
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The Company anticipates that the Transfers, the Spin-Off and the Merger
will be completed in the second quarter 1999, assuming all of the conditions to
the consummation of these transactions have been met.
SUBSIDIARIES OF THE COMPANY PRIOR TO THE TRANSFERS, THE SPIN-OFF AND THE MERGER
Jefferies & Company, Inc. JEFCO was founded in 1962 and is engaged in
equity, convertible debt and taxable fixed income securities brokerage and
trading and corporate finance. JEFCO is one of the leading national firms
engaged in the distribution and trading of blocks of equity securities both on
the national securities exchanges and in the "third market." The term "third
market" refers to transactions in listed equity securities effected away from
national securities exchanges. JEFCO's revenues are derived primarily from
commission revenues and market making or trading as principal in equity, taxable
fixed income and convertible securities with or on behalf of institutional
investors, with the balance generated by corporate finance and other activities.
JEFCO currently provides equity research in the areas of energy, communication
technologies, consumer, real estate (including real estate investment trusts or
"REITS"), gaming and entertainment, business services, and financial services.
Investment Technology Group, Inc. ITGI is a holding company which is
publicly traded (Nasdaq: ITGI) and is approximately 80.5% owned by Jefferies
Group, Inc. Its wholly owned subsidiary, ITG Inc. ("ITG"), provides automated
equity trading services and transaction research to institutional investors and
brokers. ITG is a full service execution firm that uses technology to increase
the effectiveness and lower the cost of trading. With an emphasis on ongoing
research, ITG offers the following services: POSIT, an electronic stock crossing
system; QuantEX, a decision-support, trade management and routing system;
SmartServers, offers server based implementation of trading strategies;
Electronic Trading Desk, an agency-only trading desk offering clients efficient
trading services assessing multiple sources of liquidity; ITG Platform, a PC
based routing and trade management system; ISIS, a set of pre- and post-trade
tools for systematically analyzing and lowering transaction costs; ITG/Opt, a
computer-based equity portfolio selection system; and Research, research,
development, sales and consulting services to clients.
ITG generates revenues on a "per transaction" basis for all orders
executed. Orders are delivered from ITG's "front-end" software products, QuantEX
and ITG Platform, as well as vendors' front-ends and direct computer-to-computer
links to customers. Orders may be executed on POSIT, the NYSE, certain regional
exchanges, market makers, electronic communication networks and alternative
trading systems.
Jefferies International Limited and Jefferies Pacific Limited. Jefferies
International Limited ("JIL") was incorporated in 1986 in England. JIL is a
member of The International Stock Exchange and The Securities and Futures
Authority. JIL introduces customers trading in U.S. securities to JEFCO and also
trades as a broker-dealer in international equity and convertible securities and
American Depositary Receipts ("ADRs"). In 1995, JIL formed a wholly owned Swiss
subsidiary, Jefferies (Switzerland) Ltd. In 1996, JIL formed a wholly-owned
English subsidiary, Jefferies (Japan) Limited, which maintains a branch office
in Tokyo.
Jefferies Pacific Limited ("JPL"), a broker subsidiary of the Company, was
incorporated in 1992 in Hong Kong. JPL presently introduces foreign customers
trading in U.S. securities to JEFCO.
W & D Securities, Inc. W & D Securities, Inc. ("W & D") primarily provides
execution services on the NYSE and other exchanges to JEFCO and ITG. In order to
comply with regulatory requirements of the NYSE that generally prohibit NYSE
members and their affiliates from executing, as principal and, in certain cases,
as agent, transactions in NYSE-listed securities off the NYSE, the Company gave
up its formal legal control of W & D, effective January 1, 1983, by exchanging
all of the W & D common stock owned by it for non-voting preferred stock of W &
D. The common stock of W & D is presently held by an officer of W & D who has
agreed with the Company that, at the option of the Company, he will sell such
stock to the Company for nominal consideration. In the event that the Company
were to regain ownership of such common stock, the Company believes that the
NYSE would assert that W & D would be in violation of the NYSE's rules unless
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similar arrangements satisfactory to the NYSE were made with respect to the
ownership of the common stock.
While the NYSE has generally approved the above arrangements, there can be
no assurance that it will not raise objections in the future. In light of these
arrangements and the high proportion of the equity of W & D represented by the
non-voting preferred stock held by the Company, W & D is consolidated as a
subsidiary of the Company for financial statement purposes. The Company believes
that it can make satisfactory alternative arrangements for executing
transactions in listed securities on the NYSE if it were precluded from doing so
through W & D.
COMMISSION BUSINESS
A substantial portion of the Company's revenues is derived from customer
commissions on brokerage transactions in equity (primarily listed) and debt
securities for domestic and international investors such as investment advisors,
banks, mutual funds, insurance companies and pension and profit sharing plans.
These investors normally purchase and sell securities in block transactions, the
execution of which requires special marketing and trading expertise. JEFCO is
one of the leading national firms in the execution of equity block transactions,
and believes that its institutional customers are attracted by the quality of
its execution (with respect to considerations of quantity, timing and price) and
its competitive commission rates, which are negotiated on the basis of market
conditions, the size of the particular transaction and other factors. In
addition to domestic equity securities, the Company executes transactions in
taxable fixed income securities, domestic and international convertible
securities, international equity securities, ADRs, options, preferred stocks,
financial futures and other similar products.
All of JEFCO's equity account executives are electronically interconnected
through a system permitting simultaneous verbal and graphic communication of
trading and order information by all participants. JEFCO believes that its
execution capability is significantly enhanced by this system, which permits its
account executives to respond to each other and to negotiate order indications
directly with customers rather than through a separate trading department.
PRINCIPAL TRANSACTIONS
In the regular course of its business, JEFCO takes securities positions as
a market-maker to facilitate customer transactions and for investment purposes.
In making markets and when trading for its own account, JEFCO exposes its own
capital to the risk of fluctuations in market value. Trading profits (or losses)
depend primarily upon the skills of the employees engaged in market making and
position taking, the amount of capital allocated to positions in securities and
the general trend of prices in the securities markets.
JEFCO monitors its risk by maintaining its securities positions at or below
certain pre-established levels. These levels reduce certain opportunities to
realize profits in the event that the value of such securities increases.
However, they also reduce the risk of loss in the event of a decrease in such
value and result in controlled interest costs incurred on funds provided to
maintain such positions.
Equities. The Equities Division of JEFCO makes markets in over 600
over-the-counter equity and ADR securities, and trades securities for its own
account, as well as to facilitate customer transactions. The Equities and
International Divisions engage in hedged trading involving securities listed or
traded in both domestic and foreign markets.
Taxable Fixed Income. The Taxable Fixed Income Division of JEFCO trades
high grade and non-investment grade public and private debt securities. The
Division specializes in trading and making markets in over 300 unrated or less
than investment grade corporate debt securities and accounts for these positions
at market value. At December 31, 1998, the aggregate long and short market value
of these positions was $28.7 million and $8.3 million, respectively. Risk of
loss upon default by the borrower is significantly greater with respect to
unrated or less than investment grade corporate debt securities than with other
corporate debt securities. These securities are generally unsecured and are
often subordinated to other creditors of the issuer. These issuers usually have
high levels of indebtedness and are more sensitive to adverse economic
conditions,
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such as recession or increasing interest rates, than are investment grade
issuers. There is a limited market for some of these securities and market
quotes are generally available from a small number of dealers.
Convertible Securities and Warrants. JEFCO also trades domestic and
international convertible securities and warrants and assists corporate and
institutional clients in identifying attractive investments in these securities
and warrants.
Other Proprietary Trading. During 1998, JEFCO invested in
statistically-defined market-neutral strategies in the equities markets and in
merger-related arbitrage activities. Jefferies conducted these activities
through relationships with independent management firms pursuant to which the
Company delegated investment decisions to the managers. In addition, the Company
has investments in partnerships and mutual funds as well as other relationships
with independent management firms which contribute to revenues from principal
transactions.
CORPORATE FINANCE
JEFCO's Corporate Finance Division offers corporations (primarily middle
market growth companies) a full range of financial advisory service as well as
debt, equity, and convertible financing service. Products include acquisition
financing, bridge and senior loan financing, private placements and public
offerings of debt and equity securities, debt refinancings, restructuring,
merger and acquisition and exclusive sales advice, structured financings and
securitizations, consent and waiver solicitations, and company and bondholder
representations in corporate restructurings. Its research department covers 223
companies in 12 industries.
Investment banking activity involves both economic and regulatory risks. An
underwriter may incur losses if it is unable to sell the securities it is
committed to purchase or if it is forced to liquidate its commitments at less
than the agreed upon purchase price. In addition, under the Securities Act of
1933 and other laws and court decisions with respect to underwriters' liability
and limitations on indemnification of underwriters by issuers, an underwriter is
subject to substantial potential liability for material misstatements or
omissions in prospectuses and other communications with respect to underwritten
offerings. Further, underwriting commitments constitute a charge against net
capital and JEFCO's underwriting commitments may be limited by the requirement
that it must, at all times, be in compliance with the Uniform Net Capital Rule
15c3-1 of the Securities and Exchange Commission (the "Commission").
JEFCO intends to continue to pursue opportunities for its corporate
customers which may require it to finance and/or underwrite the issuance of
securities. Under circumstances where JEFCO is required to act as an underwriter
or to trade on a proprietary basis with its customers, JEFCO may assume greater
risk than would normally be assumed in certain other principal transactions.
INTEREST
JEFCO derives a substantial portion of its interest revenues, and incurs a
substantial portion of its interest expenses, in connection with its securities
borrowed/securities loaned activity. JEFCO also earns interest on its securities
portfolio, on its operating and segregated balances, on its margin lending
activity and on certain of its investments.
Securities Borrowed/Securities Loaned. In connection with both its trading
and brokerage activities, JEFCO borrows securities to cover short sales and to
complete transactions in which customers have failed to deliver securities by
the required settlement date, and lends securities to other brokers and dealers
for similar purposes. JEFCO has an active securities borrowed and lending
matched book business ("Matched Book"), in which JEFCO borrows securities from
one party and lends them to another party. When JEFCO borrows securities, JEFCO
provides cash to the lender as collateral, which is reflected in the Company's
financial statements as receivable from brokers and dealers. JEFCO earns
interest revenues on this cash collateral. Similarly, when JEFCO lends
securities to another party, that party provides cash to JEFCO as collateral,
which is reflected in the Company's financial statements as payable to brokers
and dealers. JEFCO pays interest expense on the cash collateral received from
the party borrowing the securities. A substantial portion of the JEFCO's
interest revenues and interest expense results from the Matched Book activity.
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Margin Lending. Customers' transactions are executed on either a cash or
margin basis. In a margin transaction, JEFCO extends credit to the customer,
collateralized by securities and cash in the customer's account, for a portion
of the purchase price, and receives income from interest charged on such
extensions of credit.
In permitting a customer to purchase securities on margin, JEFCO is subject
to the risk that a market decline could reduce the value of its collateral below
the amount of the customer's indebtedness and that the customer might otherwise
be unable to repay the indebtedness.
In addition to monitoring the creditworthiness of its customers, JEFCO also
considers the trading liquidity and volatility of the securities it accepts as
collateral for its margin loans. Trading liquidity and volatility may be
dependent, in part, upon the market on which the security is traded, the number
of outstanding shares of the issuer, events affecting the issuer and/or
securities markets in general, and whether or not there are any legal
restrictions on the sale of the securities. Certain types of securities have
historical trading patterns which may assist JEFCO in making its evaluation.
Historical trading patterns, however, may not be good indicators over relatively
short time periods or in markets which are affected by unusual or unexpected
developments. JEFCO considers all of these factors at the time it agrees to
extend credit to customers and continues to review its extensions of credit on
an ongoing basis.
The majority of JEFCO's margin loans are made to United States citizens or
to corporations which are domiciled in the United States. JEFCO may extend
credit to investors or corporations who are citizens of foreign countries or who
may reside outside the United States. JEFCO believes that should such foreign
investors default upon their loans and should the collateral for those loans be
insufficient to satisfy the investors' obligations, it may be more difficult to
collect such investors' outstanding indebtedness than would be the case if
investors were citizens or residents of the United States.
Although JEFCO attempts to minimize the risk associated with the extension
of credit in margin accounts, there is no assurance that the assumptions on
which JEFCO bases its decisions will be correct or that it is in a position to
predict factors or events which will have an adverse impact on any individual
customer or issuer, or the securities markets in general.
COMPETITION
All aspects of the business of the Company are intensely competitive. The
Company competes directly with numerous other brokers and dealers, investment
banking firms and banks. In addition to competition from firms currently in the
securities business, there has been increasing competition from others offering
financial services. These developments and others have resulted, and may
continue to result, in significant additional competition for the Company.
Member firms of the NYSE generally are prohibited from effecting
transactions when acting as principal and, in certain cases, as agents, in
listed equity securities off the NYSE, and therefore, unlike JEFCO, are
precluded from effecting such transactions in the third market. Such firms may
execute certain transactions in listed equity securities in the third market for
customers, although typically they do not do so. Since firms which the Company
regards as its major competitors in the execution of transactions in equity
securities for institutional investors are members of the NYSE, any removal of
these prohibitions could adversely affect the Company's business.
Competition in various aspects of the Company's business is also
potentially impacted by regulatory changes. For example, the Commission recently
adopted a comprehensive package of rules and rule amendments affecting the
regulation of alternative trading systems. Among other things, the rules package
requires alternative trading systems ("ATSs") to register with the Commission as
such under new Regulation ATS or as national securities exchanges. Since ATSs,
some of which are also electronic communications networks under other Commission
regulations and are linked to certain Nasdaq quotation and order transmission
and execution systems, compete with the Company in the execution of equity
securities, decisions by such systems (and their owners and sponsors) to
register as exchanges may affect the nature and extent of competition in the
execution of equity securities for institutional customers and may adversely
affect the Company's business. The Company
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cannot at this time predict the impact, if any, of these regulatory changes on
competition in the execution of transactions in equity securities for
institutional customers.
REGULATION
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The Commission is the federal
agency responsible for the administration of federal securities laws. In
addition, self-regulatory organizations, principally the NASDR and the
securities exchanges, are actively involved in the regulation of broker-dealers.
These self-regulatory organizations conduct periodic examinations of member
broker-dealers in accordance with rules they have adopted and amended from time
to time, subject to approval by the Commission. Securities firms are also
subject to regulation by state securities commissions in those states in which
they do business. JEFCO is registered as a broker-dealer in 50 states, the
District of Columbia and Puerto Rico. ITG is registered as a broker-dealer in 49
states and the District of Columbia. W & D is registered as a broker-dealer in 3
states.
Broker-dealers are subject to regulations which cover all aspects of the
securities business, including sales methods, trade practices among
broker-dealers, use and safekeeping of customers' funds and securities, capital
structure of securities firms, record-keeping and the conduct of directors,
officers and employees. Additional legislation, changes in rules promulgated by
the Commission and self-regulatory organizations, or changes in the
interpretation or enforcement of existing laws and rules, may directly affect
the mode of operation and profitability of broker-dealers. The Commission,
self-regulatory organizations and state securities commissions may conduct
administrative proceedings which can result in censure, fine, suspension,
expulsion of a broker-dealer, its officers or employees, or revocation of
broker-dealer licenses. The principal purpose of regulation and discipline of
broker-dealers is the protection of customers and the securities markets, rather
than protection of creditors and stockholders of broker-dealers.
As registered broker-dealers, JEFCO, ITG and W & D are required by law to
belong to the Securities Investor Protection Corporation ("SIPC"). In the event
of a member's insolvency, the SIPC fund provides protection for customer
accounts up to $500,000 per customer, with a limitation of $100,000 on claims
for cash balances.
Net Capital Requirements. Every U.S. registered broker-dealer doing
business with the public is subject to the Commission's Uniform Net Capital Rule
(the "Rule"), which specifies minimum net capital requirements. Jefferies Group,
Inc. is not a registered broker-dealer and is therefore not subject to the Rule;
however, its United States broker-dealer subsidiaries are subject thereto.
The Rule provides that a broker-dealer doing business with the public shall
not permit its aggregate indebtedness to exceed 15 times its adjusted net
capital (the "basic method") or, alternatively, that it not permit its adjusted
net capital to be less than 2% of its aggregate debit balances (primarily
receivables from customers and broker-dealers) computed in accordance with such
Rule (the "alternative method"). JEFCO, ITG and W & D use the alternative method
of calculation.
Compliance with applicable net capital rules could limit operations of
Jefferies or ITG, such as underwriting and trading activities, that require use
of significant amounts of capital, and may also restrict loans, advances,
dividends and other payments by JEFCO, ITG or W & D to the Company. As of
December 31, 1998, JEFCO's, ITG's and W & D's net capital was $217.4 million,
$72.0 million and $2.0 million, respectively, which exceeded minimum net capital
requirements by $213.4 million, $71.7 million and $1.8 million, respectively.
See note 16 of Notes to Consolidated Financial Statements.
ITEM 2. PROPERTIES.
The Company maintains sales offices in Los Angeles, New York, Short Hills,
Chicago, Dallas, Boston, Atlanta, New Orleans, Houston, San Francisco, Stamford,
London, Hong Kong, Zurich and Tokyo. In addition, the Company maintains
operations offices in Los Angeles and Jersey City. The Company leases all of its
office space which management believes is adequate for the Company's business.
For information
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concerning leasehold improvements and rental expense, see notes 1, 7 and 13 of
Notes to Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
In re Nasdaq Market-Makers Antitrust Litigation. In July 1994, antitrust
class actions were commenced against JEFCO and 33 other defendants in various
federal courts (the "Lawsuits"). Following the filing of the Lawsuits, the
Antitrust Division of the United States Department of Justice ("DOJ") and the
Commission commenced investigations into certain issues related to the
allegations of the Lawsuits. In August 1996, the DOJ entered into an antitrust
consent decree with 24 defendants who are market makers in Nasdaq stocks. JEFCO
was neither asked nor required to settle with the DOJ. Shortly after the DOJ
settlement, the Commission filed a Section 21(a) report against the National
Association of Securities Dealers, Inc. ("NASD"), criticizing various practices
by market makers and the NASD for failing to police adequately or discipline the
market makers for those practices. However, the Commission did not take any
action at that time against the market maker firms.
In October 1994, the Lawsuits were consolidated for discovery purposes in
the United States District Court for the Southern District of New York (the
"Court"). The consolidated complaint alleges that the defendants violated the
antitrust laws by conspiring to fix the spread paid by plaintiffs and class
members to trade in certain Nasdaq securities, by refusing to quote bids and
asks in so-called odd-eighths. The cases purport to be brought on behalf of all
persons who purchased or sold certain securities on the Nasdaq National Market
System during the period May 1, 1989 to May 27, 1994. The plaintiffs seek
damages in an unspecified amount.
In order to avoid the uncertainties of litigation, JEFCO entered into a
settlement agreement which received the preliminary approval of the Court on
October 15, 1997. The settlement received the final approval of the Court on
November 9, 1998. The amount of the settlement was previously provided for and
will not have a material adverse effect on JEFCO.
Income Taxes. The Company received a "30-day letter" proposing certain
adjustments which, if sustained, would result in a tax deficiency of
approximately $10.0 million plus interest. Substantially all of the proposed
adjustments relate to Investment Technology Group, Inc., the Company's 80.5%
owned subsidiary and include (i) the disallowance of deductions taken in
connection with the termination of certain compensation plans at the time of
Investment Technology Group's initial public offering in 1994 and (ii) the
disallowance of tax credits taken in connection with certain research and
development expenditures. The Company intends to vigorously contest the proposed
adjustments and believes that resolution of this matter will not have a material
adverse effect on the Company.
Other. Many aspects of the Company's business involve substantial risks of
liability. In the normal course of business, the Company and its subsidiaries
have been named as defendants or co-defendants in lawsuits involving primarily
claims for damages. The Company's management believes that pending litigation
will not have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS.
The Company's Common Stock began trading on the NYSE on March 15, 1996,
under the symbol JEF. Previously, the Common Stock traded in the Nasdaq National
Market System under the symbol JEFG. The following table sets forth for the
periods indicated, the range of high and low prices per share for the Common
Stock as reported by the NYSE. All price range and dividends per share
information has been restated to retroactively reflect the effect of the
two-for-one stock splits declared by the Board of Directors on November 19, 1997
and March 2, 1996.
