e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005


o		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 1-14947

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)


Delaware		95-4719745

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

520 Madison Avenue, 12^th Floor, New York, New York		10022

(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (212) 284-2550

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 þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 58,083,213 shares as of the close of business September 30, 2005.

Page 1 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(Dollars in thousands, except per share amounts)


	September 30,			December 31,
	2005			2004
ASSETS
Cash and cash equivalents	$	220,369		$	284,111
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		671,136			553,720
Short term bond funds		6,989			6,861
Investments		116,795			97,586
Investments in managed funds		260,607			195,982
Securities borrowed		8,413,794			10,232,950
Receivable from brokers, dealers and clearing organizations		536,343			312,973
Receivable from customers		869,590			371,842
Securities owned		1,588,503			649,299
Securities pledged to creditors		77,806			597,434
Premises and equipment		67,003			57,749
Goodwill		209,576			134,936
Other assets		563,059			329,185

	$	13,601,570		$	13,824,628

LIABILITIES AND STOCKHOLDERS’ EQUITY
Bank loans	$	—		$	70,000
Securities loaned		7,998,627			9,330,980
Payable to brokers, dealers and clearing organizations		472,219			376,735
Payable to customers		1,208,124			702,200
Securities sold, not yet purchased		1,289,130			1,120,173
Accrued expenses and other liabilities		612,294			361,254

		11,580,394			11,961,342
Long-term debt		781,443			789,067
Minority interest		37,873			35,086

		12,399,710			12,785,495

STOCKHOLDERS’ EQUITY
Preferred stock, $.0001 par value. Authorized 10,000,000 shares; none issued		—			—
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 70,116,943 shares in 2005 and 66,700,773 shares in 2004		7			7
Additional paid-in capital		795,934			617,587
Unearned compensation		(144,964	)		(109,366	)
Retained earnings		766,110			677,464
Less:
Treasury stock, at cost, 12,033,730 shares in 2005 and 9,411,464 shares in 2004		(211,171	)		(149,039	)
Accumulated other comprehensive gain (loss):
Currency translation adjustments		2,812			9,348
Additional minimum pension liability		(6,868	)		(6,868	)

Total accumulated other comprehensive gain (loss)		(4,056	)		2,480

Total stockholders’ equity		1,201,860			1,039,133

	$	13,601,570		$	13,824,628

See accompanying unaudited notes to consolidated financial statements.

Page 3 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
(In thousands, except per share and ratio amounts)


	Three Months Ended						Nine Months Ended
	Sept. 30			Sept. 30,			Sept. 30,			Sept. 30,
	2005			2004			2005			2004
Revenues:
Commissions	$	58,157		$	62,020		$	185,304		$	200,325
Principal transactions		104,415			109,012			261,887			277,669
Investment banking		107,556			72,122			327,517			247,066
Asset management fees and investment income from managed funds		21,667			11,618			63,385			54,030
Interest		81,467			35,948			212,738			85,132
Other		4,822			2,382			15,309			9,144

Total revenues		378,084			293,102			1,066,140			873,366
Interest expense		78,804			39,316			204,292			93,206

Revenues, net of interest expense		299,280			253,786			861,848			780,160


Non-interest expenses:
Compensation and benefits		167,033			141,434			481,024			436,191
Floor brokerage and clearing fees		11,059			12,770			35,350			39,750
Technology and communications		16,432			16,029			50,053			48,632
Occupancy and equipment rental		10,936			10,250			32,852			29,306
Business development		9,651			7,189			27,698			24,529
Other		16,632			11,164			44,851			30,907

Total non-interest expenses		231,743			198,836			671,828			609,315


Earnings before income taxes and minority interest		67,537			54,950			190,020			170,845
Income taxes		26,143			21,516			73,209			63,980

Earnings before minority interest		41,394			33,434			116,811			106,865
Minority interest in earnings of consolidated subsidiaries, net		2,799			1,159			6,107			10,895

Net earnings	$	38,595		$	32,275		$	110,704		$	95,970


Earnings per share:
Basic	$	0.62		$	0.56		$	1.80		$	1.68
Diluted	$	0.57		$	0.51		$	1.64		$	1.51

Weighted average shares:
Basic		62,224			57,833			61,434			57,233
Diluted		68,112			63,867			67,374			63,616

Fixed charge coverage ratio		5.6	X		4.8	X		5.4	X		5.6	X

See accompanying unaudited notes to consolidated financial statements.