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1998
First Quarter............................................ $56.88 $32.50
Second Quarter........................................... 59.50 40.00
Third Quarter............................................ 51.25 24.38
Fourth Quarter........................................... 50.88 16.56
1997
First Quarter............................................ $24.13 $19.38
Second Quarter........................................... 30.38 20.00
Third Quarter............................................ 38.16 26.63
Fourth Quarter........................................... 48.00 31.88
</TABLE>
There were approximately 327 holders of record of the Company's Common
Stock at December 31, 1998.
In 1988, the Company instituted a policy of paying regular quarterly cash
dividends. There are no restrictions on the Company's present ability to pay
dividends on Common Stock, other than the applicable provisions of the Delaware
General Corporation Law.
Dividends per Common Share (declared and paid):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
<S> <C> <C> <C> <C>
1998..................................... $.050 $.050 $.050 $.050
1997..................................... $.025 $.025 $.025 $.050
</TABLE>
8
<PAGE> 11
ITEM 6. SELECTED FINANCIAL DATA.
The selected data presented below as of and for each of the years in the
five-year period ended December 31, 1998, are derived from the consolidated
financial statements of Jefferies Group, Inc. and its subsidiaries, which
financial statements have been audited by KPMG LLP, independent auditors. Such
data should be read in connection with the consolidated financial statements
contained on pages 20 through 45. All share and per share information has been
restated to retroactively reflect the effect of the two-for-one stock splits
declared by the Board of Directors on November 19, 1997 and March 2, 1996.
Earnings per share information has been restated to retroactively reflect the
adoption of Statement of Financial Accounting Standards No. 128. Certain
reclassifications have been made to the prior period amounts to conform to the
current periods presentation. The selected data presented in this Item 6 reports
the financial condition, results of operations, cash flows and equity of the
Company without giving effect to the proposed Transfers, Spin-Off and ITGI
Merger. See Part I, Item 1. "Business -- Proposed Transfers, Spin-Off and Merger
Transactions."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
EARNINGS STATEMENT DATA
Revenues:
Commissions.................................. $ 395,211 $ 282,317 $ 222,048 $ 165,610 $ 144,208
Principal transactions....................... 174,240 177,214 143,912 97,954 67,013
Corporate finance............................ 126,651 228,640 97,870 72,003 39,818
Interest..................................... 90,799 70,740 47,803 65,792 51,223
Other........................................ 11,809 5,593 4,993 4,228 1,902
---------- ---------- ---------- ---------- ----------
Total revenues............................. 798,710 764,504 516,626 405,587 304,164
Interest expense............................... 75,178 61,466 37,852 54,365 41,626
---------- ---------- ---------- ---------- ----------
Revenues, net of interest expense.............. 723,532 703,038 478,774 351,222 262,538
---------- ---------- ---------- ---------- ----------
Non-interest expenses:
Compensation and benefits.................... 380,737 409,979 264,041 195,278 145,372
Floor brokerage and clearing fees............ 42,063 35,028 27,323 20,273 18,660
Communications............................... 67,851 55,959 35,177 24,960 20,997
Occupancy and equipment rental............... 19,931 21,238 17,207 15,993 14,271
Travel and promotional....................... 21,662 19,207 13,541 10,296 8,909
Software royalties........................... 15,252 9,853 8,805 5,987 5,028
Other........................................ 37,844 35,824 29,493 25,197 18,522
---------- ---------- ---------- ---------- ----------
Total non-interest expenses................ 585,340 587,088 395,587 297,984 231,759
---------- ---------- ---------- ---------- ----------
Operating income............................... 138,192 115,950 83,187 53,238 30,779
Other income:
Gain on initial public offering of Investment
Technology Group, Inc. .................... -- -- -- -- 8,257
---------- ---------- ---------- ---------- ----------
Earnings before income taxes and minority
interest..................................... 138,192 115,950 83,187 53,238 39,036
Income taxes................................... 60,533 47,677 35,438 21,911 17,568
---------- ---------- ---------- ---------- ----------
Earnings before minority interest.............. 77,659 68,273 47,749 31,327 21,468
Minority interest.............................. 7,977 4,706 4,189 2,798 1,244
---------- ---------- ---------- ---------- ----------
Net earnings................................. $ 69,682 $ 63,567 $ 43,560 $ 28,529 $ 20,224
========== ========== ========== ========== ==========
Earnings per share of Common Stock:
Basic earnings............................... $ 3.12 $ 2.95 $ 1.90 $ 1.23 $ 0.84
========== ========== ========== ========== ==========
Diluted earnings............................. $ 2.96 $ 2.80 $ 1.84 $ 1.19 $ 0.81
========== ========== ========== ========== ==========
Weighted average shares of Common Stock:
Basic........................................ 22,346 21,552 22,980 23,270 23,956
Diluted...................................... 22,954 22,349 23,410 23,922 24,756
SELECTED BALANCE SHEET DATA
Total assets................................... $2,683,640 $2,099,542 $1,568,087 $1,536,969 $1,557,348
Long-term debt................................. $ 149,387 $ 149,290 $ 52,987 $ 56,322 $ 59,570
Total stockholders' equity..................... $ 334,775 $ 242,756 $ 195,445 $ 186,261 $ 163,235
Book value per share of Common Stock........... $ 15.77 $ 11.97 $ 9.43 $ 8.28 $ 7.28
Shares outstanding............................. 21,230 20,286 20,726 22,514 22,420
</TABLE>
9
<PAGE> 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The discussion and analysis presented in this Item 7 reports the financial
condition and results of operations of the Company without giving effect to the
proposed Transfers, Spin-Off and ITGI Merger. See Part I, Item 1,
"Business -- Proposed Transfers, Spin-Off and Merger Transactions."
The Company's principal activities, securities brokerage and the trading of
and market making in securities, are highly competitive.
Total assets increased $584.1 million from $2,099.5 million at December 31,
1997 to $2,683.6 million at December 31, 1998. The increase is mostly due to a
$748.4 million increase in receivable from brokers and dealers related to
securities borrowed. The increase in securities borrowed is mostly a result of
an increase in payables to brokers and dealers (related to securities loaned).
Securities owned and securities sold, not yet purchased decreased $144.6 million
and $149.1 million, respectively, from December 31, 1997 to December 31, 1998,
largely due to the discontinuance of statistical arbitrage trading.
Total liabilities increased $492.1 million from $1,856.8 million at
December 31, 1997 to $2,348.9 million at December 31, 1998. The increase is
largely due to the before-mentioned increases in payable to brokers and dealers
and partially offset by the before-mentioned decrease in securities sold, not
yet purchased.
The earnings of the Company are subject to wide fluctuations since many
factors over which the Company has little or no control, particularly the
overall volume of trading and the volatility and general level of market prices,
may significantly affect its operations. The following provides a summary of
revenues by source for the past three years.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
% OF % OF % OF
TOTAL TOTAL TOTAL
AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES
-------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Commissions and principal
transactions:
Equities Division............... $261,664 33% $206,438 27% $164,078 32%
Investment Technology Group..... 201,392 25 131,502 17 107,240 21
International Division.......... 50,889 6 56,525 7 43,288 8
Taxable Fixed Income Division... 40,071 5 34,714 5 28,839 5
Convertible Division............ 13,011 2 9,336 1 8,132 2
Other Proprietary Trading....... 2,424 0 21,016 3 14,383 3
-------- --- -------- --- -------- ---
Total................... 569,451 71 459,531 60 365,960 71
-------- --- -------- --- -------- ---
Corporate Finance................. 126,651 16 228,640 30 97,870 19
Interest.......................... 90,799 11 70,740 9 47,803 9
Other............................. 11,809 2 5,593 1 4,993 1
-------- --- -------- --- -------- ---
Total revenues.......... $798,710 100% $764,504 100% $516,626 100%
======== === ======== === ======== ===
</TABLE>
1998 COMPARED TO 1997
Revenues, net of interest expense, increased $20.5 million, or 3%, in 1998
as compared to 1997. The increase was largely due to a $112.9 million, or 40%,
increase in commissions, partially offset by a $102.0 million, or 45%, decrease
in corporate finance. Commission revenues increased, led by ITG and the Equities
Division. Revenues from principal transactions decreased $3.0 million, or 2%,
primarily due to decreased trading gains from other investments. Corporate
finance revenues decreased due to the currently difficult environment for
underwritings. Other revenue increased $6.2 million mostly due to a gain on
ITGI's sale of its interest in the LongView Group, Inc. Net interest income
(interest revenues less interest expense) was up $6.3 million mostly due to an
excess of securities borrowed interest income over securities loaned interest
expense.
10
<PAGE> 13
Total non-interest expenses remained relatively unchanged in 1998 as
compared to 1997. Compensation and benefits decreased $29.2 million, or 7%
primarily due to a $52.9 million decrease in performance-based compensation,
partially offset by a $13.1 million increase in salaries, a $6.8 million
increase in payroll taxes and employee benefits and a $2.0 million increase in
sales commissions. Salaries increased due largely to expansion in ITG, the
Corporate Finance Division and the Equities Division. Communications increased
$11.9 million, or 21%, primarily due to increased Y2K costs. Floor brokerage and
clearing fees increased $7.0 million, or 20%, mostly due to increased volume of
business executed on the various exchanges. Software royalties increased $5.4
million, or 55%, due to an increase in POSIT commissions. Travel and promotional
expense increased $2.5 million, or 13%, mostly due to increased business travel.
Other expense increased $2.0 million, or 6%, mostly due to $3.5 million of
expenses associated with the spin-off transaction.
As a result of the above, earnings before income taxes and minority
interest were up $22.2 million, or 19%.
Net earnings were up 10% to $69.7 million, as compared to $63.6 million in
1997. Minority interest of $8.0 million in 1998 represents approximately 18% of
Investment Technology Group, Inc.'s net earnings. The effective tax rate was
approximately 43.8% in 1998 compared to approximately 41.1% in 1997. The
increase in the effective tax rate was due largely to an increase non-deductible
spin-off related expenses and ITGI losses from long-term foreign investments.
Basic earnings per share were $3.12 in 1998 on 22.3 million shares compared
to $2.95 in 1997 on 21.6 million shares. Diluted earnings per share were $2.96
in 1998 on 23.0 million shares compared to $2.80 in 1997 on 22.3 million shares.
1997 COMPARED TO 1996
Revenues, net of interest expense, increased $224.3 million, or 47%, in
1997 as compared to 1996. The increase was due to a $130.8 million, or 134%,
increase in corporate finance, a $60.3 million, or 27%, increase in commissions,
a $33.3 million, or 23%, increase in principal transactions, and a $600,000
increase in other revenues, offset by a $677,000, or 7%, decrease in net
interest income (interest revenues less interest expense). Commission revenues
increased, led by ITG, the Equities Division, and the International Division.
Revenues from principal transactions increased primarily due to increased
trading gains in the Equities Division, the International Division, and the
Taxable Fixed Income Division. Corporate finance revenues benefited from
increased debt financing deals. Net interest income decreased as the $22.9
million increase in interest revenues was surpassed by the $23.6 million
increase in interest expense. Interest revenues increased due primarily to
higher securities borrowed activity. Interest expense increased due primarily to
higher securities loaned activity and interest on temporary subordinated loans
as well as the new 7 1/2% senior notes.
Total non-interest expenses increased $191.5 million, or 48%, in 1997 as
compared to 1996. Compensation and benefits increased $145.9 million, or 55%
primarily due to a $102.6 million increase in performance-based compensation, a
$24.5 million increase in sales commissions and an $11.9 million increase in
salaries. Salaries increased due largely to expansion in ITG, the Corporate
Finance Division, the Equity Research Division and the Equities Division.
Communications increased $20.8 million, or 59%, primarily due to increased trade
volume and personnel. Floor brokerage and clearing fees increased $7.7 million,
or 28%, mostly due to increased volume of business executed on the various
exchanges. Other expense increased $6.3 million, or 21%, largely due to higher
litigation expenses and provisions. Travel and promotional expense increased
$5.7 million, or 42%, mostly due to increased business travel. Occupancy and
equipment rental increased $4.0 million, or 23%, mostly due to the relocation
and addition of office space. Software royalties increased $1.0 million, or 12%,
due to an increase in POSIT commissions.
As a result of the above, earnings before income taxes and minority
interest were up $32.8 million, or 39%.
Net earnings were up 46% to $63.6 million, as compared to $43.6 million in
1996. Minority interest of $4.7 million in 1997 represents approximately 17% of
Investment Technology Group, Inc.'s net earnings. The effective tax rate was
approximately 41.1% in 1997 compared to approximately 42.6% in 1996. The
reduction
11
<PAGE> 14
in the effective tax rate was due largely to a reversal of deferred taxes
related to ITGI shares that were repurchased during 1997.
Basic earnings per share were $2.95 in 1997 on 21.6 million shares compared
to $1.90 in 1996 on 23.0 million shares. Diluted earnings per share were $2.80
in 1997 on 22.3 million shares compared to $1.84 in 1996 on 23.4 million shares.
LIQUIDITY AND CAPITAL RESOURCES
A substantial portion of the Company's assets are liquid, consisting of
cash or assets readily convertible into cash. The majority of securities
positions (both long and short) in the Company's trading accounts are readily
marketable and actively traded. Receivables from brokers and dealers are
primarily current open transactions or securities borrowed transactions which
can be settled or closed out within a few days. Receivables from customers,
officers and directors include margin balances and amounts due on uncompleted
transactions. Most of the Company's receivables are secured by marketable
securities.
The Company's assets are funded by equity capital, senior debt,
subordinated debt, securities loaned, customer free credit balances, bank loans
and other payables. Bank loans represent secured and unsecured short-term
borrowings (usually overnight) which are generally payable on demand. Secured
bank loans are collateralized by a combination of customer, non-customer and
firm securities. The Company has always been able to obtain necessary short-term
borrowings in the past and believes that it will continue to be able to do so in
the future. Additionally, the Company has letters of credit outstanding which
are used in the normal course of business to satisfy various collateral
requirements in lieu of depositing cash or securities.
JEFCO, ITG and W & D are subject to the net capital requirements of the
Commission and other regulators, which are designed to measure the general
financial soundness and liquidity of broker-dealers. JEFCO, ITG and W & D have
consistently operated in excess of the minimum requirements. As of December 31,
1998, JEFCO's, ITG's and W & D's net capital was $217.4 million, $72.0 million
and $2.0 million, respectively, which exceeded minimum net capital requirements
by $213.4 million, $71.7 million and $1.8 million, respectively. JEFCO, ITG and
W & D use the alternative method of calculating their regulatory net capital.
In 1998, Jefferies Group, Inc. repurchased 334,234 shares (including
275,400 shares purchased in connection with the Company's Capital Accumulation
Plan) of its Common Stock at prices ranging from $17.25 to $52.81.
In 1997, Jefferies Group, Inc. redeemed the remaining $3.6 million face
value of its 8.875% Subordinated Notes due 1997 in accordance with sinking fund
requirements. During 1997, Jefferies Group, Inc. issued $100 million face value
of 7 1/2% Senior Notes due in 2007. In 1997, Jefferies Group, Inc. repurchased
1,063,026 shares (including 349,200 shares purchased in connection with the
Company's Capital Accumulation Plan) of its Common Stock at prices ranging from
$19.39 to $37.41.
Also in 1997, the repurchased shares of Common Stock, excluding the shares
repurchased in connection with the Company's Capital Accumulation Plan, were
mostly retired.
During 1997, JEFCO obtained a NASDR approved $200 million revolving credit
facility to be used in connection with underwriting activities.
On January 25, 1999, in anticipation of the transaction described in the
"Jefferies Group, Inc. and Investment Technology Group, Inc. Announce Intention
to Consider Separating Into Two Independent Companies" and in note 19 of the
consolidated financial statements, Jefferies Group liquidated its Capital
Accumulation Plan -- a deferred compensation plan consisting of cash and stock
and payable to nearly 200 employees. Liquidation of this plan is part of a
capital infusion to Jefferies Group, Inc. contemplated as part of the
transaction and resulted in employees receiving approximately 1.5 million shares
of Jefferies Group. These shares payable under the Capital Accumulation Plan
have always been included in the basic and diluted weighted average shares of
Jefferies Group.
12
<PAGE> 15
MARKET RISK
The Company maintains equity securities inventories in exchange-listed,
Nasdaq and private securities on both a long and short basis. The fair value of
these securities at December 31, 1998, was $43 million in long positions and $27
million in short positions. The potential loss in fair value, using a
hypothetical 10% decline in prices, is estimated to be approximately $2 million
due to the offset of losses in long positions with gains in short positions. In
addition, the Company generally enters into exchange-traded option and index
futures contracts to hedge against potential losses in inventory positions, thus
reducing this potential loss exposure. This hypothetical 10% decline in prices
would not be material to the Company's financial position, results of operations
or cash flows.
The Company also invests in money market funds; high-yield, corporate and
U.S. Government agency debt and mutual bond funds. Money market funds do not
have maturity dates and do not present a material market risk. The fair value of
high yield, corporate and U.S. Government agency debt at December 31, 1998 was
$57 million in long positions and $12 million in short positions. Mutual bond
funds also do not have maturity dates and total $33 million at December 31,
1998. The potential loss in fair value of the high-yield, corporate and U.S.
Government agency debt and the mutual bond funds, using a hypothetical 5%
decline in value, is estimated to be approximately $4 million due to the offset
of losses in long positions with gains in short positions. This hypothetical 5%
decline in value would not be material to the Company's financial position,
results of operations or cash flows.
At December 31, 1998, the Company had $150 million aggregate principal
amount of Senior Notes, with fixed interest rates. The Company has no cash flow
exposure regarding these Notes due to the fixed rate of interest.
The table below provides information about the Company's derivative
financial instruments and other financial instruments that are sensitive to
changes in interest rates, exchange rates and stock price movements (in
thousands of dollars.) For debt obligations and reverse repurchase agreements,
the table presents principal cash flows with expected maturity dates. For
foreign exchange forward contracts, index futures contracts and option contracts
the table presents notional amounts with expected maturity dates.
<TABLE>
<CAPTION>
EXPECTED MATURITY DATE
---------------------------
AFTER FAIR
1999 2000 2003 TOTAL VALUE
------- ------ -------- -------- --------
<S> <C> <C> <C> <C> <C>
INTEREST RATE SENSITIVITY
8.875% Senior Notes.................... $ 50,000 $ 50,000 $ 51,625
7.5% Senior Notes...................... $100,000 $100,000 $100,000
Reverse repurchase agreements(1),
weighted average interest rate of
4.95%................................ $28,000 $ 28,000 $ 28,000
EXCHANGE RATE SENSITIVITY
Foreign exchange forward
contracts-Sale....................... $ 8,759 $ 8,759 $ 8,759
STOCK PRICE SENSITIVITY
Index futures contracts-Sale........... $ 3,559 $ 3,559 $ (178)
Option contracts
Purchase............................. $ 1,825 $1,125 $ 2,950 $ 666
Sale................................. $ 1,577 $1,350 $ 2,927 $ 574
</TABLE>
- ---------------
(1) Includes reverse repurchase agreements of $28,000 included in cash and
securities segregated and on deposit for regulatory purposes or deposited
with clearing and depository organizations.
EFFECTS OF CHANGES IN FOREIGN CURRENCY RATES
The Company maintains a foreign securities business in its foreign offices
(London, Hong Kong, Zurich and Tokyo) as well as in some of its domestic
offices. Most of these activities are hedged by related foreign currency
liabilities or by forward exchange contracts. However, the Company is still
subject to some foreign
13
<PAGE> 16
currency risk. A change in the foreign currency rates could create either a
foreign currency transaction gain/loss (recorded in the Company's Consolidated
Statements of Earnings) or a foreign currency translation adjustment to the
stockholders' equity section of the Company's Consolidated Statements of
Financial Condition.
NEW ACCOUNTING STANDARD ON EARNINGS PER SHARE
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share," establishes standards for computing and presenting earnings per share
("EPS"). SFAS No. 128 replaced the presentation of primary EPS with a
presentation of basic EPS. SFAS No. 128 also requires dual presentation of basic
and diluted EPS on the face of the statement of earnings for entities with
complex capital structures and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. Basic earnings per share of common stock are computed
by dividing net earnings by the average number of shares outstanding and certain
other shares committed to, but not yet issued. Diluted earnings per share of
common stock are computed by dividing net earnings by the average number of
shares outstanding of common stock and all dilutive common stock equivalents
outstanding during the period. EPS information has been restated to
retroactively reflect the adoption of SFAS No. 128.
NEW ACCOUNTING STANDARD ON COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains, and losses) in a full set of general-purpose financial
statements. All items that are required to be recognized under accounting
standards as components of comprehensive income are required to be reported in a
financial statement that is displayed with the same prominence as other
financial statements. SFAS No. 130 does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement.
SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position.
The Company implemented SFAS No. 130 in 1997. The adoption of SFAS No. 130
did not have any impact on the Company.
NEW ACCOUNTING STANDARD ON SEGMENT REPORTING
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers.
SFAS No. 131 requires that a public business enterprise report financial
and descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. Generally, financial information is required to be reported on the
basis that it is used internally for evaluating segment performance and deciding
how to allocate resources to segments.
SFAS No. 131 also requires that a public business enterprise report
descriptive information about the way that the operating segments were
determined, the products and services provided by the operating segments,
differences between the measurements used in reporting segment information and
those used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
14
<PAGE> 17
The Company implemented SFAS No. 131 in 1998. The adoption of SFAS No. 131
did not have any impact on the Company.
NEW ACCOUNTING STANDARD ON EMPLOYERS' DISCLOSURE ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS
SFAS No. 132, "Employers' Disclosure About Pensions and Other
Post-retirement Benefits," revises employers' disclosures about pension and
other postretirement benefit plans. It does not change the measurement or
recognition of those plans. It standardizes the disclosure requirements for
pensions and other postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis, and eliminates certain
disclosures.
The Company implemented SFAS No. 132 in 1998. The adoption of SFAS No. 132
did not have any impact on the Company.
NEW ACCOUNTING STANDARD ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value.
This Statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. SFAS No. 133 is not expected to have a material
impact on the Company.
THE YEAR 2000 PROJECT
The Y2K preparedness effort (the "Y2K Project") by the Company and its
subsidiaries (for the purposes of this Y2K disclosure only, the term "Company"
does not include Investment Technology Group, Inc. (Nasdaq: ITGI) and its
subsidiaries, which have developed their own Y2K plan, which is described in the
excerpt from ITGI's 10-K attached as Exhibit 99.1) began in late 1997 and early
1998 with an initial assessment of the Company's systems, its risk of exposure,
the steps necessary to achieve Y2K compliance, and the resources necessary to
implement those steps. As a result, the Company engaged Keane, Inc. as
independent Y2K consultants, and Ernst & Young, LLP ("E&Y") to provide quarterly
reviews of the Y2K Project as an internal audit outsourcer and to provide the
independent accountant's report required by Release No. 34-40608. Together with
the advice of these professionals, the Company formulated and adopted a Y2K
Master Plan.
The first phase of the Y2K Project, the Inventory, Assessment and Planning
phase, involved a complete assessment of the Company's systems, both information
technology ("IT") related and non-IT related, and a survey of all vendors and
key clients. Systems were categorized into one of three "Triage"
Levels -- Mission Critical, Business Important, or Other, with "Mission
Critical" defined as those systems, the failure of which would result in the
Company being unable to conduct business. The Company also created the framework
for the Remediation and Testing phase that would follow, and set schedules for
reaching the Operational Sustainability and Fully Compliant phases. This
planning process provided a guide for each of the Company's divisions in its
preparation of more detailed project plans that outline specific areas of work
on each system. The Y2K Project called for the devotion of resources primarily
to Mission Critical systems during 1998, and Business Important and Other
systems primarily in the first quarter of 1999.
Current State of Readiness
The Company has now completed the first phase of the Y2K Project
(Inventory, Assessment and Planning), and is working toward completion of the
second phase: Remediation and Testing. As of March 1, 1999, phase two was
approximately 90% complete. The remediation portion of this phase has been
completed, and the testing portion has been under way since mid-1998. Although
the Company originally planned to complete phase two by December 31, 1998, and
participate in extended point to point testing in early 1999, the Company
received notice during the fourth quarter that certification and extended point
to point testing would
15
<PAGE> 18
commence in November. Resources were redirected during the fourth quarter to
prepare the Company for participation in these tests, causing a delay in testing
previously scheduled for the fourth quarter 1998. In addition, compliant
versions of certain key applications did not arrive until late December 1998 or
early January 1999, which prevented their testing until that time.
The Company has polled each of its vendors about their Y2K compliance. Of
the 668 vendors contacted, 539 (80.1%) have responded and all who responded have
indicated that they are or intend to become Y2K compliant by mid-1999. The
Company is actively attempting to obtain assurances from the remaining vendors,
though none of the remaining vendors provides Mission Critical services.
Notwithstanding these representations from our vendors, the Company is not
relying on vendor statements of readiness but is independently testing each
system and connection as part of the Y2K Project. The Company has obtained
assurances from all its vendors of Mission Critical systems that each vendor
will be Y2K compliant and the Company has no reason to believe any of those
vendors will be unable to attain compliance. However, because the Company may be
forced to rely on contingency plans which may have a material adverse effect on
the Company's business and operations, as discussed below, the Company is
independently testing each system and connection for Y2K compliance.
Company representatives have also contacted key clients and have begun
testing with certain of those clients. Due to the nature of the Company's
business, the clients that comprise the vast majority of the Company's revenues
are institutional and are regulated by various governmental and self-regulatory
bodies. The Company has therefore determined to review the filings made by those
clients during the second quarter of 1999 before conducting a broad based survey
of client Y2K readiness. Depending on the result of this review, the Company may
find it necessary to survey its clients or to request written certification of
their Y2K compliance.
The Company has completed testing on systems needed to fully participate in
the Securities Industry Association's ("SIA") street-wide testing and is now
participating in the SIA tests. As of March 15, 1999, the Company had
successfully completed two testing cycles, which resulted in no external errors
and only minor internal errors. The remainder of testing to be performed
involves testing each system using either compliant environment regression
testing or unit regression and forward date testing in the existing environment.
All IT systems are then subjected to system regression testing, followed by user
group testing before they are placed into production. Each system, (IT and
non-IT) will then be subjected to forward date testing in a simulated production
environment. The Company has begun testing with certain key clients and the
Company has now obtained compliant versions of key systems and is in the process
of testing those systems and any connections with third party vendors. The
Company is working with its landlords and lessors to assure the continued
functionality of the Mission Critical non-IT systems upon which it is dependent,
and is in the process of preparing contingency plans for non-IT failures as
described below. Other than its internal audits and periodic reporting
requirements to the Commission and the NASD, the Company has not been reviewed
or audited by any state or federal regulators.
Costs to Address Y2K Issues
Jefferies Group, Inc.'s consolidated budget for the entire Y2K Project is
$19.8 million, with $16.8 million attributable to JEFCO and $3.0 million
attributable to ITGI. Current spending rates and projected expenses indicate
that the Company will stay within that budget. A discussion of the Y2K project
of ITGI and its subsidiaries is contained in ITGI's 1998 10-K under the heading
"The Year 2000 Issue" which portion is attached to this 10-K as Exhibit 99.1. As
of December 1998, approximately $12.4 million of costs in the consolidated
budget have already been incurred. This budget includes new software and
hardware, consultants to assist with project administration, quarterly internal
audit outsourcing by E&Y, and a large number of the present IT staff devoting a
substantial portion of their time to the Y2K Project. Until Operational
Sustainability is achieved, the vast majority of IT resources will continue to
be redirected into the Y2K Project and new development unrelated to Y2K has been
limited to only the most essential projects. The budget for 1999 is projected to
be approximately $6.3 million, which will be reassessed in the second half of
1999 to account for the possible implementation of contingency plans if any
vendors will not achieve Y2K compliance.
16
<PAGE> 19
Risks
Though the Company expects to achieve Operational Sustainability by
mid-1999, and to be fully compliant by the end of the third quarter of 1999, a
number of material risks remain which could have a materially adverse impact on
the Company. These risks generally arise as a result of either: (1) failures of
internal systems or (2) failures of third party systems.
Despite the considerable testing and remediation efforts the Company has
undertaken, latent errors in the Company's internal systems that remain
undetected could cause failures in those systems. Failures in one or more key
systems would almost certainly result in substantial impairment of the Company's
ability to efficiently process orders and trades or to perform its clearing
functions. Although the Company expects that the contingency plans discussed
below will allow the Company to continue operations, those contingency plans may
not support the volume of trading the Company is accustomed to and could
therefore cause substantial losses in revenue while they are relied upon. In the
event failures occur, lost data may result in failed trades and related
violations of NASD and SEC rules and regulations. To minimize the time during
which it must rely on any contingency plan, the Company plans to devote all
available resources to restoring normal system operations in the event any
failures occur.
There is also a substantial risk that failures by third parties could
compromise the major order-processing systems upon which the Company is heavily
dependent. Vendors such as Automatic Data Processing, Inc. and the Securities
Industry Automation Corporation have represented to the Company that they either
are or intend to become Y2K compliant and the Company stands ready to test with
each of these parties as soon as they are prepared to do so, but the failure of
any one of these systems could result in a significant interruption of normal
business for the Company. Due to the interdependence of the Company's systems on
those third party systems, the Company does not believe any effective
replacement products could be adopted if those systems are not remediated and is
therefore focusing its attention on assisting with the remediation and testing
process and on developing contingency plans.
In addition, there is also a risk that the Company's ability to conduct
transactions will be materially impaired by the failure of any significant
component of the national clearing and settlement system, of major
counterparties, exchanges or financial institutions in the marketplace. Failures
by one or more of the New York Stock Exchange, Inc., the Nasdaq Stock Market,
the Depository Trust Company, the National Securities Clearing Corporation or
any of the largest banks or brokerage firms could prevent the entire market from
effectively transmitting and receiving data after the Year 2000, despite the Y2K
compliance of the Company's systems. Although it is expected that each of these
parties will conduct extensive testing to ensure that each is Y2K compliant,
there can be no assurance that an unforeseen problem will not create a market
disruption that in turn affects the Company's business.
Contingency Plans
The Company is in the final drafting stages of its Y2K Contingency Plan
(the "Contingency Plan"), a detailed mediation and recovery plan that covers
each of the six most significant risks that may arise from a Y2K failure: 1)
loss of data, 2) software failures, 3) telecommunications failures, 4) loss of
key hardware, 5) loss of key personnel, and 6) loss of facilities. The
Contingency Plan addresses each of these risks with respect to each of the
Company's nine key business areas (Equities, International, Taxable Fixed
Income, Convertibles, Corporate Finance, Operations, Accounting, Facilities and
Technology), and addresses both internal systems and failures by key third party
information providers and other vendors. The Contingency Plan also sets forth an
approach to maintaining business continuity for each of the Company's key
business areas. The specific workarounds for failures of various systems are set
forth in the Contingency Plan, and range from the use of cellular phones or
relocation of personnel in the event of a communications failure to the
installation of backup software or hardware.
The completed portion of the Contingency Plan provides an analysis of each
reasonably possible failure scenario for a given Mission Critical system or
process. Specifically, the Contingency Plan sets forth (i) the likelihood of
failure of the system or process, (ii) the circumstances under which such a
failure would occur, (iii) the impact the failure would have on the competitive
environment of the Company, and (iv) a detailed
17
<PAGE> 20
mitigation strategy for each type of failure. Mitigation strategies typically
list specific products or vendors that can be used to replace failed systems,
manual workarounds for ordinarily automated processes and alternative sources
for data or datastreams that are interrupted or become unreliable. Additional
mitigation strategies are offered where appropriate. The Contingency Plan also
includes a specific description of start up procedures to reactivate systems
that go down, itemizes the staffing and equipment requirements that will be
associated with repairing or re-starting a given system and a contact list of
key individuals familiar with the system or process that should be contacted to
assist with remediation or business restoration procedures. Finally, the
Contingency Plan includes a matrix showing the way each system or process would
be impacted by each of the six primary risk areas discussed above, and the
testing, remediation, business recovery, responsible persons and timetable
involved in the restoration of each.
As of the date hereof, the Y2K Contingency Plan was complete with respect
to Mission Critical systems, except for finalization of the business continuity
section, which should be completed by the end of the second quarter of 1999.
Funds to begin actual implementation of Contingency Plans will be allocated in
the second or third quarter of 1999 based upon perceived risk of failure of each
system.
Forward Looking Statements
The Company's projections in this section are based upon assumptions, which
it believes to be correct, but which are not guaranteed. Any change in those
assumptions could result in material variations in those projections, including
the projected costs for remediation and testing, the feasibility of using
contingency plans, and the impact of third party failures. Any such change could
have a material adverse impact on the Company and its results of operations.
18
<PAGE> 21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company are presented in this Item 8
without giving effect to the proposed Transfers, Spin-Off and ITGI Merger, and
the information in this Item 8 in no way reflects the Transfers, Spin-Off and
ITGI Merger, except as set forth in footnote 19 to the financial statements of
the Company. See Part I, Item 1, "Business -- Proposed Transfers, Spin-Off and
Merger Transactions."
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Consolidated Financial Statements of Jefferies Group, Inc.
and Subsidiaries Independent Auditors' Report............. 20
Consolidated Statements of Financial Condition as of
December 31, 1998 and 1997................................ 21
Consolidated Statements of Earnings for the Three Years
Ended December 31, 1998................................... 22
Consolidated Statements of Changes in Stockholders' Equity
for the Three Years Ended December 31, 1998............... 23
Consolidated Statements of Cash Flows for the Three Years
Ended December 31, 1998................................... 24
Notes to Consolidated Financial Statements.................. 25
</TABLE>
19
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
JEFFERIES GROUP, INC.:
We have audited the accompanying consolidated statements of financial
condition of Jefferies Group, Inc. and subsidiaries as of December 31, 1998 and
1997 and the related consolidated statements of earnings, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Jefferies
Group, Inc. and subsidiaries as of December 31, 1998 and 1997 and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
Los Angeles, California
January 19, 1999, except as to
Note 19 to the consolidated
financial statements, which
is as of March 17, 1999.
20
<PAGE> 23
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 172,505 $ 109,488
Cash and securities segregated and on deposit for regulatory
purposes or deposited with clearing and depository
organizations............................................. 62,518 30,977
Receivable from brokers and dealers......................... 2,018,090 1,269,664
Receivable from customers, officers and directors........... 93,526 166,284
Securities owned............................................ 100,812 245,413
Investments................................................. 110,867 154,584
Premises and equipment...................................... 40,186 42,828
Other assets................................................ 85,136 80,304
---------- ----------
$2,683,640 $2,099,542
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Bank loans.................................................. $ 21,000 $ --
Payable to brokers and dealers.............................. 1,602,906 981,705
Payable to customers........................................ 226,774 202,255
Securities sold, not yet purchased.......................... 39,653 188,703
Accrued expenses and other liabilities...................... 281,391 318,258
---------- ----------
2,171,724 1,690,921
Long-term debt.............................................. 149,387 149,290
Minority interest........................................... 27,754 16,575
---------- ----------
2,348,865 1,856,786
---------- ----------
Stockholders' equity:
Preferred stock, $.01 par value. Authorized 1,000,000
shares; none issued.................................... -- --
Common stock, $.01 par value. Authorized 100,000,000
shares; issued 23,368,268 shares in 1998 and 22,393,910
shares in 1997......................................... 234 224
Additional paid-in capital................................ 28,943 39
Retained earnings......................................... 344,441 271,589
Less:
Treasury stock, at cost; 2,138,238 shares in 1998 and
2,107,842 shares in 1997.............................. (37,125) (26,954)
Accumulated other comprehensive income (loss):
Currency translation adjustments..................... (49) (622)
Additional minimum pension liability adjustment...... (1,669) (1,520)
---------- ----------
Total accumulated other comprehensive income (loss).... (1,718) (2,142)
---------- ----------
Net stockholders' equity............................. 334,775 242,756
---------- ----------
$2,683,640 $2,099,542
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE> 24
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
THREE YEARS ENDED DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
REVENUES:
Commissions.............................................. $395,211 $282,317 $222,048
Principal transactions................................... 174,240 177,214 143,912
Corporate finance........................................ 126,651 228,640 97,870
Interest................................................. 90,799 70,740 47,803
Other.................................................... 11,809 5,593 4,993
-------- -------- --------
Total revenues........................................ 798,710 764,504 516,626
Interest expense......................................... 75,178 61,466 37,852
-------- -------- --------
Revenues, net of interest expense..................... 723,532 703,038 478,774
-------- -------- --------
NON-INTEREST EXPENSES:
Compensation and benefits................................ 380,737 409,979 264,041
Floor brokerage and clearing fees........................ 42,063 35,028 27,323
Communications........................................... 67,851 55,959 35,177
Occupancy and equipment rental........................... 19,931 21,238 17,207
Travel and promotional................................... 21,662 19,207 13,541
Software royalties....................................... 15,252 9,853 8,805
Other.................................................... 37,844 35,824 29,493
-------- -------- --------
Total non-interest expenses........................... 585,340 587,088 395,587
-------- -------- --------
Earnings before income taxes and minority interest......... 138,192 115,950 83,187
Income taxes............................................... 60,533 47,677 35,438
-------- -------- --------
Earnings before minority interest..................... 77,659 68,273 47,749
Minority interest in earnings of consolidated subsidiaries,
net...................................................... 7,977 4,706 4,189
-------- -------- --------
Net earnings.......................................... $ 69,682 $ 63,567 $ 43,560
======== ======== ========
EARNINGS PER SHARE:
Basic.................................................... $ 3.12 $ 2.95 $ 1.90
======== ======== ========
Diluted.................................................. $ 2.96 $ 2.80 $ 1.84
======== ======== ========
WEIGHTED AVERAGE SHARES OF COMMON STOCK:
Basic.................................................... 22,346 21,552 22,980
Diluted.................................................. 22,954 22,349 23,410
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 25
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER NET
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK CAPITAL EARNINGS STOCK INCOME (LOSS) EQUITY
------ ---------- -------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995............................ $ 93 $ 58,117 $192,234 $(63,075) $(1,108) $186,261
Exercise of stock options, including tax benefits
(352,460 shares).................................... 1 2,555 -- 97 -- 2,653
Purchase of 2,320,352 shares of treasury stock........ -- -- -- (36,766) -- (36,766)
Issuance of common stock (71,388 shares).............. -- 770 -- -- -- 770
Issuance of restricted stock, including tax benefits
and additional vesting (68,864 shares).............. -- 1,083 -- -- -- 1,083
Capital Accumulation Plan distributions, including tax
benefits (39,186 shares)............................ -- 138 -- 340 -- 478
Net increase in proportionate share of subsidiary's
equity.............................................. -- -- (1,115) -- -- (1,115)
Comprehensive income:
Net earnings........................................ -- -- 43,560 -- -- 43,560
Other comprehensive income (loss), net of tax:
Currency translation adjustment..................... -- -- -- -- 426 426
Additional minimum pension liability adjustment..... -- -- -- -- 33 33
------- --------
Other comprehensive income (loss)................... 459 459
--------
Comprehensive income.................................. -- -- -- -- -- 44,019
Dividends paid ($.0875 per share)..................... -- -- (1,883) -- -- (1,883)
Redemption of rights ($.0025 per right)............... -- -- (55) -- -- (55)
Two-for-one stock split............................... 94 (94) -- -- --
---- -------- -------- -------- ------- --------
Balance, December 31, 1996............................ 188 62,569 232,741 (99,404) (649) 195,445
Exercise of stock options, including tax benefits
(240,028 shares).................................... 2 3,431 -- -- -- 3,433
Purchase of 1,063,026 shares of treasury stock........ -- -- -- (23,584) -- (23,584)
Issuance of common stock (41,052 shares).............. -- 879 -- 3 -- 882
Issuance of restricted stock, including tax benefits
and additional vesting (198,888 shares)............. -- 3,666 -- -- -- 3,666
Capital Accumulation Plan distributions, including tax
benefits (143,228 shares)........................... -- 508 -- 1,289 -- 1,797
Retirement of treasury shares (15,600,000 shares)..... (78) (70,902) (23,762) 94,742 -- --
Net decrease in proportionate share of subsidiary's
equity.............................................. -- -- 1,558 -- -- 1,558
Comprehensive income:
Net earnings........................................ -- -- 63,567 -- -- 63,567
Other comprehensive income (loss), net of tax:
Currency translation adjustment..................... -- -- -- -- (526) (526)
Additional minimum pension liability adjustment..... -- -- -- -- (967) (967)
------- --------
Other comprehensive income (loss)................... (1,493) (1,493)
--------
Comprehensive income.................................. 62,074
Dividends paid ($.125 per share)...................... -- -- (2,515) -- -- (2,515)
Two-for-one stock split............................... 112 (112) -- -- -- --
---- -------- -------- -------- ------- --------
Balance, December 31, 1997............................ 224 39 271,589 (26,954) (2,142) 242,756
Exercise of stock options, including tax benefits
(737,125 shares).................................... 7 15,144 -- -- -- 15,151
Purchase of 334,234 shares of treasury stock.......... -- -- -- (13,815) -- (13,815)
Issuance of common stock (53,286 shares).............. 1 2,180 -- -- -- 2,181
Issuance of restricted stock, including tax benefits
and additional vesting (182,095 shares)............. 2 8,170 -- (22) -- 8,150
Capital Accumulation Plan distributions, including tax
benefits (305,690 shares)........................... -- 3,410 -- 3,666 -- 7,076
Net decrease in proportionate share of subsidiary's
equity.............................................. -- -- 7,337 -- -- 7,337
Comprehensive income:
Net earnings........................................ -- -- 69,682 -- -- 69,682
Other comprehensive income (loss), net of tax:
Currency translation adjustment..................... -- -- -- -- 573 573
Additional minimum pension liability adjustment..... -- -- -- -- (149) (149)
------- --------
Other comprehensive income (loss)................... 424 424
--------
Comprehensive income.................................. 70,106
Dividends paid ($.20 per share)....................... -- -- (4,167) -- -- (4,167)
---- -------- -------- -------- ------- --------
Balance, December 31, 1998............................ $234 $ 28,943 $344,441 $(37,125) $(1,718) $334,775
==== ======== ======== ======== ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 26
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings.............................................. $ 69,682 $ 63,567 $ 43,560
--------- --------- --------
Adjustments to reconcile net earnings to net cash provided
by (used in) operating activities:
Depreciation and amortization........................... 23,651 16,504 13,644
Deferred income taxes................................... (5,609) (8,813) (10,462)
Increase in cash and securities segregated.............. (31,541) (1,870) (23,849)
(Increase) decrease in receivables:
Brokers and dealers................................... (748,426) (304,039) 152,529
Customers, officers and directors..................... 72,758 (52,412) (6,714)
(Increase) decrease in securities owned................. 144,601 (47,643) (30,560)
(Increase) decrease in investments...................... 43,717 (103,975) (25,452)
Increase in other assets................................ (9,118) (16,316) (38,044)
Increase (decrease) in payables:
Brokers and dealers................................... 621,201 175,992 (58,743)
Customers............................................. 24,519 31,871 (44,171)
Increase (decrease) in securities sold, not yet
purchased............................................. (149,050) 64,388 41,383
Increase (decrease) in accrued expenses and other
liabilities........................................... (31,407) 118,822 83,252
--------- --------- --------
Net cash provided by (used in) operating activities... 24,978 (63,924) 96,373
--------- --------- --------
Cash flows from financing activities:
Net proceeds from bank loans.............................. 21,000 -- --
Issuance of term debt..................................... -- 99,722 --
Net payments on:
Repurchase of treasury stock............................ (13,815) (23,584) (36,766)
Redemption of 8 7/8% Subordinated Notes, due 1997....... -- (3,576) (3,576)
Dividends paid.......................................... (4,167) (2,515) (1,883)
Redemption of rights.................................... -- -- (55)
Proceeds from exercise of stock options................... 15,151 3,433 2,653
Increase in minority interest............................. 11,179 4,613 3,581
Net decrease (increase) in proportionate share of
subsidiary's equity..................................... 7,337 1,558 (1,115)
Distribution of Capital Accumulation Plan shares.......... 7,076 1,797 478
Issuance of restricted shares............................. 8,150 3,666 1,083
Issuance of common shares................................. 2,181 882 770
--------- --------- --------
Net cash provided by (used in) financing activities..... 54,092 85,996 (34,830)
--------- --------- --------
Cash flows from investing activities -- purchase of premises
and equipment............................................. (16,626) (26,200) (16,145)
--------- --------- --------
Effect of currency translation on cash...................... 573 (526) 426
--------- --------- --------
Net increase (decrease) in cash and cash equivalents........ 63,017 (4,654) 45,824
Cash and cash equivalents at beginning of year.............. 109,488 114,142 68,318
--------- --------- --------
Cash and cash equivalents at end of year.................... $ 172,505 $ 109,488 $114,142
========= ========= ========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest................................................ $ 73,757 $ 58,038 $ 38,522
Income taxes............................................ 50,018 52,030 42,724
</TABLE>
Supplemental disclosure of non-cash financing activities:
In 1996, the additional minimum pension liability included in stockholders'
equity of $553 resulted from a decrease of $33 to accrued expenses and other
liabilities and an offsetting increase in stockholders' equity. In 1997, the
additional minimum pension liability included in stockholders' equity of
$1,520 resulted from an increase of $967 to accrued expenses and other
liabilities and an offsetting decrease in stockholders' equity. In 1998, the
additional minimum pension liability included in stockholders' equity of
$1,669 resulted from an increase of $149 to accrued expenses and other
liabilities and an offsetting decrease in stockholders' equity.