Page 4 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND YEAR ENDED DECEMBER 31, 2004
(Dollars in thousands, except per share amounts)


	Nine Months			Year
	Ended			Ended
	September 30,			December 31,
	2005			2004
Common stock, par value $.0001 per share
Balance, beginning of year	$	7		$	6
Issued stock		—			1

Balance, end of period	$	7		$	7


Additional paid in capital
Balance, beginning of year	$	617,587		$	443,022
Stock-based grants (1)		125,752			148,567
Proceeds from exercise of stock options		29,062			10,184
Tax benefits		23,533			15,814

Balance, end of period	$	795,934		$	617,587


Unearned stock compensation
Balance, beginning of year	$	(109,366	)	$	(78,248	)
Grants		(105,629	)		(106,670	)
Amortization expense		48,491			54,935
Previously expensed compensation		16,795			13,904
Forfeitures		4,745			6,713

Balance, end of period	$	(144,964	)	$	(109,366	)


Retained earnings
Balance, beginning of year	$	677,464		$	567,632
Net earnings		110,704			131,366
Dividends		(22,058	)		(21,534	)

Balance, end of period	$	766,110		$	677,464


Treasury stock, at cost
Balance, beginning of year	$	(149,039	)	$	(91,908	)
Purchases		(69,951	)		(59,492	)
Returns / forfeitures		(3,525	)		(8,525	)
Issued		11,344			10,886

Balance, end of period	$	(211,171	)	$	(149,039	)


Accumulated other comprehensive income (loss)
Balance, beginning of year	$	2,480		$	(2,133	)
Currency adjustment		(6,536	)		4,017
Pension adjustment		—			596

Balance, end of period	$	(4,056	)	$	2,480


Net stockholders’ equity	$	1,201,860		$	1,039,133


(1)		Includes grants related to various compensation plans and acquisitions.

See accompanying unaudited notes to consolidated financial statements.

Page 5 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)


	Nine Months Ended
	Sept. 30,			Sept. 30,
	2005			2004

Cash flows from operating activities:

Net earnings	$	110,704		$	95,970


Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization		7,913			10,959
Accruals related to various benefit plans, stock issuances, net of forfeitures		70,975			93,752
Increase in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		(117,416	)		(233,521	)
(Increase) decrease in receivables:
Securities borrowed		1,819,112			(2,049,073	)
Brokers, dealers and clearing organizations		(234,576	)		(219,351	)
Customers		(513,173	)		(123,553	)
Increase in securities owned		(938,936	)		(196,524	)
Decrease (increase) in securities pledged to creditors		519,628			(67,901	)
Increase in other assets		(227,292	)		(31,979	)
Increase (decrease) in operating payables:
Securities loaned		(1,332,353	)		1,457,969
Brokers, dealers and clearing organizations		104,829			432,025
Customers		519,712			211,076
Increase in securities sold, not yet purchased		168,957			352,769
Increase in accrued expenses and other liabilities		268,577			7,203
Increase (decrease) in minority interest		2,787			(14,232	)


Total adjustments		118,744			(370,381	)


Net cash provided by (used in) operating activities		229,448			(274,411	)

Continued on next page.

Page 6 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — CONTINUED (Unaudited)
(Dollars in thousands)


	Nine Months Ended
	Sept. 30,			Sept. 30,
	2005			2004

Cash flows from investing activities:
(Increase) decrease in short term bond funds		(128	)		21,010
Increase in investments		(18,388	)		(2,043	)
Increase in investments in managed funds		(64,625	)		(57,298	)
Net additional acquisition payments		(58,336	)		(5,941	)
Purchase of premises and equipment		(16,773	)		(10,658	)


Net cash used in investing activities		(158,250	)		(54,930	)


Cash flows from financing activities:
Net proceeds from (payments on):
Bank loans		(70,000	)		176,000
Issuance of 5 1/2% Senior Notes		—			347,809
Retirement of 10% Senior Notes		—			(300	)
Repurchase of treasury stock		(69,951	)		(59,382	)
Dividends		(22,058	)		(15,539	)
Exercise of stock options, not including tax benefits		29,062			8,959


Net cash (used in) provided by financing activities		(132,947	)		457,547


Effect of foreign currency translation on cash		(1,993	)		(558	)


Net (decrease) increase in cash and cash equivalents		(63,742	)		127,648

Cash and cash equivalents — beginning of period		284,111			107,876


Cash and cash equivalents — end of period	$	220,369		$	235,524


Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	208,510		$	92,845
Income taxes	$	54,344		$	59,045

Helix Associates acquisition:
Fair value of assets acquired, including goodwill	$	40,151
Liabilities assumed		(3,621	)
Stock issued (315,597 shares)		(9,498	)

Cash paid for acquisition	$	27,032


Randall & Dewey acquisition:
Fair value of assets acquired, including goodwill	$	48,578
Stock issued (456,442 shares)		(17,500	)

Cash paid for acquisition	$	31,078

See accompanying unaudited notes to consolidated financial statements.