See accompanying notes to consolidated financial statements.
24
<PAGE> 27
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Jefferies Group, Inc. (Company) and all subsidiaries, including Jefferies &
Company, Inc. (JEFCO) and Investment Technology Group, Inc. (ITGI) and its
wholly owned subsidiary, ITG Inc. (ITG). The accounts of W & D Securities, Inc.
(W & D) are also consolidated because of the nature and extent of the Company's
ownership interest in W & D. The Company and its subsidiaries are primarily
engaged in a single line of business as a securities broker-dealer, which
includes several types of services, such as principal and agency transactions in
equity, convertible debt and taxable fixed income securities, as well as
corporate finance activities. Operations of the Company include agency and
principal transactions and other securities-related financial services.
All significant intercompany accounts and transactions are eliminated in
consolidation.
SECURITIES TRANSACTIONS
All transactions in securities, commission revenues and related expenses
are recorded on a trade-date basis.
Securities owned and securities sold, not yet purchased, are valued at
market, and unrealized gains or losses are reflected in revenues from principal
transactions.
INVESTMENTS
Partnership interests are recorded at their initial cost. The carrying
values of these investments are adjusted when the adjustment can be supported by
quoted market prices, adjusted for liquidity and other relevant factors. In
addition, the carrying values are reduced when the Company determines that the
estimated realizable value is less than the carrying value based on relevant
financial and market information.
Debt and equity investments consist primarily of mutual funds which are
valued at market, based on available quoted prices.
Equity and debt interests in affiliates are recorded under either the
equity or cost method depending on the Company's level of ownership and control.
RECEIVABLE FROM, AND PAYABLE TO, CUSTOMERS, OFFICERS AND DIRECTORS
Receivable from, and payable to, customers includes amounts receivable and
payable on cash and margin transactions. Securities owned by customers and held
as collateral for these receivables are not reflected in the accompanying
consolidated financial statements. Receivable from officers and directors
represents balances arising from their individual security transactions. Such
transactions are subject to the same regulations as customer transactions.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Substantially all of the Company's financial instruments are carried at
fair value or amounts approximating fair value. Assets, including cash and cash
equivalents, securities borrowed or purchased under agreements to sell, and
certain receivables, are carried at fair value or contracted amounts, which
approximate fair value due to the short period to maturity. Similarly,
liabilities, including bank loans, securities loaned or sold under agreements to
repurchase, long-term debt and certain payables, are carried at amounts
approximating fair value. Securities owned and securities sold, not yet
purchased, are valued at quoted market
25
<PAGE> 28
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
prices, if available. For securities without quoted prices, the reported fair
value is estimated using various sources of information, including quoted prices
for comparable securities.
The Company has derivative financial instrument positions in option
contracts, foreign exchange forward contracts and index futures contracts which
are measured at fair value with gains and losses recognized in earnings. The
gross contracted or notional amount of these contracts is not reflected in the
consolidated statements of financial condition (see note 14 of the notes to
consolidated financial statements).
PREMISES AND EQUIPMENT
Premises and equipment are depreciated using the straight-line method over
the estimated useful lives of the related assets (generally three to ten years).
Leasehold improvements are amortized using the straight-line method over the
term of related leases or the estimated useful lives of the assets, whichever is
shorter.
GOODWILL
Goodwill, which represents the excess of cost over net assets acquired, is
amortized on a straight-line basis over ten to fifteen years. The Company
assesses the recoverability of this intangible asset by determining whether the
amortization of the goodwill balance over its remaining life can be recovered
through future operating cash flows of the acquired business.
CAPITALIZED SOFTWARE
The Company capitalizes software development costs where technological
feasibility of the product has been established. The establishment of
technological feasibility and the ongoing assessment of recoverability of
capitalized software development costs requires considerable judgment by
management with respect to certain external factors, including, but not limited
to, technological feasibility, anticipated future gross revenues, estimated
economic life and changes in software and hardware technologies. The Company is
amortizing capitalized software costs using the straight-line method over one to
two years, with an average remaining life of under two years. Amortization
begins when the product is available for release to the customers. As of
December 31, 1998 and 1997, respectively, the Company had $6.5 million and $6.0
million of capitalized software costs, net of accumulated amortization included
in other assets. In 1998, 1997 and 1996, the Company amortized software costs of
$3.5 million, $1.5 million, and $1.4 million, respectively.
Research and development expenses related to software were $11.0 million,
$8.4 million and $6.8 million in 1998, 1997 and 1996, respectively. In 1998,
1997 and 1996, $4.0 million, $4.4 million and $1.6 million, respectively, were
capitalized.
INCOME TAXES
The Company files a consolidated U.S. Federal income tax return which
includes all qualifying subsidiaries. Amounts provided for income taxes are
based on income reported for financial statement purposes and do not necessarily
represent amounts currently payable. Deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. Deferred
income taxes are provided for temporary differences in reporting certain items,
principally state income taxes, depreciation,
26
<PAGE> 29
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
deferred compensation and unrealized gains and losses on securities owned. Tax
credits are recorded as a reduction of income taxes when realized.
CASH EQUIVALENTS
The Company generally invests its excess cash in money market funds and
other short-term investments. At December 31, 1998 and 1997, such cash
equivalents amounted to $139,801,000 and $90,064,000, respectively. Cash
equivalents are part of the cash management activities of the Company and
generally mature within 90 days.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
Repurchase agreements consist of sales of U.S. Treasury notes under
agreements to repurchase. They are treated as collateralized financing
transactions and are recorded at their contracted repurchase amount.
Reverse repurchase agreements consist of purchases of U.S. Treasury notes
under agreements to re-sell. They are treated as collateralized financing
transactions and are recorded at their contracted re-sale amount.
EARNINGS PER COMMON SHARE
Basic earnings per share of common stock are computed by dividing net
earnings by the average number of shares outstanding and certain other shares
committed to, but not yet issued. Diluted earnings per share of common stock are
computed by dividing net earnings by the average number of shares outstanding of
common stock and all dilutive common stock equivalents outstanding during the
period. All shares used in the earnings per share calculations were restated to
retroactively reflect the two-for-one stock splits approved by the Board of
Directors on November 19, 1997 and March 2, 1996.
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share." SFAS 128 established new standards for computing and presenting earnings
per share. SFAS No. 128 replaced the presentation of primary earnings per share
with a presentation of basic earnings per share. SFAS No. 128 also requires dual
presentation of basic and diluted earnings per share on the face of the
statement of earnings for entities with complex capital structures and requires
a reconciliation of the numerator and denominator of the basic earnings per
share computation to the numerator and denominator of the diluted earnings per
share computation. SFAS 128 did not have a material impact on the Company.
Earnings per share information has been restated to retroactively reflect the
adoption of Statement of Financial Accounting Standards No. 128.
COMMON STOCK
On November 19, 1997, the Company's Board of Directors approved a
two-for-one split of all of the outstanding shares of the Company's common
stock, payable December 15, 1997 to stockholders of record at the close of
business on November 28, 1997. The stated par value of each share was not
changed from $0.01. In addition, the Board of Directors, approved the quarterly
cash dividend at $0.05 per share on the approximately 20,000,000 common shares
outstanding after the split (effectively doubling the dividend rate).
On March 2, 1996, the Company's Board of Directors approved a two-for-one
split of all of the outstanding shares of the Company's common stock, payable
March 29, 1996 to stockholders of record at the close of business on March 15,
1996. The stated par value of each share was not changed from $0.01. In
addition, the Board of Directors, approved the quarterly cash dividend at $0.05
per share (pre November 1997 stock split) on the approximately 12,000,000 common
shares (pre November 1997 stock split) to be outstanding after the March 2, 1996
split (effectively doubling the dividend rate), as well as repurchase of up
27
<PAGE> 30
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
to 1 million of the new common shares (pre November 1997 stock split), on the
open market or otherwise, from time to time.
All share, share price and per share information included in the
consolidated financial statements has been restated to retroactively reflect the
effect of the November 19, 1997 and the March 2, 1996 two-for-one stock splits.
TRANSFERS OF FINANCIAL ASSETS
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS 125
establishes, among other things, new criteria for determining whether a transfer
of financial assets should be accounted for as a sale or as a pledge of
collateral in a secured borrowing. SFAS No. 125 also establishes new accounting
requirements for pledged collateral. The Company implemented SFAS No. 125 in
1997. SFAS No. 125 did not have a material impact on the Company.
COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. All items that are
required to be recognized under accounting standards as components of
comprehensive income are required to be reported in a financial statement that
is displayed with the same prominence as other financial statements. SFAS No.
130 does not require a specific format for that financial statement but requires
that an enterprise display an amount representing total comprehensive income for
the period in that financial statement.
SFAS No. 130 requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position.
The Company implemented SFAS No. 130 in 1997. The adoption of SFAS No. 130
did not have a material impact on the Company.
SEGMENT REPORTING
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
SFAS No. 131 requires that a public business enterprise report financial
and descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. Generally, financial information is required to be reported on the
basis that it is used internally for evaluating segment performance and deciding
how to allocate resources to segments.
28
<PAGE> 31
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
SFAS No. 131 also requires that a public business enterprise report
descriptive information about the way that the operating segments were
determined, the products and services provided by the operating segments,
differences between the measurements used in reporting segment information and
those used in the enterprise's general-purpose financial statements, and changes
in the measurement of segment amounts from period to period.
The Company implemented SFAS No. 131 in 1998. The adoption of SFAS No. 131
did not have a material impact on the Company.
PENSION DISCLOSURE
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosure
About Pensions and Other Post-retirement Benefits," which revises employers'
disclosures about pension and other post-retirement benefit plans. It does not
change the measurement or recognition of those plans. It standardizes the
disclosure requirements for pensions and other post-retirement benefits to the
extent practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures.
The Company implemented SFAS No. 132 in 1998. The adoption of SFAS No. 132
did not have a material impact on the Company.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value.
This Statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. SFAS No. 133 is not expected to have a material
impact on the Company.
FOREIGN CURRENCY TRANSLATION
The Company's foreign revenues and expenses are translated at average
current rates during each reporting period. Foreign currency transaction gains
and losses are included in the consolidated statement of earnings. Gains and
losses resulting from translation of financial statements are excluded from the
consolidated statement of earnings and are recorded directly to a separate
component of stockholders' equity.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' amounts to
conform to the current year's presentation.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare these financial statements in
conformity with generally accepted accounting principles. Actual results could
differ from those estimates.
29
<PAGE> 32
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
(2) GOODWILL
At December 31, 1998 and 1997, excess of purchase price over net assets
acquired remaining was $6,673,000 and $3,556,000, net of accumulated
amortization of $4,174,000 and $3,436,000, respectively, and is included in
other assets.
(3) RECEIVABLE FROM, AND PAYABLE TO, BROKERS AND DEALERS
The following is a summary of the major categories of receivable from, and
payable to, brokers and dealers as of December 31, 1998 and 1997 (in thousands
of dollars):
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Receivable from brokers and dealers:
Securities borrowed......................................... $1,922,691 $1,197,227
Reverse repurchase agreements............................... 5,066 --
Other....................................................... 90,333 72,437
---------- ----------
$2,018,090 $1,269,664
========== ==========
Payable to brokers and dealers:
Securities loaned........................................... $1,580,811 $ 966,132
Repurchase agreements....................................... 5,061 --
Other....................................................... 17,034 15,573
---------- ----------
$1,602,906 $ 981,705
========== ==========
</TABLE>
The Company has a securities borrowed versus securities loaned business
with other brokers. The Company also borrows securities to cover short sales and
to complete transactions in which customers have failed to deliver securities by
the required settlement date, and lends securities to other brokers and dealers
for similar purposes. From these activities, the Company derives interest
revenue and interest expense.
(4) RECEIVABLE FROM, AND PAYABLE TO, CUSTOMERS, OFFICERS AND DIRECTORS
The following is a summary of the major categories of receivables from
customers, officers and directors as of December 31, 1998 and 1997 (in thousands
of dollars):
<TABLE>
<CAPTION>
1998 1997
------- --------
<S> <C> <C>
Customers (net of allowance for uncollectible accounts of
$3,427 in 1998 and $2,453 in 1997)........................ $92,646 $164,099
Officers and directors...................................... 880 2,185
------- --------
$93,526 $166,284
======= ========
</TABLE>
Interest is paid on free credit balances in accounts of customers who have
indicated that the funds will be used for investment at a future date. The rate
of interest paid on such free credit balances varies between the thirteen-week
treasury bill rate and 1% below that rate, depending upon the size of the
customers' free credit balances.
30
<PAGE> 33
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
(5) SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED
The following is a summary of the market value of major categories of
securities owned and securities sold, not yet purchased, as of December 31, 1998
and 1997 (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997
------------------------ ------------------------
SECURITIES SECURITIES
SOLD, SOLD,
SECURITIES NOT YET SECURITIES NOT YET
OWNED PURCHASED OWNED PURCHASED
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Corporate equity securities...................... $ 43,483 $26,759 $120,316 $134,163
High-yield securities............................ 28,684 8,253 59,270 52,332
Corporate debt securities........................ 20,903 4,067 37,382 1,571
U.S. Government and agency obligations........... 7,076 -- 25,370 --
Other............................................ 666 574 3,075 637
-------- ------- -------- --------
$100,812 $39,653 $245,413 $188,703
======== ======= ======== ========
</TABLE>
(6) INVESTMENTS
The following is a summary of the major categories of investments, as of
December 31, 1998 and 1997 (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Partnership interests....................................... $ 56,170 $ 75,814
Debt and equity investments................................. 42,088 64,397
Equity and debt interests in affiliates..................... 12,609 14,373
-------- --------
$110,867 $154,584
======== ========
</TABLE>
(7) PREMISES AND EQUIPMENT
The following is a summary of premises and equipment as of December 31,
1998 and 1997 (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Furniture, fixtures and equipment........................... $89,372 $78,440
Leasehold improvements...................................... 23,820 22,595
------- -------
Total............................................. 113,192 101,035
Less accumulated depreciation and amortization.............. 73,006 58,207
------- -------
$40,186 $42,828
======= =======
</TABLE>
Depreciation and amortization expense amounted to $19,268,000, $14,243,000
and $11,480,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
(8) BANK LOANS
Bank loans represent short-term borrowings that are payable on demand and
generally bear interest at the brokers' call loan rate. At December 31, 1998,
the Company had unsecured bank loans amounting to $21,000,000 with a weighted
average interest rate of 5.6%. At December 31, 1997, there were no bank loans.
31
<PAGE> 34
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
(9) LONG TERM DEBT
The following summarizes long term debt outstanding at December 31, 1998
and 1997 (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
8 7/8% Series B Senior Notes, due 2004, less unamortized
discount of $372 and $442 in 1998 and 1997, respectively,
effective rate of 9%...................................... $ 49,628 $ 49,558
7 1/2% Senior Notes, due 2007, less unamortized discount of
$241 and $268 in 1998 and 1997, effective rate of 8%...... 99,759 99,732
-------- --------
$149,387 $149,290
======== ========
</TABLE>
During 1997, JEFCO obtained a NASDR approved $200,000,000 revolving credit
facility to be used in connection with underwriting activities. The revolving
credit facility terminates on October 30, 1999. Loans under this facility bear
interest at 2.5% over either the Federal funds rate or the London Interbank
Offered Rate. During 1998, there were several borrowings against the revolving
credit facility. During 1997, there were no borrowings against the revolving
credit facility.
(10) INCOME TAXES
Total income taxes for the years ended December 31, 1998, 1997 and 1996
were allocated as follows (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Income from operations...................................... $60,533 $47,677 $35,438
Stockholders' equity, for compensation expense for tax
purposes in excess of amounts recognized for financial
reporting purposes........................................ (12,804) (1,704) (1,568)
------- ------- -------
$47,729 $45,973 $33,870
======= ======= =======
</TABLE>
Income taxes (benefits) for the years ended December 31, 1998, 1997 and
1996 consists of the following (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
CURRENT:
Federal................................................... $49,274 $42,895 $35,059
State and city............................................ 16,868 13,595 10,841
------- ------- -------
66,142 56,490 45,900
------- ------- -------
DEFERRED:
Federal................................................... (4,258) (6,450) (8,756)
State and city............................................ (1,351) (2,363) (1,706)
------- ------- -------
(5,609) (8,813) (10,462)
------- ------- -------
$60,533 $47,677 $35,438
======= ======= =======
</TABLE>
32
<PAGE> 35
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
Income taxes differed from the amounts computed by applying the Federal
income tax rate of 35% for 1998, 1997 and 1996 as a result of the following (in
thousands of dollars):
<TABLE>
<CAPTION>
1998 1997 1996
-------------- -------------- --------------
AMOUNT % AMOUNT % AMOUNT %
------- ---- ------- ---- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Computed expected income taxes................ $48,367 35.0% $40,583 35.0% $29,115 35.0%
Increase (decrease) in income taxes resulting
from:
State and city income taxes, net of Federal
income tax benefit....................... 10,086 7.3 7,301 6.3 5,938 7.1
Foreign income.............................. 1,514 1.1 -- -- -- --
Non-deductible spin-off expenses............ 1,355 1.0 -- -- -- --
Limited deductibility of meals and
entertainment............................ 1,370 1.0 1,263 1.1 867 1.1
Non-taxable interest income................. (968) (0.7) (481) (0.4) (473) (0.6)
Research and development tax credits........ (584) (0.4) (584) (0.5) (291) (0.3)
Other, net.................................. (607) (0.5) (405) (0.4) 282 0.3
------- ---- ------- ---- ------- ----
Total income taxes.................. $60,533 43.8% $47,677 41.1% $35,438 42.6%
======= ==== ======= ==== ======= ====
</TABLE>
The cumulative tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and liabilities at December 31,
1998 and 1997 are presented below (in thousands of dollars):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Deferred tax assets:
Long-term compensation.................................... $ 30,497 $ 25,018
Lease allowances.......................................... 582 929
Accounts receivable....................................... 3,518 2,888
State income taxes........................................ 2,357 2,516
Premises and equipment.................................... 445 1,328
Other..................................................... 627 581
-------- --------
Total gross deferred tax assets................... 38,026 33,260
Valuation allowance......................................... -- --
-------- --------
Net deferred tax assets........................... 38,026 33,260
-------- --------
Deferred tax liabilities:
Investment in subsidiaries................................ (12,922) (13,765)
-------- --------
Total gross deferred tax liabilities.............. (12,922) (13,765)
-------- --------
Net deferred tax asset, included in other
assets.......................................... $ 25,104 $ 19,495
======== ========
</TABLE>
There was no valuation allowance for deferred tax assets as of December 31,
1998, 1997 and 1996.
Management believes it is more likely than not that the Company will
generate sufficient taxable income in the future to realize the deferred tax
asset.
(11) BENEFIT PLANS
PENSION PLAN
The Company has a defined benefit pension plan which covers certain
employees of the Company and its subsidiaries. The plan is subject to the
provisions of the Employee Retirement Income Security Act of 1974. Benefits are
based on years of service and the employee's career average pay. The Company's
funding policy is to contribute to the plan at least the minimum amount that can
be deducted for Federal income tax purposes.
33
<PAGE> 36
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
The following tables set forth the plan's funded status and amounts
recognized in the Company's accompanying consolidated statements of financial
condition and consolidated statements of earnings (in thousands of dollars):
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1998 1997
------- -------
<S> <C> <C>
Actuarial present value of benefit
obligations -- accumulated benefit obligation, including
vested benefits of $19,594 and $18,449 as of December 31,
1998 and 1997, respectively............................... $21,141 $19,777
======= =======
Projected benefit obligation for service rendered to date... $24,837 $22,603
Plan assets, at fair market value........................... 17,203 16,479
------- -------
Excess of the projected benefit obligation over plan
assets................................................. 7,634 6,124
Unamortized prior service cost.............................. 420 624
Unrecognized net transition obligation being recognized over
15 years.................................................. (129) (172)
Unrecognized net loss....................................... (6,841) (5,876)
Adjustment to recognize minimum liability................... 2,853 2,598
------- -------
Pension liability included in other liabilities........... $ 3,937 $ 3,298
======= =======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------
1998 1997 1996
------ ------- ------
<S> <C> <C> <C>
Net pension cost included the following components:
Service cost -- benefits earned during the period......... $1,895 $ 1,288 $1,125
Interest cost on projected benefit obligation............. 1,551 1,222 1,064
Expected return on plan assets............................ (1,310) (1,065) (889)
Net amortization.......................................... 363 178 198
------ ------- ------
Net periodic pension cost.............................. $2,499 $ 1,623 $1,498
====== ======= ======
</TABLE>
The following tables reconcile the fair value of assets and the projected
benefit obligation for the years ending December 31, 998 and 1997 (in thousands
of dollars):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1998 1997
-------- --------
<S> <C> <C>
Fair value of assets, beginning of year..................... $16,479 $13,102
Employer contributions...................................... 2,114 1,476
Benefit payments made....................................... (2,124) (544)
Total investment return..................................... 734 2,445
------- -------
Fair value of assets, end of year........................... $17,203 $16,479
======= =======
</TABLE>
34
<PAGE> 37
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------
1998 1997
-------- --------
<S> <C> <C>
Projected benefit obligation, beginning of year............. $22,603 $16,279
Service cost................................................ 1,895 1,288
Interest cost............................................... 1,551 1,222
Actuarial gains and losses.................................. 763 4,358
Benefits paid............................................... (2,124) (544)
Plan amendments............................................. 149 --
------- -------
Projected benefit obligation, end of year................... $24,837 $22,603
======= =======
</TABLE>
The plan assets consist of approximately 60% equities and 40% fixed income
securities.
The weighted average discount rate and the rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation were 6.75% and 5.00%, respectively, in 1998, 7.00%
and 5.00%, respectively, in 1997 and 7.50% and 5.00%, respectively, in 1996. The
expected long-term rate of return on assets was 8.40% in 1998, 1997 and 1996.
STOCK COMPENSATION PLANS
In October 1995, the FASB issued SFAS 123, "Accounting for Stock-Based
Compensation." SFAS 123 defines a fair value based method of accounting for an
employee stock option or similar instrument and encourages all entities to adopt
that method of accounting for all of their employee stock compensation plans.
However, it allows an entity to continue to measure compensation cost for these
plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees." Entities electing to remain with the accounting in APB Opinion
No. 25 must make pro forma disclosures of net earnings and earnings per share,
as if the fair value based method of accounting defined in SFAS 123 had been
applied. The Company implemented the statement during the year ended December
31, 1996.
At December 31, 1998, the Company had six stock-based compensation plans
and ITGI had two stock-based compensation plans, which are described below. The
Company and ITGI applied APB Opinion No. 25 in accounting for their plans.
Accordingly, no compensation cost has been recognized for fixed stock option
plans. Had compensation cost for the Company's and ITGI's stock-based
compensation plans been determined consistent with SFAS 123, the Company's net
earnings and earnings per share would have been reduced to the pro forma amounts
indicated below (in thousands of dollars, except per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net earnings:
As reported............................................ $69,682 $63,567 $43,560
Pro forma.............................................. $65,240 $58,927 $40,102
Basic earnings per share:
As reported............................................ $ 3.12 $ 2.95 $ 1.90
Pro forma.............................................. $ 2.92 $ 2.73 $ 1.75
Diluted earnings per share:
As reported............................................ $ 2.96 $ 2.80 $ 1.84
Pro forma.............................................. $ 2.77 $ 2.60 $ 1.69
</TABLE>
35
<PAGE> 38
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
1993 PLAN
The Company has a Stock Ownership and Long-Term Incentive Plan (1993 Plan)
which allows awards in the form of incentive stock options (within the meaning
of Section 422 of the Internal Revenue code), nonqualified stock options, stock
appreciation rights, restricted stock, unrestricted stock, performance awards,
dividend equivalents or other stock based awards. The maximum number of shares
of common stock of the Company with respect to which any awards may be made in
any calendar year during the term of the 1993 Plan may not exceed 20% of the
number of shares of common stock issued and outstanding as of the first day of
the calendar year in which awards are made, less the number of shares of common
stock reserved for issuance with respect to, or underlying, any award, made
pursuant to the 1993 Plan or any predecessor plan, as of such date. The 1993
Plan provides flexibility as to exercise price and term of each option.
DIRECTOR PLAN
The Company, also, has a Non-Employee Directors' Stock Option Plan
(Director Plan) which provides for an annual grant to each non-employee director
of an option to purchase 2,000 shares of the Company's common stock. Such grants
will be made automatically on the date directors are elected or reelected at the
Company's annual meeting. In addition, the Director Plan provides for the
automatic grant to a non-employee director, at the time he or she is first
elected or appointed, of an option to purchase 5,000 shares of the Company's
common stock. A total of 300,000 shares of the Company's common stock are
reserved under the Director Plan. Under the Director Plan, the exercise price of
each option equals the market price of the Company's stock on the date of grant
and the option's maximum term is five years.
1996 PLAN
Additionally, in 1996, the Company established a Non-Employee Directors'
Deferred Compensation Plan (1996 Plan). The 1996 Plan permits each non-employee
director to elect to be paid annual retainer fees and annual fees for service as
chairman or a member of a Board committee in the form of stock options and to
defer receipt of any director fees in an interest-bearing cash account or as
deferred shares in a deferred share account. A total of 200,000 shares of the
Company's common stock are reserved under the 1996 Plan. Under the 1996 Plan,
the exercise price of each option equals the market price of the Company's stock
on the date of grant and the options expire ten years after the date of grant.
UNITED KINGDOM CAPITAL ACCUMULATION PLAN
The Company has a United Kingdom Capital Accumulation Plan (UK CAP) for
certain officers and key employees of the Company who work in the United
Kingdom. Participation in the plan is optional, with those who elect to
participate agreeing to defer graduated percentages of their compensation. The
UK CAP allows selected employees to acquire the Company's common stock (through
the granting of stock options) at a 15% discount with 40% of the amount
deferred. The remaining 60% of the amount deferred is placed in a Profit-Based
Deferred Compensation Account that earns interest at a rate based on the
performance of the Company.
OPTIONS ISSUED UNDER ALL PLANS
The fair value of all option grants for all the Company's plans are
estimated on the date of grant using the Black-Scholes option-pricing model with
the weighted-average assumptions used for all fixed option grants in 1998, 1997
and 1996, respectively: dividend yield of 0.6%, 0.4%, and 0.6%; expected
volatility of 32.6%, 33.4%, and 33.3%; risk-free interest rates of 5.5%, 6.4%,
and 5.4%; and expected lives of 5.0 years, 5.5 years, and 3.3 years.
36
<PAGE> 39
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
A summary of the status of Company stock options in all its stock-based
plans as of December 31, 1998, 1997 and 1996 and changes during the year then
ended is presented below:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year.......................... 1,829,033 $12.05 1,702,000 $ 9.35 1,467,832 $6.34
Granted......................... 377,949 39.70 367,061 22.91 594,628 13.28
Exercised....................... (748,142) 7.93 (240,028) 9.48 (352,460) 3.47
Forfeited....................... (16,023) 40.00 -- -- (8,000) 8.13
--------- --------- ---------
Outstanding at end of year...... 1,442,817 21.12 1,829,033 12.05 1,702,000 9.35
========= ========= =========
Options exercisable at
year-end...................... 941,955 1,349,124 858,996
Weighted-average fair value of
options granted during the
year.......................... $13.43 $10.05 $4.19
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -----------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AT REMAINING AVERAGE AT AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1998 LIFE (YEARS) PRICE 1998 PRICE
------------------------ ------------ ------------ -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$ 1.28 to 9.99........................ 346,437 0.8 $ 7.33 302,470 $ 7.60
$10.00 to 19.99........................ 412,600 0.7 14.20 408,600 14.21
$20.00 to 29.99........................ 287,532 3.4 22.56 217,532 22.06
$30.00 to 39.99........................ 45,000 8.2 32.15 5,000 35.38
$40.00 to 47.94........................ 351,248 4.1 40.26 8,353 47.68
--------- -------
$ 1.28 to 47.94........................ 1,442,817 2.3 21.12 941,955 14.31
========= =======
</TABLE>
INVESTMENT TECHNOLOGY GROUP, INC.'S PLANS
In 1994 ITGI, established the 1994 Employee Stock Option and Long-Term
Incentive Plan (ITGI Plan) which allows for the granting of options to purchase
a total of 3,650,000 shares of ITGI common stock. In 1995, the ITGI Board of
Directors adopted, and the ITGI stockholders approved, the Non-Employee
Directors' Plan (ITGI Director Plan). The ITGI Director Plan generally provides
for an annual grant to each non-employee director an option to purchase 2,500
shares of ITGI common stock. In addition, the ITGI Director Plan provides for
the automatic grant to a non-employee director, at the time he or she is
initially elected, a stock option to purchase 10,000 shares of ITGI common
stock. Stock options granted under the ITGI Director Plan are non-qualified
stock options having an exercise price equal to 100% of the fair market value of
ITGI common stock at the date of grant. A total of 125,000 shares of ITGI common
stock are reserved for issuance under the ITGI Director Plan. There were a total
of 3,458,216 fixed stock options outstanding and 18,220,968 ITGI common stock
shares outstanding as of December 31, 1997. There were a total of 2,888,106
fixed stock options outstanding and 18,590,361 ITGI common stock shares
outstanding as of December 31, 1998.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the weighted-average assumptions
used for all fixed option grants in 1998, 1997 and 1996,
37
<PAGE> 40
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
respectively: dividend yield of 0.0%, 0.0% and 0.0%; expected volatility of 45%,
54% and 49%; risk-free interest rates of 5.5%, 6.6% and 6.1%; and expected lives
of 7 years, 5 years and 4 years.
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -----------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AT REMAINING AVERAGE AT AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICES 1998 LIFE (YEARS) PRICE 1998 PRICE
------------------------ ------------ ------------ -------- ------------ --------
<S> <C> <C> <C> <C> <C>
$ 7.50 - 9.99......................... 445,909 1.9 $ 9.08 445,909 $ 9.08
$10.00 - 14.99......................... 1,167,117 0.9 $12.30 1,167,117 $12.30
$15.00 - 19.99......................... 157,976 3.4 $19.22 73,256 $18.94
$20.00 - 24.99......................... 1,019,604 3.1 $22.21 1,010,000 $22.19
$25.00 - 29.99......................... 92,500 8.4 $27.80 26,000 $27.97
$30.00 - 32.10......................... 5,000 4.3 $32.10 -- --
--------- ---------
$ 7.50 - 32.10......................... 2,888,106 2.2 $16.21 2,722,282 $15.77
========= =========
</TABLE>
PERFORMANCE-BASED STOCK OPTIONS
While the 1993 Plan allows for the granting of performance-based stock
options, no such options were granted during 1998, 1997 and 1996, and no such
options were outstanding at December 31, 1998, 1997 and 1996.
RESTRICTED STOCK
The 1993 Plan allows for grants of restricted stock awards, whereby certain
key employees are granted restricted shares of common stock subject to
forfeiture until the restrictions lapse or terminate. With certain exceptions,
the employee must remain with the Company for a period of years after the date
of grant to receive the full number of shares granted. During 1998, 1997 and
1996, there were restricted stock awards of 183,947 shares, 198,888 shares and
49,264 shares, respectively, with a corresponding market value of $6,488,000,
$4,189,000 and $624,000, respectively. Certain grants are expensed over the
vesting periods of one to three years, while others have been granted in
settlement of previously accrued compensation liabilities. The compensation
cost, excluding the cost associated with the settlement of previously accrued
compensation liabilities, charged against earnings was $993,000, $1,142,000 and
$394,000 in 1998, 1997 and 1996, respectively. As of December 31, 1998, 1997 and
1996, restricted stock shares outstanding were 381,585 shares, 203,468 shares
and 95,160 shares, respectively.
EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan (ESPP). All regular
full-time employees are eligible for the ESPP. Employee contributions are
voluntary and are made via payroll deduction. The employee contributions are
used to purchase the Company's common stock which is then held in an outside
trust account. The Company matches employee contributions at a rate of 15%
(more, if profits exceed targets set by the Company's Board of Directors). The
Company's match vests after two years. The Company recognizes compensation cost
related to its ESPP matching. The compensation cost charged against earnings was
$297,000, $228,000 and $250,000 in 1998, 1997 and 1996, respectively.
38
<PAGE> 41
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
CAPITAL ACCUMULATION PLAN
The Company has a Capital Accumulation Plan (CAP) for certain officers and
key employees of the Company. Participation in the plan is optional, with those
who elect to participate agreeing to defer graduated percentages of their
compensation. The plan allows selected employees to acquire the Company's common
stock at a 15% discount with 50% of the amount deferred. The remaining 50% of
the amount deferred is placed in a Profit-Based Deferred Compensation Account
that earns interest at a rate based on the performance of the Company.
The Company will from time to time repurchase shares of its common stock in
the open market for use in both the CAP and UK CAP plans. The Company has
acquired 2,580,034 shares since the inception of the plans (CAP in 1993 and UK
CAP in 1995) and has made distributions of 653,410 shares. The Company
recognizes compensation cost related to the 15% discount and interest on
Profit-Based Deferred Compensation Accounts. The compensation cost charged
against earnings was $4,334,000, $4,834,000 and $2,742,000 in 1998, 1997 and
1996, respectively.
PROFIT SHARING PLAN
The Company has a profit sharing plan, covering substantially all
employees, which includes a salary reduction feature designed to qualify under
Section 401-K of the Internal Revenue Code. Expenses related to this plan
amounted to $9,140,000, $7,923,000 and $5,713,000 in 1998, 1997 and 1996,
respectively.
(12) EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for the years 1998, 1997 and
1996 (in thousands of dollars, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Net earnings for basic earnings per share................... $69,682 $63,567 $43,560
Earnings adjustment -- stock options on subsidiary........ (1,672) (890) (501)
------- ------- -------
Adjusted earnings for diluted earnings per share.......... $68,010 $62,677 $43,059
======= ======= =======
Shares of common stock and common stock equivalents:
Average number of common shares........................... 20,902 20,148 21,644
Capital Accumulation Plan unissued shares................. 1,444 1,404 1,336
------- ------- -------
Average shares used in basic computation.................. 22,346 21,552 22,980
Stock options............................................. 508 651 398
Other unissued common shares.............................. 100 146 32
------- ------- -------
Average shares used in diluted computation................ 22,954 22,349 23,410
======= ======= =======
Earnings per share:
Basic..................................................... $ 3.12 $ 2.95 $ 1.90
======= ======= =======
Diluted................................................... $ 2.96 $ 2.80 $ 1.84
======= ======= =======
</TABLE>
The Company had no anti-dilutive securities during 1998, 1997 and 1996.
39
<PAGE> 42
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
(13) LEASES
As lessee, the Company leases certain premises and equipment under
noncancelable agreements expiring at various dates through 2014. Future minimum
lease payments for all noncancelable operating leases at December 31, 1998 are
as follows (in thousands of dollars):
<TABLE>
<S> <C>
1999........................................................ $12,691
2000........................................................ 13,919
2001........................................................ 12,408
2002........................................................ 8,984
2003........................................................ 8,922
Thereafter.................................................. 73,098
</TABLE>
Rental expense for the Company was $9,851,000, $8,342,000 and $6,759,000 in
1998, 1997 and 1996, respectively.
(14) FINANCIAL INSTRUMENTS
OFF-BALANCE SHEET RISK
The Company has contractual commitments arising in the ordinary course of
business for securities loaned or purchased under agreements to sell, securities
sold but not yet purchased, repurchase agreements, future purchases and sales of
foreign currencies, securities transactions on a when-issued basis, options
contracts, futures index contracts, and underwriting. Each of these financial
instruments and activities contains varying degrees of off-balance sheet risk
whereby the market values of the securities underlying the financial instruments
may be in excess of, or less than, the contract amount. The settlement of these
transactions is not expected to have a material effect upon the Company's
consolidated financial statements.
In the normal course of business, the Company had letters of credit
outstanding aggregating $35,825,000 at December 31, 1998 to satisfy various
collateral requirements in lieu of depositing cash or securities.