Page 7 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Jefferies Group, Inc. and all its subsidiaries (together, the “Company”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc., formerly known as Helfant Group, Inc. (“Jefferies Execution”), Jefferies International Limited, Jefferies Asset Management, LLC, Jefferies Financial Products, LLC and all other entities in which the Company has a controlling financial interest or is the “primary beneficiary”, including Jefferies Employees Opportunity Fund, LLC (“JEOF”). The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain reclassifications have been made to previously reported balances to conform to the current presentation. Operating results for the nine-month period ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. These unaudited consolidated financial statements of the Company should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Beginning with the quarter ended September 30, 2004, the Company changed its quarter end to the last day of the calendar quarter from the last Friday of the quarter. With the expansion of its businesses and products, the Company believes calendar period reporting is more consistent with its operating cycle, as well as the reporting periods of industry peers.

Principles of Consolidation

The Company’s policy is to consolidate all entities in which it owns more than 50% of the outstanding voting stock and has control. In addition, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), as revised, the Company consolidates entities which lack characteristics of an operating entity or business for which it is the primary beneficiary. Under FIN 46R, the primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests. In situations where the Company has significant influence but not control, the Company applies the equity method of accounting. In those cases where the Company’s investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation, or when we hold at least 3% of a limited partnership interest.

All material intercompany accounts and transactions are eliminated in consolidation.

Revenue Recognition Policies

Commissions. All customer securities transactions are reported on the consolidated statement of financial condition on a settlement date basis with related income reported on a trade-date basis. Under clearing agreements, the Company clears trades for unaffiliated correspondent brokers and retains a portion of commissions as a fee for its services. Correspondent clearing revenues are included in other revenue.

Page 9 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Principal Transactions. Securities and other inventory positions owned, securities and other inventory positions pledged and securities and other inventory positions sold, but not yet purchased (all of which are recorded on a trade-date basis) are valued at market or fair value, as appropriate, with unrealized gains and losses reflected in principal transactions in the Consolidated Statement of Earnings on a trade date basis. The Company follows the American Institute of Certified Public Accountants (“AICPA”) Audit and Accounting Guide, “Brokers and Dealers in Securities” (the “Guide”) when determining market or fair value for financial instruments. Market value generally is determined based on listed prices or broker quotes. In certain instances, such price quotations may be deemed unreliable when the instruments are thinly traded or when we hold a substantial block of a particular security and the listed price is not deemed to be readily realizable. In accordance with the Guide, in these instances the Company determines fair value based on management’s best estimate, giving appropriate consideration to reported prices and the extent of public trading in similar securities, the discount from the listed price associated with the cost at the date of acquisition, and the size of the position held in relation to the liquidity in the market, among other factors. When the size of our holding of a listed security is likely to impair our ability to realize the quoted market price, the Company records the position at a discount to the quoted price reflecting our best estimate of fair value. In such instances, the Company generally determines fair value with reference to the discount associated with the acquisition price of the security. When listed prices or broker quotes are not available, the Company determines fair value based on pricing models or other valuation techniques, including the use of implied pricing from similar instruments. The Company typically uses pricing models to derive fair value based on the net present value of estimated future cash flows including adjustments, when appropriate, for liquidity, credit and/or other factors.

Investment Banking. Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments are recorded when the services related to the underlying transaction are completed under the terms of the assignment or engagement. Unreimbursed expenses associated with these transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded. Revenue associated with underwriting, restructuring and advisory engagements is presented net of unreimbursed deal related expenses.

Asset Management Fees and Investment Income From Managed Funds. Asset management fees and investment income from managed funds include revenues the Company receives from management, administrative and performance fees from funds managed by the Company, revenues from management and performance fees the Company receives from third-party managed funds, and investment income from the Company’s investments in these funds. The Company receives fees in connection with management and investment advisory services performed for various funds and managed accounts, including two Jefferies Partners Opportunity funds, Jefferies Paragon Fund, Jefferies Real Asset Fund, Jefferies RTS Fund, Victoria Falls CLO and third-party managed funds. These fees are based on the value of assets under management and may include performance fees based upon the performance of the funds. Management and administrative fees are generally recognized over the period that the related service is provided based upon the beginning or ending Net Asset Value of the relevant period. Generally, performance fees are earned when the return on assets under management exceeds certain benchmark returns, “high-water marks”, or other performance targets. Performance fees are generally accrued on a monthly basis and are not subject to adjustment once the measurement period ends (generally quarterly or annually) and performance fees have been realized.

Interest Revenue and Expense. We recognize contractual interest on securities and other inventory positions owned and securities and other inventory positions sold but not yet purchased on an accrual basis as a component of interest revenue and interest expense, respectively. Interest flows on derivative transactions and dividends are included as part of the mark-to-market valuation of these contracts in principal transactions in the Consolidated Statement of Income and are not recognized as a component of interest revenue or expense. We account for our short-term and long-term borrowings on an accrual basis with related interest recorded as interest revenue or interest expense, as applicable.

Page 10 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Cash Equivalents

Cash equivalents include highly liquid investments not held for resale with original maturities of three months or less.

Cash and Securities Segregated and on Deposit for Regulatory Purposes or Deposited With Clearing and Depository Organizations

In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies & Company, Inc., as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, deposits with clearing and depository organizations are included in this caption.

Foreign Currency Translation

Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at exchange rates at the end of a period. Revenues and expenses are translated at average exchange rates during the period. The gains or losses resulting from translating foreign currency financial statements into U.S. dollars, net of hedging gains or losses and taxes, if any, are included in accumulated other comprehensive income, a component of stockholders’ equity. Gains or losses resulting from foreign currency transactions are included in the Consolidated Statement of Earnings.

Investments

Investments include direct investments in limited liability companies and partnerships that make investments in private equity companies, strategic investments in financial service entities and other investments. In situations where the Company has significant influence but not control, the Company applies the equity method of accounting. In those cases where the Company’s investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation or when we hold at least 3% of a limited partnership interest. Factors considered in valuing investments where significant influence does not exist include, without limitation, available market prices, reported net asset values, type of security, purchase price, purchases of the same or similar securities by other investors, marketability, restrictions on disposition, current financial position and operating results of the issuer, and other pertinent information.

Investments in Managed Funds

Investments in managed funds includes the Company’s investments in funds managed by the Company and the Company’s investments in third-party managed funds in which the Company is entitled to a portion of the management and/or performance fees. Investments in managed funds are carried at fair value.

Receivable from, and Payable to, Customers

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. These transactions are subject to the same regulations as customer transactions.

Page 11 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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 and certain payables, are carried at amounts approximating fair value. Long-term debt is carried at face value less unamortized discount, except for the $200.0 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 hedged by interest rate swaps which is carried at fair value. Securities owned and securities sold, not yet purchased, are valued at quoted market prices, if available. For securities that do not have readily determinable fair values through quoted market prices, the determination of fair value is based upon consideration of available information, including types of securities, current financial information, restrictions on dispositions, market values of underlying securities and quotations for similar instruments.

In addition to the interest rate swaps mentioned above, the Company has derivative financial instrument positions in exchange traded and over-the-counter option contracts, foreign exchange forward contracts, index futures contracts, commodities swap and option contracts and commodities 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.

Securities Borrowed and Securities Loaned

In connection with both trading and brokerage activities, the Company 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. The Company has an active securities borrowed and lending matched book business (“Matched Book”), in which the Company borrows securities from one party and lends them to another party. When the Company borrows securities, the Company provides cash to the lender as collateral, which is reflected in the Company’s Consolidated Statement of Financial Condition as securities borrowed. The Company earns interest revenues on this cash collateral. Similarly, when the Company lends securities to another party, that party provides cash to the Company as collateral, which is reflected in the Company’s Consolidated Statement of Financial Condition as securities loaned. The Company pays interest expense on the cash collateral received from the party borrowing the securities. A substantial portion of the Company’s interest revenues and interest expenses results from the Matched Book activity. The initial collateral advanced or received approximates or is greater than, the fair value of the securities borrowed or loaned. The Company monitors the fair value of the securities borrowed and loaned on a daily basis and requests additional collateral or returns excess collateral, as appropriate.

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

In accordance with FASB No. 142, “Goodwill and Other Intangible Assets”, goodwill is not amortized, instead it is reviewed, on at least an annual basis, for impairment. Goodwill is impaired when the carrying amount of the reporting unit exceeds the implied fair value of the reporting unit. While goodwill is no longer amortized, it is tested for impairment annually as of the third quarter or at the time of a triggering event requiring re-evaluation, if one were to occur.

Page 12 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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, deferred compensation and unrealized gains and losses on securities owned. Tax credits are recorded as a reduction of income taxes when realized.

Legal Reserves

The Company recognizes a liability for a contingency when it is probable that a liability has been incurred and when the amount of loss can be reasonably estimated. When a range of probable loss can be estimated, the Company accrues the most likely amount of such loss, and if such amount is not determinable, then the Company accrues at least the minimum of the range of probable loss.

The Company records reserves related to legal proceedings in “accrued expenses and other liabilities.” Such reserves are established and maintained in accordance with FASB No. 5, “Accounting for Contingencies”, and FASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss an Interpretation of FASB Statement No. 5”. The determination of these reserve amounts requires significant judgment on the part of management. Management considers many factors including, but not limited to: the amount of the claim; the basis and validity of the claim; the possibility of wrongdoing on the part of an employee of the Company; previous results in similar cases; and legal precedents and case law. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management. Any change in the reserve amount is recorded in the consolidated financial statements and is recognized as a charge/credit to earnings in that period.