The Company has derivative financial instrument positions in foreign
exchange forward contracts, option contracts, and index futures contracts, all
of which are measured at fair value with realized and unrealized gains and
losses recognized in earnings. The foreign exchange forward contract positions
are generally taken to lock in the dollar cost or proceeds of foreign currency
commitments associated with unsettled foreign denominated securities purchases
or sales. The average maturity of the forward contracts is generally less than
two weeks. The option positions taken are generally part of a strategy in which
offsetting equity positions are taken. The index futures positions are taken as
a hedge against other securities positions.
The gross contracted or notional amount of index futures contracts, options
contracts, and foreign exchange forward contracts, which are not reflected in
the consolidated statements of financial condition, is set forth in the table
below and provide only a measure of the Company's involvement in these contracts
at December 31, 1998 and 1997. They do not represent amounts subject to market
risk and, in many cases, serve to reduce the Company's overall exposure to
market and other risks (in thousands of dollars):
<TABLE>
<CAPTION>
NOTIONAL OR CONTRACTED AMOUNT
----------------------------------------
1998 1997
------------------ ------------------
PURCHASE SALE PURCHASE SALE
-------- ------ -------- ------
<S> <C> <C> <C> <C>
Index futures contracts............................... $ -- $3,559 $ -- $8,173
Option contracts...................................... 2,950 2,927 6,277 4,803
Foreign exchange forward contracts.................... -- 8,759 430 4,461
</TABLE>
40
<PAGE> 43
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
FAIR VALUE OF DERIVATIVE FINANCIAL INSTRUMENTS
The following is an aggregate summary of the average 1998 and 1997 and
December 31, 1998 and 1997 fair values of derivative financial instruments (in
thousands of dollars):
<TABLE>
<CAPTION>
1998 1997
------------------------ ------------------------
AVERAGE END OF PERIOD AVERAGE END OF PERIOD
------- ------------- ------- -------------
<S> <C> <C> <C> <C>
Index futures contracts:
In a favorable position....................... $ 42 $ -- $ 55 $ --
In an unfavorable position.................... 150 178 204 149
Option contracts:
Purchases..................................... 500 666 682 799
Sales......................................... 506 574 372 637
Foreign exchange forward contracts:
Purchases..................................... 2,093 -- 3,406 430
Sales......................................... 6,623 8,759 3,291 4,461
</TABLE>
CREDIT RISK
In the normal course of business, the Company is involved in the execution,
settlement and financing of various customer and principal securities
transactions. Customer activities are transacted on a cash, margin or
delivery-versus-payment basis. Securities transactions are subject to the risk
of counterparty or customer nonperformance. However, transactions are
collateralized by the underlying security, thereby reducing the associated risk
to changes in the market value of the security through settlement date or to the
extent of margin balances.
The Company seeks to control the risk associated with these transactions by
establishing and monitoring credit limits and by monitoring collateral and
transaction levels daily. The Company may require counterparties to deposit
additional collateral or return collateral pledged. In the case of aged
securities failed to receive, the Company may, under industry regulations,
purchase the underlying securities in the market and seek reimbursement for any
losses from the counterparty.
CONCENTRATION OF CREDIT RISK
As a major securities firm, the Company's activities are executed primarily
with and on behalf of other financial institutions, including brokers and
dealers, banks and other institutional customers. Concentrations of credit risk
can be affected by changes in economic, industry or geographical factors. The
Company seeks to control its credit risk and the potential risk concentration
through a variety of reporting and control procedures, including those described
in the preceding discussion of credit risk.
41
<PAGE> 44
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
(15) OTHER COMPREHENSIVE INCOME
The following summarizes other comprehensive income and accumulated other
comprehensive income at December 31, 1998 and for the year then ended (in
thousands of dollars):
<TABLE>
<CAPTION>
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
---------- ---------- ----------
<S> <C> <C> <C>
Currency translation adjustments........................... $ 573 $ -- $ 573
Minimum pension liability adjustment....................... (254) 105 (149)
----- ---- -----
Other comprehensive income (loss).......................... $ 319 $105 $ 424
===== ==== =====
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
MINIMUM OTHER
CURRENCY PENSION COMPREHENSIVE
TRANSLATION LIABILITY INCOME
ADJUSTMENTS ADJUSTMENT (LOSS)
----------- ---------- -------------
<S> <C> <C> <C>
Beginning balance....................................... $(622) $(1,520) $(2,142)
Change in 1998.......................................... 573 (149) 424
----- ------- -------
Ending balance.......................................... $ (49) $(1,669) $(1,718)
===== ======= =======
</TABLE>
The following summarizes other comprehensive income and accumulated other
comprehensive income at December 31, 1997 and for the year then ended (in
thousands of dollars):
<TABLE>
<CAPTION>
BEFORE-TAX INCOME TAX NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
---------- ---------- ----------
<S> <C> <C> <C>
Currency translation adjustments.......................... $ (526) $ -- $ (526)
Minimum pension liability adjustment...................... (1,645) 678 (967)
------- ---- -------
Other comprehensive income (loss)......................... $(2,171) $678 $(1,493)
======= ==== =======
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
MINIMUM OTHER
CURRENCY PENSION COMPREHENSIVE
TRANSLATION LIABILITY INCOME
ADJUSTMENTS ADJUSTMENT (LOSS)
----------- ---------- -------------
<S> <C> <C> <C>
Beginning balance....................................... $ (96) $ (553) $ (649)
Change in 1997.......................................... (526) (967) (1,493)
----- ------- -------
Ending balance.......................................... $(622) $(1,520) $(2,142)
===== ======= =======
</TABLE>
The following summarizes other comprehensive income and accumulated other
comprehensive income at December 31, 1996 and for the year then ended (in
thousands of dollars):
<TABLE>
<CAPTION>
BEFORE-TAX INCOME TAX NET-OF-TAX
AMOUNT OR BENEFIT AMOUNT
---------- ---------- ----------
<S> <C> <C> <C>
Currency translation adjustments........................ $426 $ -- $426
Minimum pension liability adjustment.................... 58 (25) 33
---- ---- ----
Other comprehensive income (loss)....................... $484 $(25) $459
==== ==== ====
</TABLE>
42
<PAGE> 45
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ACCUMULATED
MINIMUM OTHER
CURRENCY PENSION COMPREHENSIVE
TRANSLATION LIABILITY INCOME
ADJUSTMENTS ADJUSTMENT (LOSS)
----------- ---------- -------------
<S> <C> <C> <C>
Beginning balance....................................... $(522) $(586) $(1,108)
Change in 1996.......................................... 426 33 459
----- ----- -------
Ending balance.......................................... $ (96) $(553) $ (649)
===== ===== =======
</TABLE>
(16) NET CAPITAL REQUIREMENTS
As registered broker-dealers, JEFCO, ITG and W & D are subject to the
Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1), which
requires the maintenance of minimum net capital. JEFCO, ITG and W & D have
elected to use the alternative method permitted by the Rule, which requires that
they each maintain minimum net capital, as defined, equal to the greater of
$250,000 or 2% of the aggregate debit balances arising from customer
transactions, as defined.
At December 31, 1998, JEFCO's, ITG Inc.'s and W & D's net capital was
$217,367,000, $71,996,000 and $2,026,000, respectively, which exceeded minimum
net capital requirements by $213,362,000, $71,746,000 and $1,776,000,
respectively.
(17) CONTINGENCIES
In re Nasdaq Market-Makers Antitrust Litigation. Beginning in July 1994,
antitrust class actions were commenced against JEFCO and 33 other defendants in
various federal courts (the "Lawsuits"). Following the filing of the Lawsuits,
the Antitrust Division of the United States Department of Justice ("DOJ") and
the Commission commenced investigations into certain issues related to the
allegations of the Lawsuits. In August 1996, the DOJ entered into a antitrust
consent decree with 24 defendants who are market makers in Nasdaq stocks. JEFCO
was neither asked nor required to settle with the DOJ. Shortly after the DOJ
settlement, the Commission filed a Section 21(a) report against the National
Association of Securities Dealers, Inc. ("NASD"), criticizing various practices
by market makers, and the NASD for failing to adequately police or discipline
the market makers for those practices. However, the Commission did not take any
action at that time against the market maker firms.
In October 1994, the Lawsuits were consolidated for discovery purposes in
the United States District Court for the Southern District of New York (the
"Court"). The consolidated complaint alleges that the defendants violated the
antitrust laws by conspiring to fix the spread paid by plaintiffs and class
members to trade in certain Nasdaq securities, by refusing to quote bids and
asks in so-called odd-eighths. The cases purport to be brought on behalf of all
persons who purchased or sold certain securities on the Nasdaq National Market
System during the period May 1, 1989 to May 27, 1994. The plaintiffs seek
damages in an unspecified amount.
In order to avoid the uncertainties of litigation, JEFCO has entered into a
settlement agreement which received the preliminary approval of the Court on
October 15, 1997. The settlement received the final approval of the Court on
November 9, 1998. The amount of the settlement has been previously provided for
and will not have a material adverse effect on JEFCO.
Income Taxes. The Company received a "30-day letter" proposing certain
adjustments which, if sustained, would result in a tax deficiency of
approximately $10.0 million plus interest. Substantially all of the proposed
adjustments relate to Investment Technology Group, Inc., the Company's 80.5%
owned subsidiary and include (i) the disallowance of deductions taken in
connection with the termination of certain
43
<PAGE> 46
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
compensation plans at the time of Investment Technology Group's initial public
offering in 1994 and (ii) the disallowance of tax credits taken in connection
with certain research and development expenditures. The Company intends to
vigorously contest the proposed adjustments and believes that resolution of this
matter will not have a material adverse effect on the Company.
Other. Many aspects of the Company's business involve substantial risks of
liability. In the normal course of business, the Company and its subsidiaries
have been named as defendants or co-defendants in lawsuits involving primarily
claims for damages. The Company's management believes that pending litigation
will not have a material adverse effect on the Company.
(18) SEGMENT REPORTING
The Company's operations have been classified into two business segments:
Financial Services and ITGI. The Financial Services segment includes the
traditional securities brokerage and investment banking activities of Jefferies
Group, Inc. and its subsidiaries, except ITGI and its subsidiaries. The ITGI
segment includes the automated equity trading and transaction research
activities of ITGI and its subsidiaries. Financial information by segment for
the three years in the period ended December 31, 1998 are summarized as follows
(in thousands of dollars):
<TABLE>
<CAPTION>
FINANCIAL ELIMINATIONS/
SERVICES ITGI RECLASSIFICATIONS CONSOLIDATED
---------- -------- ----------------- ------------
<S> <C> <C> <C> <C>
1998
Total revenues........................... $ 590,615 $212,205 $(4,110) $ 798,710
Operating income......................... 57,257 80,935 -- 138,192
Identifiable assets...................... 2,509,531 180,512 (6,403) 2,683,640
Capital expenditures..................... 8,968 7,658 -- 16,626
Depreciation and amortization............ 12,052 11,599 -- 23,651
1997
Total revenues........................... $ 630,842 $137,042 $(3,380) $ 764,504
Operating income......................... 68,690 47,260 -- 115,950
Identifiable assets...................... 1,993,049 113,641 (7,148) 2,099,542
Capital expenditures..................... 10,521 15,679 -- 26,200
Depreciation and amortization............ 9,862 6,642 -- 16,504
1996
Total revenues........................... $ 407,023 $111,556 $(1,953) $ 516,626
Operating income......................... 42,186 41,001 -- 83,187
Identifiable assets...................... 1,493,117 82,798 (7,828) 1,568,087
Capital expenditures..................... 10,521 5,624 -- 16,145
Depreciation and amortization............ 9,687 3,957 -- 13,644
</TABLE>
Financial Services provided trade execution, clearance and administrative
services to ITGI for $26.7 million, $21.6 million and $14.7 million in 1998,
1997 and 1996, respectively. ITGI provided automated trade execution services to
Financial Services for $4.8 million, $3.1 million and $1.7 million in 1998, 1997
and 1996, respectively.
The Company's business is predominantly in the U.S. with less than 6% of
revenues and 2% of assets coming from international operations.
44
<PAGE> 47
JEFFERIES GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1998 AND 1997
(19) JEFFERIES GROUP, INC. AND INVESTMENT TECHNOLOGY GROUP, INC. ANNOUNCE
INTENTION TO CONSIDER SEPARATING INTO TWO INDEPENDENT COMPANIES
On March 17, 1998, Jefferies Group, Inc. ("Group") and ITGI jointly
announced plans for a series of transactions (the "Transactions") that would
result in the separation of ITGI from the other Group businesses. Group would
transfer all non-ITGI assets and liabilities to JEF Holding Company, Inc. (the
"Transfers"). After the Transfers, Group's 15 million shares of ITGI would be
its only asset. Group would then distribute all of the common stock of the JEF
Holding Company, Inc. to the Group stockholders (the "Spin-Off"). Immediately
following the Spin-Off, ITGI would merge with and into Group with Group as the
surviving corporation (the "Merger"). In connection with the Merger, Group would
be renamed Investment Technology Group, Inc. (the "Surviving Corporation").
Subject to the terms and conditions of the merger agreement, each issued and
outstanding share of ITGI common stock (other than any shares held by Group or
held in the Treasury of ITGI) will be converted into the right to receive a
number of shares of common stock of the Surviving Corporation equal to the ratio
derived after dividing the number of shares of Group Common Stock outstanding
immediately prior to the effective time of the Merger by the number of shares of
ITGI Common Stock owned by Group immediately prior to the effective time of the
Merger.
As a result of the Transactions, former Group stockholders will own, in the
aggregate, 100% of JEF Holding Company, Inc. and, in the aggregate,
approximately 80.5% of the Surviving Corporation. The public ITGI stockholders,
in the aggregate, will own approximately 19.5% of the Surviving Corporation, the
same proportionate ownership they held in ITGI prior to the Transactions.
On March 12, 1999, Group received tax rulings from the Internal Revenue
Service (the "IRS") with the concurrence of the IRS concerning the tax-free
treatment of the Transfers and the Spin-Off for Group and its stockholders,
respectively. On March 17, 1999, Group's Board of Directors unanimously approved
the Transfers and the Spin-Off. The Transactions are contingent on a number of
factors, including receipt of stockholder approvals.
In anticipation of the Spin-Off, Group liquidated its CAP plan -- a
deferred compensation plan consisting of cash and stock and payable to nearly
200 employees effective January 25, 1999. Liquidation of this plan is part of a
capital infusion to Group contemplated as part of the Spin-Off and resulted in
employees receiving approximately 1.5 million shares of Group.
(20) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of unaudited quarterly statements of earnings
for the years ended December 31, 1998 and 1997 (in thousands of dollars, except
per share amounts):
<TABLE>
<CAPTION>
MARCH JUNE SEPTEMBER DECEMBER YEAR
-------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
1998
Revenues.................................... $203,408 $198,832 $184,281 $212,189 $798,710
Earnings before income taxes and minority
interest.................................. 32,125 35,017 32,009 39,041 138,192
Net earnings................................ 17,476 17,826 15,676 18,704 69,682
Basic earnings per share.................... 0.79 0.80 0.70 0.82 3.12
Diluted earnings per share.................. 0.75 0.76 0.66 0.79 2.96
1997
Revenues.................................... $147,178 $201,485 $184,823 $231,018 $764,504
Earnings before income taxes and minority
interest.................................. 21,567 35,327 26,405 32,651 115,950
Net earnings................................ 11,397 19,748 14,420 18,002 63,567
Basic earnings per share.................... 0.53 0.92 0.67 0.83 2.95
Diluted earnings per share.................. 0.50 0.87 0.63 0.79 2.80
</TABLE>
45
<PAGE> 48
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information presented in this Item 10 reports information without
giving effect to the proposed Transfers, Spin-Off and Merger. See Part I, Item
1. "Business -- Proposed Transfers, Spin-Off and Merger Transactions."
The biographical data of the members of management of Group, before giving
effect to the Transactions, and of New JEF, after giving effect to the
transactions, is set forth below.
DIRECTORS
FRANK E. BAXTER, 62, has been Chairman of the Board since September 26,
1990, Chief Executive Officer since March 19, 1987, and a Director of Group and
of JEFCO since 1975. Mr. Baxter has previously served as President of Group and
of JEFCO from January 1986 until December 1996, Executive Vice President,
National Sales Manager and New York Branch Manager of JEFCO, and Managing
Director of Group's U.K. subsidiary. Mr. Baxter has been a Director of ITGI
since March 1994, and was a Director of ITG, ITGI's wholly owned broker-dealer
subsidiary, from January 1994 through January 1997. Mr. Baxter has also been a
member of the Board of Governors of the National Association of Securities
Dealers, Inc. since January 1998, and a member of the Board of Directors of the
Securities Industry Association since November 1995.
RICHARD G. DOOLEY, 69, has been a Director of Group since November 1993.
From 1978 until his retirement in June 1993, Mr. Dooley was Executive Vice
President and Chief Investment Officer of Massachusetts Mutual Life Insurance
Company ("Mass Mutual"); Mr. Dooley is currently a consultant to Mass Mutual.
Mr. Dooley has also been a director of Advest Group, Inc. since 1983, HSB Group,
Inc. since 1984, Kimco Realty Corporation since 1990, ITGI from 1996 to January
1999 and various Mass Mutual sponsored investment companies. Mr. Dooley is also
a trustee of Saint Anselm College and Chairman of the Board of The Nellie Mae
Foundation and Corporation. Mr. Dooley is Chairman of Group's Compensation
Committee and a member of the Audit Committee.
RICHARD B. HANDLER, 37, has been a Director of Group since May 1998, an
Executive Vice President of JEFCO since April 1990 and a Director of JEFCO since
May 1993. Mr. Handler is the Manager of the Taxable Fixed Income Division of
JEFCO.
TRACY G. HERRICK, 65, has been a Director of Group since 1983 and of JEFCO
since 1981. He is also President of Tracy G. Herrick, Inc., an economic
consulting firm, a Director of Anderson Capital Management, a registered
investment adviser, a Director of The Committee for Monetary Research and
Education and is a member of the advisory Board of the San Xavier Foundation of
Monterey, California.
MICHAEL L. KLOWDEN, 53, has been a Director of Group since May 1987 and the
President and Chief Operating Officer of Group and of JEFCO since December 1996.
From May 1995 until December 1996, he was Vice Chairman of Group and of JEFCO.
Mr. Klowden has been a Director of JEFCO since May 1995, and has been a trustee
of the University of Chicago since 1986. From 1978 until May 1995, Mr. Klowden
was a senior partner of Morgan, Lewis & Bockius LLP, a law firm that renders
legal services to Group. Mr. Klowden was a Director of ITGI from January 1997 to
January 1999.
SHELDON B. LUBAR, 69, has been a Director of Group since January 1998. He
has been Chairman of the Board of Lubar & Co. Incorporated, an investment
banking firm, since 1977. From 1986 to the present, he
46
<PAGE> 49
has also been Chairman of the Board of Christiana Companies, Inc., a New York
Stock Exchange listed company that supplies refrigerated warehousing and
logistics. Mr. Lubar has also been a Director of EVI, Inc. since 1995, Ameritech
Corporation since 1993, MGIC Investment Corporation since 1991, Firstar
Corporation since 1986, Weatherford International, Inc. since 1995 and of
Massachusetts Mutual since 1977.
FRANK J. MACCHIAROLA, 57, has been a Director of Group since August 1991.
He is currently the President of St. Francis College, where he has served in
that capacity since July 1996. He also serves as special counsel to the law firm
of Newman, Tannenbaum, Halpern, Syracuse & Hirschtritt LLP. Previously, Mr.
Macchiarola was a Professor of Law and Political Science and the Dean of the
Benjamin N. Cardozo School of Law at Yeshiva University in New York City from
1991 to 1996, Professor of Business in the Graduate School of Business at
Columbia University from 1987 to 1991, and President and Chief Executive Officer
of the New York City Partnership, Inc. from 1983 to 1987 and prior to 1985, he
was a faculty member at the City University of New York and Chancellor of the
New York City Public School System. Mr. Macchiarola has been a Trustee of the
Manville Personal Injury Trust since 1991. Mr. Macchiarola is Chairman of
Group's Audit Committee and a member of the Compensation Committee.