Stock-Based Compensation

On January 1, 2003, the Company adopted, on a prospective basis, the fair value method of accounting for stock-based compensation under FASB No. 123, “Accounting for Stock-Based Compensation” as amended by FASB No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123”. Therefore, employee stock options granted on and after January 1, 2003 are expensed by the Company over the option vesting period, based on the estimated fair value of the award on the date of grant. There were no stock option grants in the first nine months of 2005. Additionally, in the first nine months of 2005 the Company recorded compensation expense of $1.4 million related to the Company’s Employee Stock Purchase Plan, based on a discount from market. There were grants of restricted stock and restricted stock units, most of which relate to 2004 employee compensation, totaling 2,980,888 shares and $105.6 million in the first nine months of 2005. Grants of restricted stock and restricted stock units are expensed by the Company over the vesting period, based on the estimated fair value of the award on the date of grant.

Page 13 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


	Nine Months			Full Year
	2005			2004
	(Shares in 000s)
Restricted stock
Balance, beginning of year		5,271			5,811
Grants		961			1,763
Forfeited		(278	)		(298	)
RSU conversion		(1,456	)		(455	)
Vested		(837	)		(1,550	)

Balance, end of period		3,661			5,271


	Nine Months			Full Year
	2005			2004
	(Shares in 000s)
Restricted stock units (RSU)
Balance, beginning of year		6,029			3,433
Grants, includes dividends		2,020			1,564
Restricted stock conversion		1,456			455
Deferral expiration		(106	)		—
Forfeited		(51	)		—
Grants related to stock option exercises		67			577

Balance, end of period		9,415			6,029

In 2002 and prior years, the Company measured the cost of its stock-based compensation plans using the intrinsic value approach under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, rather than applying the fair value method provisions of FASB No. 123. Accordingly, the Company has not recognized compensation expense related to stock options granted prior to January 1, 2003 and shares issued to participants in the Company’s employee stock purchase plan prior to January 1, 2003. Therefore, the cost of $51.0 million and $49.1 million related to stock-based compensation included in the determination of net income for the first nine months of 2005 and 2004, respectively, is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of FASB No. 123.

Page 14 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Had compensation cost for the Company’s stock-based compensation plans been determined consistent with FASB No. 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):


	Three Months Ended						Nine Months Ended
	Sept. 30,			Sept. 30,			Sept. 30,			Sept. 30,
	2005			2004			2005			2004

Net earnings, as reported	$	38,595		$	32,275		$	110,704		$	95,970
Add: Stock-based employee compensation expense included in reported net earnings, net of related tax effects		9,188			8,842			29,726			28,589
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(9,337	)		(9,440	)		(30,458	)		(30,527	)

Pro forma net earnings	$	38,446		$	31,677		$	109,972		$	94,032


Earnings per share:
Basic — as reported	$	0.62		$	0.56		$	1.80		$	1.68

Basic — pro forma	$	0.62		$	0.55		$	1.79		$	1.64

Diluted — as reported	$	0.57		$	0.51		$	1.64		$	1.51

Diluted — pro forma	$	0.56		$	0.50		$	1.63		$	1.48

Recent Accounting Developments

In December 2004, the FASB issued a revision to FASB No. 123, FASB No. 123R, “Share-Based Payments.” FASB No. 123R establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods and services. FASB No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. On April 14, 2005, the U.S. Securities and Exchange Commission (SEC) announced new rules that require companies to implement FASB No. 123R by the start of their fiscal year beginning after June 15, 2005. Among other requirements, FASB No. 123R generally requires the immediate expensing of equity-based awards granted to retirement-eligible employees. Management is currently evaluating the effect of adoption of FASB No. 123R on the Company’s financial condition, results of operations and cash flows.

Page 15 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 2. Asset Management Fees and Investment Income From Managed Funds

Period end assets under management by predominant asset strategy were as follows (in millions of dollars):


	September 30,		September 30,
	2005		2004
Assets under management:
Fixed Income (1)	$	717	$	590
Equities (2)		523		435
Convertibles (3)		1,576		1,199
Real Assets (4)		182		164

		2,998		2,388

Assets under management by third parties (5):
Equities, Convertibles and Fixed Income		399		882
Private Equity		1,035		625

		1,434		1,507

Total	$	4,432	$	3,895


(1)		The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO and the Victoria Falls CLO, but does not include third-party managed funds. The Company completed the liquidation of the Jackson Creek CDO during the second quarter of 2005. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.

(2)		The Jefferies RTS Fund and Jefferies Paragon Fund.

(3)		Managed convertible bond assets.

(4)		The Jefferies Real Asset Fund.

(5)		Third party managed funds in which the Company has a 50% or less interest in the entities that manage these assets or otherwise receives a portion of the management or incentive fees. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.

The following summarizes revenues from asset management fees and investment income from managed funds relating to funds managed by the Company and funds managed by third parties for the three-month and nine-month periods ended September 30, 2005 and 2004 (in thousands of dollars):


	Three Months Ended				Nine Months Ended
	Sept. 30,		Sept. 30,		Sept. 30,		Sept. 30,
	2005		2004		2005		2004
Asset management fees:
Fixed Income (1)	$	6,246	$	3,162	$	16,427	$	8,497
Equities (2)		5,348		2,278		16,448		9,409
Convertibles (3)		1,375		1,592		3,873		5,776
Real Assets (4)		1,269		958		5,979		2,054

		14,238		7,990		42,727		25,736
Investment income from managed funds		7,429		3,628		20,658		28,294

Total	$	21,667	$	11,618	$	63,385	$	54,030


(1)		The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO and the Victoria Falls CLO and certain third-party managed funds. The Company completed the liquidation of the Jackson Creek CDO during the second quarter of 2005. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.