OTHER EXECUTIVE OFFICERS
The executive officers of Group are appointed by the Group Board, and serve
at the discretion of the Group Board. Other than Messrs. Baxter, Handler and
Klowden, for whom information is provided above, the following sets forth
information as to the other executive officers of Group:
GARY BURNISON, 37, has been the Senior Vice President -- Corporate
Development since July 1998, the Treasurer of Group since January 1997 and a
Director of JEFCO since November 1995. Mr. Burnison has also been responsible
for strategic planning and analysis for Jefferies. Prior to November, 1995, Mr.
Burnison was a Partner with KPMG Peat Marwick ("KPMG") responsible for its
Investment Banking and Advisory practice in the Southwestern U.S.
JERRY M. GLUCK, 51, has been Secretary and General Counsel of Group and
JEFCO since May 1985 and a Director of JEFCO since November 1984. From March
1994 until September 1995, Mr. Gluck was the Secretary of ITGI.
CLARENCE T. SCHMITZ, 50, has been an Executive Vice President and Chief
Financial Officer of Group and an Executive Vice President and a Director of
JEFCO since February 1995. Prior to 1990, Mr. Schmitz founded and chaired KPMG
International Mergers and Acquisitions Group. From 1990 until May 1993, Mr.
Schmitz was the Managing Partner of KPMG's Los Angeles Business Unit and a
member of KPMG's Board of Directors. From June 1993 until January 1995, Mr.
Schmitz was the National Managing Partner for KPMG's Manufacturing, Retailing
and Distribution line of business, and was a member of KPMG's Management
Committee.
MAXINE SYRJAMAKI, 54, has been Controller of Group since May 1987, an
Executive Vice President of JEFCO since November 1986 and the Chief Financial
Officer and a director of JEFCO since September 1984.
RAYMOND L. KILLIAN, JR., 61, as Chairman, President and Chief Executive
officer of Group's subsidiary, ITGI, is an executive officer of Group. Mr.
Killian has been the Chairman of the Board of ITGI since January 1997 and a
director of ITGI since March 1994. Mr. Killian served as the President and Chief
Executive Officer of ITGI from March 1994 through January 1997 and has resumed
his service in such capacity since the death of Scott Mason, President and Chief
Executive Officer of ITGI in September 1998. He has directed the activities of
ITG since 1987 and has been Chairman of the Board of ITG since 1977. Mr. Killian
was a director of Group from January 1997 to January 1999, was an Executive Vice
President of Group from 1985 to 1995, a director and an Executive Vice President
of JEFCO from 1985 to 1991 and served as National Sales Manager of JEFCO from
1985 to 1990.
47
<PAGE> 50
ITEM 11. EXECUTIVE COMPENSATION.
The information presented in this Item 11 reports information without
giving effect to the proposed Transfers, Spin-Off and Merger. See Part I, Item
1. "Business -- Proposed Transfers, Spin-Off and Merger Transactions."
EXECUTIVE COMPENSATION
Shown below is information concerning the annual and long-term compensation
for services in all capacities to Group for the fiscal years ended December 31,
1998, 1997 and 1996 for the Chief Executive Officer and four most highly
compensated executive officers of Group as of December 31, 1998, all of whom
will serve as executive officers of New JEF in connection with the Spin-Off, and
for the two individuals who served during fiscal 1998 as Chief Executive Officer
of ITGI (collectively, the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION(1) LONG-TERM COMPENSATION
--------------------------------- -------------------------------------
AWARDS PAYOUTS
------------------------ ---------
(A) (B) (C) (D) (F) (G) (H)
(E) SECURITIES (I)
OTHER UNDER- ALL
ANNUAL RESTRICTED LYING OTHER
COMPEN- STOCK OPTIONS/ LTIP COMPEN-
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS SATION(2) AWARD(S) SARS PAYOUTS SATION(3)
--------------------------- ---- ------- ---------- --------- ---------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Frank E. Baxter................ 1998 400,000 818,918 15,848 1,638,082(4) -- 1,487,660(5) 81,004
Chairman and Chief 1997 400,000 818,918 16,228 2,088,082 72,000 2,628,322 90,940
Executive Officer of 1996 400,000 601,240 12,289 150,000 -- 1,465,857 77,504
Group
Jerry M. Gluck................. 1998 214,000 166,000 4,299 79,448(6) -- -- 33,172
Secretary and General 1997 214,000 161,000 3,842 -- 10,000 -- 30,527
Counsel of Group 1996 214,000 131,000 2,802 -- -- -- 26,853
Richard B. Handler............. 1998 250,000 8,135,197 15,963 3,320,061(6) -- -- 78,485
Executive Vice President 1997 500,000 17,105,403 14,971 -- -- -- 82,826
of Group and Manager 1996 500,000 7,897,172 14,005 -- -- -- 84,561
of the Taxable Fixed Income
Division of Jefferies
Michael L. Klowden............. 1998 300,000 1,023,000 15,664 826,411(7) -- -- 62,662
President and Chief 1997 300,000 1,050,750 13,405 650,250 40,000 -- 54,239
Operating Officer 1996 275,000 825,000 11,394 275,000 126,000 -- 33,759
of Group
Clarence T. Schmitz............ 1998 275,000 756,750 14,596 294,969(7) -- -- 36,740
Executive Vice President 1997 275,000 703,500 13,538 234,500 10,000 -- 31,273
and Chief Financial 1996 275,000 693,750 8,767 231,250 106,000 -- 22,305
Officer of Group
Raymond L. Killian, Jr.(8)..... 1998 300,000 1,672,477 53,624 -- -- -- 54,632
Chairman, President and 1997 300,000 475,957 5,483 -- -- -- 68,294
Chief Executive Officer 1996 295,184 725,957 11,477 -- -- -- 59,981
of ITGI
Scott P. Mason(9).............. 1998 219,423 956,250 26,708 -- -- -- 6,988
Former President and 1997 296,538 549,557 11,600 -- 1,000,000(10) -- 8,216
Chief Executive Officer 1996 240,580(11) -- -- -- -- -- --
of ITGI
</TABLE>
- ---------------
(1) The amounts shown include cash and non-cash compensation earned by the
Named Executive Officers as well as amounts earned but deferred at the
election of those Named Executive Officers.
(2) Each Named Executive Officer participating in the Group CAP Plan was
credited with units representing shares of Group's Common Stock ("CSUs") at
a price equal to eighty-five percent (85%) of Group's average cost per
share of the shares available for distribution in the Group CAP Plan.
Group's average cost per share is based upon the average cost of shares
repurchased specifically for purposes of the Group CAP Plan and held as
treasury shares pending distribution upon settlement of CSUs. During each
calendar quarter, each Group CAP Plan participant defers receipt of
compensation, part of which is credited to his or her cash account. At the
end of the quarter, the cash account is debited by an amount equal to the
number of CSUs multiplied by 85% of the average cost per share. During
1998, the amount of the 15% discount on the CSUs with respect to each Named
Executive Officer was as follows: Mr. Baxter: $15,848; Mr. Gluck: $4,299;
Mr. Handler: $15,963; Mr. Klowden: $15,664; Mr. Schmitz: $14,596.
48
<PAGE> 51
(3) The total amounts for 1998 shown in the "All Other Compensation" column
include the following:
a. Group's matching contributions under Group's Section 401(k) plan.
During the plan year ended November 30, 1998, Mr. Baxter received
$12,650 as Group's matching contribution. Messrs. Gluck, Handler,
Klowden, Schmitz and Killian each received $13,800 as Group's matching
contributions. Mr. Mason received $2,500 as Group's matching
contribution.
b. Allocation resulting from forfeitures under Group's Employee Stock
Ownership Plan ("ESOP"). During the plan year ended November 30, 1998
Messrs. Baxter, Gluck, Handler, Klowden and Schmitz's accounts were
each credited with 3,095 shares at an original cost of $10.875 per
share, for a total of $34.00 each, as a result of such forfeitures.
c. Group's matching contributions to Group's Employee Stock Purchase Plan
("ESPP"). During the year ended December 31, 1998, the Named Executive
Officers received the following total matching contributions: Mr.
Baxter and Mr. Gluck: $5,400; and Mr. Klowden: $18,900; Messrs.
Handler, Schmitz, Killian and Mason did not receive matching
contributions in fiscal 1997.
d. Contributions of $2,683 and forfeiture allocations of $1,410 for each
Messrs. Baxter, Gluck, Handler, Klowden, Schmitz, Killian and Mason
under Group's Profit Sharing Plan.
e. Dividend equivalents and interest payments to the cash accounts of the
Named Executive Officers under the CAP paid at a rate equal to the
average percentage rate JEFCO paid on its margin accounts carrying
credit balances, as follows: Mr. Baxter: $11,731; Mr. Gluck: $1,751:
Mr. Handler: $12,357; Mr. Klowden: $4,342; Mr. Schmitz: $3,068; Mr.
Killian: $6,918; and Mr. Mason: $395.
f. An amount of "deemed interest" credited to each participant's CAP
account. The CAP participants defer a portion of their cash
compensation to Profit-Based Deferred Compensation Accounts. The amount
of "deemed interest" is determined by multiplying (1) the daily
weighted average amount in the CAP participant's Profit-Based Deferred
Compensation Account by (2) an interest rate equal to 100% of the
fully-diluted earnings per share (if any) of Common Stock for that
fiscal year divided by the fair market value of a share at the end of
the preceding year. In 1998, the Named Executive Officers received the
following amounts of such "deemed interest" under the CAP: Mr. Baxter:
$47,096; Mr. Gluck: $8,094; Mr. Handler: $48,201; Mr. Klowden: $21,493;
Mr. Schmitz: $15,745; and Mr. Killian: $29,821. Mr. Mason did not
receive any deemed interest in 1998.
(4) In prior years, incentive compensation which was deferred was considered
Long-Term Compensation and reported as "phantom shares" in a "Long-Term
Incentive Plan Awards Table" in the year awarded, and as "LTIP Payouts" in
the year it became payable. As a result of amendments to Mr. Baxter's
Incentive Compensation Plan under Group's Pay-for-Performance Plan,
compensation earned in 1998 is being reported as a grant of Restricted
Stock. However, compensation previously reported as grants of long-term
incentive compensation in 1996 continues to be treated as such; the
settlement of phantom shares which constitute such long-term incentive
compensation and as to which the risk of forfeiture lapsed in 1998 is
reported in the "LTIP Payouts" column for 1998. Under Mr. Baxter's
Incentive Compensation Plan for 1998, two-thirds of Mr. Baxter's annual
bonus was deferred, one-half of which generally was to become payable on
each of December 31, 1999 and December 31, 2000 (the "deferred incentive
compensation"). The amount of deferred incentive compensation was
calculated by dividing that portion of the 1998 incentive compensation
which was deferred ($1,638,082) by the closing price of Group's Common
Stock on December 31, 1998 ($49.625), and designating the result (33,009)
as "phantom shares" of Group's Common Stock. The amount of the deferred
incentive compensation actually paid to Mr. Baxter is determinable as of
the time it is to be paid, generally by multiplying (a) the number of
phantom shares by (b) the sum of (1) the closing price of Group's Common
Stock on the first trading day coincident with or following the close of
Group's fiscal year and (2) the amount of dividends, if any, declared on
shares of Group's Common Stock during the years of deferral. The total
number of phantom shares and shares of restricted stock held by Mr. Baxter
on December 31, 1998 (including phantom shares credited in respect of 1998
but excluding phantom shares settled as of that date) was 65,737, with an
aggregate value of $3,262,199. In 1999, in connection with the Spin-Off and
49
<PAGE> 52
Merger, the Compensation Committee terminated and settled on an accelerated
basis 53,016 phantom shares (including the phantom shares credited for
1998) and dividend equivalents relating thereto, with the amount paid for
each phantom share equal to the fair market value of a share of Common
Stock on the date of settlement.
(5) Pursuant to Mr. Baxter's Incentive Compensation Plan, a portion of Mr.
Baxter's 1996 incentive compensation was converted as of December 31, 1996
($20.1875) into 29,783 phantom shares which became payable on December 31,
1998, at a closing price of $49.625, together with dividend equivalents
totaling $9,679 for a long-term compensation payout of $1,487,660.
(6) Mr. Gluck's 1998 Restricted Stock Award represents 1,585 shares of
restricted stock granted as of January 27, 1999 at a price of $50.125 per
share, as a portion of his bonus for 1998. Mr. Handler's 1998 Restricted
Stock Award represents 66,903 shares of restricted stock granted as of
December 31, 1998 at a price of $49.625 per share, as a portion of his
bonus for 1998. These awards entitle the executive to receive dividends on
the shares of restricted stock. Mr. Gluck held no shares of restricted
stock at December 31, 1998, and Mr. Handler held no shares of restricted
stock at that date other than the Restricted Stock Award he received on
that date, the aggregate value of which is shown in the table.
(7) Under Mr. Klowden's and Mr. Schmitz's Incentive Compensation Plans, adopted
pursuant to Group's Pay-for-Performance Plan, one fourth of each of Mr.
Klowden's and Mr. Schmitz's annual bonus was deferred generally to become
payable on December 31, 1999 (the "deferred incentive compensation"). For
Mr. Klowden, the portion of the 1998 incentive compensation which has been
deferred ($341,000) was converted into 6,872 "phantom shares" based on the
closing price of Group's Common Stock on December 31, 1998 ($49.625). For
Mr. Schmitz, the portion of the 1998 incentive compensation which has been
deferred ($227,250) was converted into 4,579 "phantom shares" based on the
closing price of Group's Common Stock on December 31, 1998 ($49.625). The
amount of the incentive compensation to be actually paid to Mr. Klowden and
Mr. Schmitz is determinable as of the time it is to be paid, generally by
multiplying (a) the number of phantom shares by (b) the sum of (1) the
closing price of Group's Common Stock on the first trading day coincident
with or following the close of Group's fiscal year and (2) the amount of
dividends, if any, declared on shares of Group's Common Stock during the
years of deferral. Mr. Klowden's and Mr. Schmitz's 1998 Restricted Stock
Awards also includes 9,684 and 1,351 shares of restricted stock,
respectively, granted to Mr. Klowden and Mr. Schmitz on January 27, 1999
when the price was $50.125 per share for an aggregate of $485,411 and
$67,719, respectively, as a portion of their bonuses for 1998. These
Restricted Stock Awards vest one year after the date of grant, and entitle
the executive to receive dividends on the shares of restricted stock. The
total number of phantom shares and shares of restricted stock held by Mr.
Klowden and Mr. Schmitz at December 31, 1998 (including phantom shares
credited in respect of 1998 but excluding phantom shares settled as of that
date and excluding Restricted Stock Awards granted in 1999 in respect of
1998 performance) were 15,353 and 4,579, respectively, with an aggregate
value of $761,893 and $227,233, respectively. In 1999, in connection with
the Spin-Off and Merger, the Compensation Committee terminated and settled
on an accelerated basis the phantom shares credited for 1998 to Mr. Klowden
and Mr. Schmitz by converting each phantom share to a cash obligation equal
to the fair market value of a share of Common Stock on the date of
settlement.
(8) Mr. Killian served as President and Chief Executive Officer of ITGI from
1994 to 1997 and has served as President and Chief Executive Officer since
September 1998.
(9) Mr. Mason died on September 7, 1998.
(10) Represents grant of ITGI stock options by ITGI.
(11) Represents amounts paid by ITGI to Mr. Mason in his capacity as ITGI's
consultant during 1996. No stock options were granted by Group to the Named
Executive Officers during 1998.
50
<PAGE> 53
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
BENEFICIAL OWNERSHIP OF GROUP COMMON STOCK BY DIRECTORS, OFFICERS AND
PRINCIPAL STOCKHOLDERS OF GROUP
The following table sets forth certain information regarding beneficial
ownership of Group Common Stock by (1) each person known by Group to
beneficially own more than 5% of Group's Common Stock, (2) each Director, (3)
each Executive Officer named in the Summary Compensation Table and (4) all
Directors and Executive Officers as a group. The information set forth below is
as of March 1, 1999. Information regarding stockholders other than Directors,
Executive Officers and employee benefit plans is based upon information
contained in Schedules 13D or 13G filed with the SEC and furnished to Group by
such stockholders. The number of shares beneficially owned by each stockholder
and the percentage of the outstanding Common Stock those shares represent
include shares that may be acquired by that stockholder within 60 days through
the exercise of any option, warrant or right. Unless otherwise indicated in a
footnote and subject to applicable community property and similar statutes, each
person listed as the beneficial owner of the shares possesses sole voting and
dispositive power with respect to such shares. The mailing address of the
parties listed below is Group's principal business address unless otherwise
indicated.
<TABLE>
<CAPTION>
SHARES OF PERCENTAGE OF
COMMON STOCK COMMON STOCK
BENEFICIALLY BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED OWNED
------------------------------------ ------------ -------------
<S> <C> <C>
Jefferies Group, Inc. Employee Stock Ownership Plan.... 2,074,165(1) 8.9%
Tweedy, Browne Company L.P. and Affiliates............. 1,689,744(2) 7.3%
52 Vanderbilt Ave., 8th Floor
New York, New York 10017
Frank E. Baxter........................................ 1,562,863(3) 6.7%
The Guardian Life Insurance Company Of America
and Affiliates....................................... 1,182,308(4) 5.1%
201 Park Avenue South
New York, New York 10003
Richard B. Handler..................................... 572,263(5) 2.5%
Raymond L. Killian, Jr. ............................... 332,256(6) 1.4%
Michael L. Klowden..................................... 259,542(7) 1.1%
Clarence T. Schmitz.................................... 150,130(8) *
Tracy G. Herrick....................................... 53,503(9) *
Richard G. Dooley...................................... 64,436(10) *
Frank J. Macchiarola................................... 53,586(11) *
Jerry M. Gluck......................................... 43,449(12) *
Sheldon B. Lubar....................................... 10,472(13) *
All Directors and Executive Officers................... 3,162,681(14) 13.6%
</TABLE>
- ---------------
* The percentage of shares beneficially owned does not exceed one percent of
the class.
(1) Amounts reported above are based upon information supplied by the ESOP as
of December 31, 1998. The terms of the ESOP provide for the voting rights
associated with the shares held by the ESOP to be passed through and
exercised exclusively by the participants in the ESOP to the extent that
such securities are allocated to a participant's account. See "Management
of Group and New JEF -- Impact of the Spin-Off on Group's Employee Benefit
Plans." Shares held by the ESOP and allocated to the accounts of Directors
and Executive Officers are indicated in the ESOP figure referenced above
and are also included elsewhere in the table and in the succeeding notes to
the table, where appropriate. The ESOP and the Trustee of the ESOP (Wells
Fargo Bank) may be deemed to have shared dispositive power over the shares
held by the ESOP. The Board of Directors of Group appoints the members of
the committee which serves as the Plan Administrator of the ESOP. Messrs.
Frank E. Baxter, a Director of Group, Alan D. Browning, an Executive Vice
President of JEFCO, and Melvin W. Locke, Jr., Director
51
<PAGE> 54
of Human Resources of Group, presently serve on the committee. These
individuals each disclaim beneficial ownership of the shares held by the
ESOP except those shares allocated to his ESOP account.
(2) Tweedy, Browne Company L.P., a Delaware limited partnership ("TBC"),
together with TBK Partners, L.P., a Delaware limited partnership ("TBK"),
and Vanderbilt Partners L.P., a Delaware limited partnership
("Vanderbilt"), filed a combined statement on Schedule 13D dated and
reporting beneficial ownership at February 6, 1997, and as of the date
hereof, had not filed an amended Schedule 13D. The holdings for TBC and
related entities are therefore based on the 1997 Schedule 13D, as adjusted
for the December 1997 Stock Split. As adjusted, TBC reported beneficial
ownership of 1,405,860 shares (6.8% of the outstanding class), with sole
voting power over 1,211,000 shares and shared dispositive power over all
1,405,860 shares. TBK reported having sole voting and dispositive power
over 226,040 shares. Vanderbilt reported having sole voting and dispositive
power over 57,844 shares. The aggregate number of shares with respect to
which TBC, TBK and Vanderbilt could be deemed to be the beneficial owner is
1,689,744 shares (8.2% of the outstanding class). As of February 6, 1997,
the three general partners in Vanderbilt (Christopher H. Browne, William H.
Browne, and John D. Spears) were the three general partners of TBC and are
also three of the four general partners of TBK (Thomas P. Knapp was also a
general partner of TBK, but is not a general partner of TBC or Vanderbilt).
The general partners in each of TBC, TBK and Vanderbilt, as the case may
be, solely by reason of their positions as such, may be deemed to have
shared power to vote and dispose of the shares held by TBC, TBK, and
Vanderbilt, respectively.