(2)		The Jefferies RTS Fund and Jefferies Paragon Fund.

(3)		Convertible bond assets managed by the Company, and Asymmetric Convertible Fund, a third party managed fund. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.

(4)		The Jefferies Real Asset Fund.

Page 16 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following tables detail the Company’s average investment in managed funds, investment income from managed funds, investment income from managed funds — minority interest portion and net investment income from managed funds relating to funds managed by the Company and funds managed by third parties for the quarters ended September 30, 2005 and 2004 (in millions of dollars):

Quarter Ended September 30, 2005


						Investment		Net
			Investment			Income from		Investment
			Income from			Managed Funds —		Income from
	Average		Managed			Minority Interest		Managed
	Investment (5)		Funds			Portion		Funds

Fixed Income (1)	$	142.6	$	8.2		$	2.6	$	5.6
Equities (2)		65.0		(1.1	)		0.1		(1.2	)
Convertibles (3)		11.2		0.2			¾		0.2
Real Assets (4).		10.5		0.1			¾		0.1

Total	$	229.3	$	7.4		$	2.7	$	4.7

Quarter Ended September 30, 2004


						Investment		Net
			Investment			Income from		Investment
			Income from			Managed Funds —		Income from
	Average		Managed			Minority Interest		Managed
	Investment (5)		Funds			Portion		Funds

Fixed Income (1)	$	104.5	$	5.3		$	1.4	$	3.9
Equities (2)		52.9		(0.9	)		¾		(0.9	)
Convertibles (3)		11.8		(0.8	)		¾		(0.8	)
Real Assets (4).		10.1		0.0			¾		0.0

Total	$	179.3	$	3.6		$	1.4	$	2.2


(1)		The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO, the Victoria Falls CLO and certain third-party managed funds. The Company completed the liquidation of the Jackson Creek CDO during the second quarter of 2005. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.

(2)		The Jefferies RTS Fund and Jefferies Paragon Fund.

(3)		Convertible bond assets managed by the Company, and Asymmetric Convertible Fund, a third party managed fund. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.

(4)		The Jefferies Real Asset Fund.

(5)		The Company has excluded the portion of average investment in managed funds that represent an economic hedge against certain employee deferred compensation obligations.

Page 17 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following tables detail the Company’s average investment in managed funds, investment income from managed funds, investment income from managed funds — minority interest portion and net investment income from managed funds relating to funds managed by the Company and funds managed by third parties for the nine-month periods ended September 30, 2005 and 2004 (in millions of dollars):

Nine Months Ended September 30, 2005


					Investment		Net
			Investment		Income from		Investment
			Income from		Managed Funds —		Income from
	Average		Managed		Minority Interest		Managed
	Investment (5)		Funds		Portion		Funds

Fixed Income (1)	$	137.2	$	13.1	$	6.1	$	7.0
Equities (2)		62.9		6.6		0.2		6.4
Convertibles (3)		11.2		0.1		¾		0.1
Real Assets (4).		10.5		0.9		¾		0.9

Total	$	221.8	$	20.7	$	6.3	$	14.4

Nine Months Ended September 30, 2004


						Investment		Net
			Investment			Income from		Investment
			Income from			Managed Funds —		Income from
	Average		Managed			Minority Interest		Managed
	Investment (5)		Funds			Portion		Funds

Fixed Income (1)	$	100.9	$	19.5		$	4.2	$	15.3
Equities (2)		31.1		9.0			4.6		4.4
Convertibles (3)		12.2		(0.5	)		¾		(0.5	)
Real Assets (4).		8.9		0.3			¾		0.3

Total	$	153.1	$	28.3		$	8.8	$	19.5


(1)		The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO, the Victoria Falls CLO and certain third-party managed funds. The Company completed the liquidation of the Jackson Creek CDO during the second quarter of 2005. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.

(2)		The Jefferies RTS Fund and Jefferies Paragon Fund.

(3)		Convertible bond assets managed by the Company, and Asymmetric Convertible Fund, a third party managed fund. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.

(4)		The Jefferies Real Asset Fund.

(5)		The Company has excluded the portion of average investment in managed funds that represent an economic hedge against certain employee deferred compensation obligations.