(3) Includes 9,026 shares Mr. Baxter holds as custodian for his children's
accounts; 34,900 shares held under the ESOP; and 298,008 shares held under
the PSP. Participants in the ESOP have sole voting power and no dispositive
power over shares allocated to their ESOP accounts. Participants in the PSP
have sole voting power and limited dispositive power over shares allocated
to their PSP accounts. Mr. Baxter also owns 4,122 shares (less than 1% of
the outstanding class) of the common stock of ITGI.
(4) The Guardian Life Insurance Company of America ("Guardian"), Guardian
Investor Services Corporation ("GISC"), The Guardian Park Ave. Fund
("GPAF"), The Guardian Stock Fund, Inc. ("GSF"), The Guardian Park Avenue
Small Cap Fund ("GPASCF"), The Guardian Small Cap Stock Fund, Inc.
("GSCSF"), The Guardian Life Insurance Company of America Master Pension
Trust ("Guardian MPT"), and The Guardian Employees' Incentive Savings Plan
("GEISP") filed a group Schedule 13G dated February 11, 1998, reporting
beneficial ownership at December 31, 1997. The members of the group
reported having voting and dispositive power as follows: Guardian reported
sole voting and dispositive power over 497,736 shares and shared voting and
dispositive power over 132,172 shares; GISC reported shared voting and
dispositive power over 552,400 shares; GPAF reported shared voting and
dispositive power over 200,000 shares; GSF reported shared voting and
dispositive power over 338,000 shares; GPASCF reported shared voting and
dispositive power over 8,300 shares; GSCSF reported shared voting and
dispositive power over 6,100 shares; Guardian MPT reported shared voting
and dispositive power over 52,172 shares; and GEISP reported shared voting
and dispositive power over 80,000 shares.
(5) Includes 10,544 shares held under the ESOP.
(6) Includes 26,176 shares held under the ESOP, 30,325 shares held under the
PSP and 4,920 shares held by members of Mr. Killian's immediate family, as
to which he disclaims beneficial ownership. Mr. Killian also owns 564,836
shares (2.9% of the outstanding class) of ITGI common stock, 548,978 of
which are subject to immediately exercisable options.
(7) Includes 40,000 shares subject to immediately exercisable options; and 87
shares held under the ESOP. Mr. Klowden also owns 1,000 shares (less than
1% of the outstanding class) of ITGI common stock.
52
<PAGE> 55
(8) Includes 87 shares held under the ESOP, and 3,065 shares under the PSP.
(9) Includes 18,000 shares subject to immediately exercisable options and
13,048 held by the Tracy G. Herrick, Inc. D.B.P.P. for the benefit of Mr.
Herrick as to which Mr. Herrick has shared investment power.
(10) Includes 25,612 shares subject to immediately exercisable options. Mr.
Dooley also beneficially owns 22,000 shares (less than 1% of the
outstanding class) of ITGI Common Stock, 15,000 of which are subject to
immediately exercisable options.
(11) Includes 21,612 shares subject to immediately exercisable options. Mr.
Macchiarola also beneficially owns 6,600 shares (less than 1% of the
outstanding class) of ITGI Common Stock.
(12) Includes 10,000 shares subject to immediately exercisable options, 20,633
shares held by the Trustee of the ESOP, and 661 shares held by the Trustee
of the PSP.
(13) Includes 2,134 shares held by Mr. Lubar's spouse and 5,353 shares subject
to immediately exercisable options.
(14) Includes 313,577 shares subject to options, all of which are immediately
exercisable, 113,720 shares held under the ESOP for Executive Officers as a
group and 334,004 shares held under the PSP for Executive Officers as a
group. In addition, all Directors and current Executive Officers as a group
beneficially own 598,558 shares (3.2% of the outstanding class) of ITGI
Common Stock, 563,978 of which are subject to immediately exercisable
options.
53
<PAGE> 56
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Group has extended credit to certain of its Directors, Officers, employees
and stockholders in connection with their purchase of securities on margin.
Receivables from its Officers and Directors were $880,310 at December 31, 1998.
Such extensions of credit were made in the ordinary course of business, on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons and did
not involve more than the normal risk of collectibility or present other
unfavorable features.
During 1998, in the ordinary course of business, Group executed securities
transactions on behalf of Tweedy, Browne Company L.P., a stockholder of Group
beneficially owning in excess of 5% of Group's Common Stock, and received
commissions of approximately $85,331.
During 1998, in the ordinary course of business, the Group's subsidiaries
executed securities transactions on behalf of Guardian Life Insurance Company
and its affiliates, stockholders of Group beneficially owning in excess of 5% of
Group's Common Stock, and received commissions of approximately $992,867.
During fiscal year 1998, Tracy G. Herrick, a Director of Group, provided
Group with certain financial and other consulting services. Mr. Herrick was paid
$126,000 for his services.
Group believes the foregoing transactions were on terms no less favorable
to Group than could have been obtained from unaffiliated parties. The Board of
Directors has adopted a policy which provides that Group will nor enter into any
transactions with its Directors, Officers, or affiliates (not including
companies consolidated with it for financial reporting purposes), other than
those related to compensation or expense reimbursement and other than those
having terms no less favorable to Group than could have been obtained from
unaffiliated parties, unless approved by Group's disinterested and independent
Directors.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.
<TABLE>
<CAPTION>
PAGES
-----
<S> <C> <C>
(a)1. FINANCIAL STATEMENTS
Included in Part II of this report:
Independent Auditors' Report................................ 20
Consolidated Statements of Financial Condition.............. 21
Consolidated Statements of Earnings......................... 22
Consolidated Statements of Changes in Stockholders'
Equity...................................................... 23
Consolidated Statements of Cash Flows....................... 24
Notes to Consolidated Financial Statements.................. 25
</TABLE>
All Schedules are omitted because they are not applicable or because the
required information is shown in the financial statements or notes thereto.
(a)3. EXHIBITS
<TABLE>
<C> <S>
(3.1) Amended and Restated Certificate of Incorporation is
incorporated by reference to Exhibit 3.1 of the Registrant's
Form 10-K filed for the fiscal year ended December 31, 1987.
(3.2) Amended By-Laws are incorporated by reference to Exhibit 3.2
of the Registrant's Form 10-K filed for the fiscal year
ended December 31, 1986.
</TABLE>
54
<PAGE> 57
<TABLE>
<C> <S>
(4.1) Indenture dated as of August 18, 1997 by and between the
Registrant and the Bank of New York as Trustee including
form of 7 1/2% Series B Senior Notes due 2007 is
incorporated by reference to Exhibit 4.1 to Registrant's
Registration Statement on Form S-4 (No. 333-40263) filed on
November 14, 1997 including amendments thereto.
(4.2) Registration Rights Agreement dated as of August 18, 1997 by
and among the Registrant and the purchasers of the
Registrant's 7 1/2% Series B Senior Notes due 2007 is
incorporated by reference to Exhibit 10.2 to Registrant's
Registration Statement on Form S-4 (No. 333-40263) filed on
November 14, 1997 including amendments thereto.
(10.1) Incentive Compensation Plan for Frank E. Baxter, Chairman,
President and Chief Executive Officer, Jefferies Group, Inc.
is incorporated by reference to Exhibit 10.1 of Registrant's
Form 10-K filed for the fiscal year ended December 31, 1992.
(10.2) Form of Employment Agreement between Investment Technology
Group, Inc. and Raymond L. Killian, Jr. is incorporated by
reference to Exhibit 10.3.2 of Investment Technology Group,
Inc.'s Registration Statement on Form S-1 (No. 33-76474)
filed on March 15, 1994, including amendments thereto.
(10.3) Amendment No. 2 to Employment Agreement between Investment
Technology Group, Inc., ITG Inc. and Raymond L. Killian, Jr.
is incorporated by reference to Exhibit 3.2A of Investment
Technology Group, Inc.'s Form 10-K for the period ended
December 31, 1996.
(10.4) Employment Agreement between Scott P. Mason and Investment
Technology Group, Inc. dated as of January 6, 1997, is
incorporated by reference to Exhibit 10.3.18 of Investment
Technology Group, Inc.'s Form 10-K filed for the fiscal year
ended December 31, 1996.
(10.5) Jefferies Group, Inc. 1983 Incentive Stock Option Plan is
incorporated by reference to Registrant's Registration
Statement on Form S-8 (No. 2-94727) filed on December 6,
1984.
(10.6) 1985 Incentive Stock Option Plan of Jefferies Group, Inc. is
incorporated by reference to Registrant's Registration
Statement on Form S-8 (No. 33-17065) filed on September 8,
1987.
(10.7) Jefferies Group, Inc. 1985 Non-qualified Stock Option Plan
is incorporated by reference to Registrant's Registration
Statement on Form S-8 (No. 33-17065) filed on September 8,
1987.
(10.8) Jefferies Group, Inc. 1993 Stock Ownership and Long-Term
Incentive Plan as Amended and Restated is incorporated by
reference to Appendix B to the Registrant's Proxy Statement
filed on March 29, 1997.
(10.9) Jefferies Group, Inc. Capital Accumulation Plan for Key
Employees is incorporated by reference to Registrant's
Registration Statement on Form S-8 (No. 33-64490) filed on
June 15, 1993.
(10.10) Jefferies Group, Inc. Non-Employee Directors' Stock Option
Plan is incorporated by reference to Appendix C of
Registrant's Proxy Statement filed on April 4, 1994.
(10.11) Jefferies Group, Inc. Pay-for-Performance Incentive Plan is
incorporated by reference to Appendix B of Registrant's
Proxy Statement filed on April 4, 1994.
(10.12) Jefferies Group, Inc. Non-Employee Directors' Deferred
Compensation Plan is incorporated by reference to Appendix B
of Registrant's Proxy Statement filed on March 29, 1996.
</TABLE>
55
<PAGE> 58
<TABLE>
<C> <S>
(10.13) Jefferies Group, Inc. United Kingdom Capital Accumulation Plan for Key Employees is
incorporated by reference to Exhibit 10.13 of Registrant's Form 10-K filed for the fiscal
year ended December 31, 1996.
(10.14)+ Agreement and Plan of Merger, dated as of March 17, 1999, by and between Jefferies Group,
Inc. ("Group") and Investment Technology Group, Inc. ("ITGI").
(10.15)+ Distribution Agreement, dated as of March 17, 1999, by and between Group and JEF Holding
Company, Inc. ("New Jefferies").
(10.16)+ Tax Sharing and Indemnification Agreement, dated as of March 17, 1999, by and among ITGI,
Group and New Jefferies.
(10.17)+ Amended and Restated Tax Sharing Agreement, dated as of March 17, 1999, by and among ITGI,
Group and New Jefferies.
(10.18)+ Benefits Agreement, dated as of March 17, 1999, by and between Group and New Jefferies.
(10.19)+ Fully Disclosed Clearing Agreement, dated as of January 1, 1999, by and between Jefferies &
Company, Inc. and ITG Inc.
(10.20)+ Amendment No. 1 dated as of January 1, 1999 to Service Agreement dated March 15, 1994, by and
between Jefferies & Company, Inc. and ITG Inc.
(10.21)+ Execution Agreement, dated as of January 1, 1999, by and between W&D Securities, Inc. and ITG
Inc.
(10.22)+ Form of Pre-Closing and Escrow Agreement by and among The Bank of New York, Group, New
Jefferies and ITGI.
(21)* List of Subsidiaries of Registrant.
(23)* Consent of KPMG LLP.
(27) Financial Data Schedules
(99.1)* ITGI's 1998 Year 2000 discussion. An excerpt from ITGI's 1998 10-K.
</TABLE>
- ---------------
* Filed herewith.
+ To be filed as an Exhibit to the registrant's Form S-4 to be filed with the
SEC on March 18, 1999.
Exhibits 10.1 to and including 10.13 are management contracts or
compensatory plans or arrangements.
ALL OTHER EXHIBITS ARE OMITTED BECAUSE THEY ARE NOT APPLICABLE.
(b) The following reports on Form 8-K have been filed by the Registrant
during the fourth quarter of 1998.
On November 6, 1998, the Company filed a Form 8-K updating financial
information related to the previously announced plans to separate the Company's
100% owned subsidiary, Jefferies & Company, Inc., and its 80.5% owned
subsidiary, Investment Technology Group, Inc., through a proposed spin-off and
related transactions.
56
<PAGE> 59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
JEFFERIES GROUP, INC.
By /s/ FRANK E. BAXTER
------------------------------------
Frank E. Baxter
Chairman of the Board of Directors
Dated: March 17, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ FRANK E. BAXTER Chairman of the Board of March 17, 1999
- -------------------------------------------------------- Directors and Chief
Frank E. Baxter Executive Officer
/s/ MICHAEL L. KLOWDEN President and Chief March 17, 1999
- -------------------------------------------------------- Operating Officer
Michael L. Klowden
/s/ CLARENCE T. SCHMITZ Executive Vice President and March 17, 1999
- -------------------------------------------------------- Chief Financial Officer
Clarence T. Schmitz
/s/ RICHARD G. DOOLEY Director March 17, 1999
- --------------------------------------------------------
Richard G. Dooley
/s/ RICHARD B. HANDLER Director March 17, 1999
- --------------------------------------------------------
Richard B. Handler
/s/ TRACY G. HERRICK Director March 17, 1999
- --------------------------------------------------------
Tracy G. Herrick
/s/ SHELDON B. LUBAR Director March 17, 1999
- --------------------------------------------------------
Sheldon B. Lubar
/s/ FRANK J. MACCHIAROLA Director March 17, 1999
- --------------------------------------------------------
Frank J. Macchiarola
</TABLE>
57
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF JEFFERIES GROUP, INC.
NAME OF SUBSIDIARY PLACE OF INCORPORATION
- ------------------ ----------------------
Jefferies & Company, Inc. Delaware
Investment Technology Group, Inc. Delaware
Jefferies International Limited England
Jefferies Pacific Limited Hong Kong
Jefferies Analytical Trading Group, Inc. Delaware
JEF Investment Company Delaware
JEF Holding Company, Inc. Delaware
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Jefferies Group, Inc.:
We consent to incorporation by reference in the Registration Statements No.
2-94727 dated December 6, 1984; No. 33-17065 dated September 8, 1987; No.
33-19741 dated January 21, 1998; No. 33-64318 dated May 27, 1993; No. 33-64490
dated June 15, 1993; No. 33-52139 dated February 3, 1994; No. 33-54373 dated
June 30, 1994, and No. 33-02489 dated April 12, 1996, all on Form S-8, and No.
33-54265 dated July 14, 1994, and No. 33-40263 dated December 5, 1997, both on
Form S-4 of Jefferies Group, Inc. of our report dated January 19, 1999, except
as to note 19 to the consolidated financial statements, which is as of March 17,
1999, relating to the consolidated statements of financial condition of
Jefferies Group, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of earnings, changes in stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1998, which report appears in the December 31, 1998 annual report on Form 10-K
of Jefferies Group, Inc.
/s/ KPMG LLP
Los Angeles, California
March 17, 1999
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION AND THE CONSOLIDATED STATEMENTS
OF EARNINGS AS OF DECEMBER 31, 1998 AND FOR THE YEAR THEN ENDED AND THE NOTES
THERETO AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS FILED IN THE 1998 JEFFERIES GROUP, INC. 10-K FILING.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 172,505
<RECEIVABLES> 183,859
<SECURITIES-RESALE> 5,066
<SECURITIES-BORROWED> 1,922,691
<INSTRUMENTS-OWNED> 100,812
<PP&E> 40,186
<TOTAL-ASSETS> 2,683,640
<SHORT-TERM> 21,000
<PAYABLES> 243,808
<REPOS-SOLD> 5,061
<SECURITIES-LOANED> 1,580,811
<INSTRUMENTS-SOLD> 39,653
<LONG-TERM> 149,387
0
0
<COMMON> 234
<OTHER-SE> 334,541
<TOTAL-LIABILITY-AND-EQUITY> 2,683,640
<TRADING-REVENUE> 174,240
<INTEREST-DIVIDENDS> 90,799
<COMMISSIONS> 395,211
<INVESTMENT-BANKING-REVENUES> 126,651
<FEE-REVENUE> 0
<INTEREST-EXPENSE> 75,178
<COMPENSATION> 380,737
<INCOME-PRETAX> 138,192
<INCOME-PRE-EXTRAORDINARY> 138,192
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 69,682
<EPS-PRIMARY> 3.12
<EPS-DILUTED> 2.96
</TABLE>
<PAGE> 1
EXHIBIT 99.1
ITGI'S 1998 YEAR 2000 DISCUSSION
AN EXCERPT FROM ITGI'S 1998 10-K
THE YEAR 2000 ISSUE
Some computer systems and software products were originally designed to
accept two digit entries in the data code field. As a result, certain computer
systems and software packages will not be able to interpret dates beyond
December 31, 1999 and thus will interpret dates beginning January 1, 2000
incorrectly. This could potentially result in computer failure or
miscalculations, causing operating disruptions, including an inability to
process transactions, send invoices or engage in normal business operations.
Therefore, companies may have to upgrade or replace computer and software
systems in order to comply with the "Year 2000" requirements.
Strategy
We are well aware of and are actively addressing the Year 2000 issue and
the potential problems that can arise in any computer and software system.
Planning and evaluation work began in 1997 including the identification of those
systems affected. We established a "Year 2000 working group" to address the Year
2000 issue. We have targeted our efforts into three major areas: (1) vendors;
(2) company proprietary products; and (3) clients.
Vendors. Our ability to successfully meet the Year 2000 challenge is in
part dependent on our vendors. We have contacted our vendors to determine the
status of their Year 2000 programs and have created a database recording each
vendor's readiness status. Over 95% of our vendors have responded that their
systems are currently Year 2000 compliant, and substantially all or our vendors
have indicated that they expect their systems to be Year 2000 compliant by
September 30, 1999. Based upon the results of our testing to date, we are
satisfied with the representations we have received from our vendors. We are in
the process of integrating Year 2000 compliant versions of our vendors' software
and hardware with our proprietary products.
Company Proprietary Products. We have evaluated our trading systems and
have endeavored to examine all code contained in our internally produced
software. We have completed regression testing of all mission critical systems
and released Year 2000 compliant versions of all such systems other than
QuantEX. We plan to complete date-forward testing of all mission critical
systems and release a Year 2000 compliant version of QuantEX by the end of June
1999. We also intend to participate in the Securities Industry Association's
industry-wide testing program in 1999.
Clients. We sent a letter explaining our Year 2000 strategy to all clients
in July 1999. In addition, we contacted clients on a project-by-project basis to
ascertain compatibility between our systems and changes made to the clients'
systems. We plan to provide point-to-point testing opportunities for our clients
starting in April 1999.
Contingency Planning
We are in the early stages of establishing a Year 2000 contingency plan to
deal with both internal and external failures of critical systems. The Year 2000
issue can affect all businesses that rely heavily on automated systems. Our Year
2000 contingency plan is therefore intended to address failures of internal
systems, client connections and connections to trading destinations, as well as
failures of major infrastructure components. We intend to have our contingency
plan in place by July 1999 and to update and refine such plan as needed on a
continuing basis. We believe, however, that such contingency plan will not
provide satisfactory solutions for our worst-case scenario -- the general
failure of computer and communication systems relied upon by the securities
industry, such as the systems provided by long distance telephone companies, the
stock exchanges, Nasdaq, The Depository Trust Company and ADP Brokerage
Services, and the failure of Jefferies & Company and W&D to provide services
under their clearing and execution agreement with us. Such failure
<PAGE> 2
would prevent us from operating in whole or in part until such systems or
services have been restored and could have a material adverse effect on us.
In the event any of our internally developed systems fails, we will
undertake to remediate such system on an emergency basis at the time of such
failure. To ensure that adequate staff will be available to handle any such
emergencies in January of 2000, we have imposed a moratorium on employee
vacations during the first two weeks of January 2000, and have made arrangements
to have a number of software development personnel (normally based in our Culver
City office) at our New York headquarters during the final week of December 1999
and the first week of January 2000. Our inability to remediate a failure of any
of our internally developed mission critical systems would prevent us from
operating in whole or in part until such systems have been restored and could
have a material adverse effect on us.
Costs
We do not believe that the costs incurred to ready our systems for the Year
2000 will have a material effect on our financial condition. Total costs for the
whole project are estimated to be between $2.5 and $3.0 million, which includes
the cost of personnel, consultants and software and hardware costs. Through
December 31, 1998, we have spent approximately $1.5 million on the Year 2000
project.