Page 18 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 3. Cash, Cash Equivalents, and Short-Term Investments

The Company generally invests its excess cash in money market funds and other short-term investments. Cash equivalents are part of the cash management activities of the Company and generally mature within 90 days (“readily convertible into cash”). The following are financial instruments that are cash and cash equivalents or are deemed by management to be generally readily convertible into cash as of September 30, 2005 and December 31, 2004 (in thousands of dollars):


	September 30, 2005		December 31, 2004

Cash and cash equivalents:
Cash in banks	$	53,587	$	105,814
Money market investments		166,782		178,297

Total cash and cash equivalents		220,369		284,111
Cash and securities segregated (1)		671,136		553,720
Short-term bond funds		6,989		6,861
Auction rate preferreds (2)		26,847		50,365
Mortgage-backed securities (2)		15,608		27,511
Asset-backed securities (2)		33,469		21,093

	$	974,418	$	943,661


(1)		In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies, as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, deposits with clearing and depository organizations are included in this caption.

(2)		Items are included in Securities Owned (see Note 4 below). Items are financial instruments utilized in the Company’s overall cash management activities and are readily convertible to cash.

Note 4. Securities Owned, Securities Pledged to Creditors 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 September 30, 2005 and December 31, 2004 (in thousands of dollars):


	September 30, 2005				December 31, 2004
			Securities				Securities
			Sold,				Sold,
	Securities		Not Yet		Securities		Not Yet
	Owned		Purchased		Owned		Purchased

Corporate debt securities	$	673,604	$	579,568	$	189,684	$	480,882
U.S. Government and agency obligations		372,163		351,591		26,954		96,747
Corporate equity securities		328,544		289,098		217,478		503,536
High-yield securities		109,657		25,603		92,364		20,340
Asset-backed securities		33,469		—		21,093		—
Options		28,611		42,893		22,775		18,044
Auction rate preferreds		26,847		—		50,365		—
Mortgage-backed securities.		15,608		—		27,511		—
Other		—		377		1,075		624

	$	1,588,503	$	1,289,130	$	649,299	$	1,120,173

Page 19 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following is a summary of the market value of major categories of securities pledged to creditors as of September 30, 2005 and December 31, 2004 (in thousands of dollars):


	September 30, 2005		December 31, 2004

Corporate equity securities	$	51,326	$	99,407
High-yield securities		14,261		25,929
Corporate debt securities		12,219		429,278
U.S. Government and agency obligations		—		42,820

	$	77,806	$	597,434

Note 5. Bank Loans

Bank loans represent short-term borrowings that are payable on demand and generally bear interest at the brokers’ call loan rate. At September 30, 2005, there were no bank loans outstanding. Unsecured bank loans are typically overnight loans used to finance securities owned or clearing related balances. Unsecured bank loans were $70 million at December 31, 2004. Average daily bank loans for the three-month and nine-month periods ending September 30, 2005 were $4.9 million and $11.9 million, respectively.

Note 6. Long-Term Debt

The following summarizes long-term debt outstanding as of September 30, 2005 and December 31, 2004 (in thousands of dollars):


	September 30, 2005		December 31, 2004

7¹/2% Senior Notes, due 2007, less unamortized discount of $53 (2005)	$	99,947	$	99,926
7³/4% Senior Notes, due 2012, less unamortized discount of $5,523 (2005)		333,403		341,184
5¹/2% Senior Notes, due 2016, less unamortized discount of $1,907 (2005)		348,093		347,957

	$	781,443	$	789,067

The Company has entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200 million aggregate principal amount of unsecured 7³/4% senior notes, after giving effect to the swaps, is 6.0%. The fair value of the mark to market of the swaps was positive $13.9 million as of September 30, 2005, which was recorded as an increase in the book value of the debt and an increase in other assets.

Page 20 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7. Pension

The following summarizes the net periodic pension cost for the three-month and nine-month periods ended September 30, 2005 and 2004 (in thousands of dollars):


	Three Months Ended						Nine Months Ended
	Sept. 30			Sept. 30			Sept. 30			Sept. 30
	2005			2004			2005			2004

Net pension cost included the following components:
Service cost — benefits earned during the period	$	543		$	631		$	1,535		$	1,354
Interest cost on projected benefit obligation		661			677			1,890			1,780
Expected return on plan assets		(658	)		(561	)		(1,581	)		(1,285	)
Amortization of prior service cost		(3	)		(3	)		(9	)		(9	)
Amortization of net loss (gain)		211			365			807			827

Net periodic pension cost	$	754		$	1,109		$	2,642		$	2,667

The Company has contributed approximately $3.3 million to its pension plan during 2005 and does not anticipate contributing any more during the remainder of 2005.

Note 8. Minority Interest

Minority interest primarily represents the minority equity holders’ proportionate share of the equity of JEOF. At September 30, 2005, the Company controlled and owned approximately 31% of JEOF.

Note 9. Earnings Per Share

The following reconciles the numerators and denominators of the basic and diluted earnings per share computations for the three-month and nine-month periods ended September 30, 2005 and 2004 (in thousands, except per share amounts):


	Three Months Ended				Nine Months Ended
	Sept. 30,		Sept. 30,		Sept. 30,		Sept. 30,
	2005		2004		2005		2004

Earnings	$	38,595	$	32,275	$	110,704	$	95,970


Shares:
Average shares used in basic computation		62,224		57,833		61,434		57,233
Stock options		1,269		1,730		1,489		1,965
Unvested restricted stock and restricted stock units		4,619		4,304		4,451		4,418

Average shares used in diluted computation		68,112		63,867		67,374		63,616


Earnings per share:
Basic	$	0.62	$	0.56	$	1.80	$	1.68

Diluted	$	0.57	$	0.51	$	1.64	$	1.51

Page 21 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 10. Other Comprehensive Gain (Loss)

The following summarizes other comprehensive loss and accumulated other comprehensive loss at September 30, 2005 and for the three months then ended (in thousands of dollars):


				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Loss
Beginning at June 30, 2005	$	3,440		$	(6,868	)	$	(3,428	)
Change in third quarter of 2005		(628	)		¾			(628	)

Ending at September 30, 2005	$	2,812		$	(6,868	)	$	(4,056	)

The following summarizes other comprehensive loss and accumulated other comprehensive loss at September 30, 2004 and for the three months then ended (in thousands of dollars):


				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Loss
Beginning at June 25, 2004	$	5,987		$	(7,464	)	$	(1,477	)
Change in third quarter of 2004		(1,214	)		¾			(1,214	)

Ending at September 30, 2004	$	4,773		$	(7,464	)	$	(2,691	)

Comprehensive income for the three months ended September 30, 2005 and 2004 was as follows (in thousands of dollars):


	September 30,			September 30,
	2005			2004
Net earnings	$	38,595		$	32,275
Other comprehensive loss		(628	)		(1,214	)

Comprehensive income	$	37,967		$	31,061

The following summarizes other comprehensive loss and accumulated other comprehensive gain (loss) at September 30, 2005 and for the nine months then ended (in thousands of dollars):


				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Gain (Loss)
Beginning at December 31, 2004	$	9,348		$	(6,868	)	$	2,480
Change in first nine months of 2005		(6,536	)		¾			(6,536	)

Ending at September 30, 2005	$	2,812		$	(6,868	)	$	(4,056	)

Page 22 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following summarizes other comprehensive loss and accumulated other comprehensive loss at September 30, 2004 and for the nine months then ended (in thousands of dollars):


				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Loss
Beginning at December 31, 2003	$	5,331		$	(7,464	)	$	(2,133	)
Change in first nine months of 2004		(558	)		¾			(558	)

Ending at September 30, 2004	$	4,773		$	(7,464	)	$	(2,691	)

Comprehensive income for the nine months ended September 30, 2005 and 2004 was as follows (in thousands of dollars):


	September 30,			September 30,
	2005			2004
Net earnings	$	110,704		$	95,970
Other comprehensive loss		(6,536	)		(558	)

Comprehensive income	$	104,168		$	95,412

Note 11. Net Capital Requirements

As registered broker-dealers, Jefferies and Jefferies Execution are subject to the Securities and Exchange Commission’s Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital. Jefferies and Jefferies Execution 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.

As of September 30, 2005, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):


	Net Capital		Excess Net Capital

Jefferies	$	191,865	$	170,989
Jefferies Execution	$	13,570	$	13,320

Note 12. Quarterly Dividends

In 1988, the Company instituted a policy of paying regular quarterly dividends. There are no restrictions on the Company’s present ability to pay dividends on common stock, other than the governing provisions of the Delaware General Corporation Law.

Dividends per Common Share (declared and paid):


	1^st Quarter		2^nd Quarter		3^rd Quarter
2005	$	.120	$	.120	$	.120
2004	$	.080	$	.080	$	.100

On October 18, 2005, the Company announced that its Board of Directors declared a regular quarterly dividend of $0.15 per share of common stock, up 25% from $0.12 per share. The dividend will be payable on December 15, 2005 to stockholders of record as of November 15, 2005.

Page 23 of 48

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 13. Jefferies Financial Products, LLC.

Jefferies Financial Products, LLC (“JFP”), a wholly-owned subsidiary of the Company, was formed as a limited liability company in November 2003. JFP is a market maker in commodity index products and a trader in commodities futures and options. JFP offers customers exposure to over-the-counter commodity indices and other commodity baskets in the form of fixed-for-floating swaps (“swaps”) and options, where the return is based on a specific commodity or basket of commodities (e.g., Jefferies Commodity Performance Index (“JCPI”)). The primary end users in this market are creditworthy institutional investors, such as pension funds, mutual funds, foundations, endowments, and insurance companies. These investors generally seek exposure to commodities in order to diversify their existing stock and bond portfolios. Generally, JFP will enter into swaps whereby JFP receives a stream of fixed cash flows against paying the return of a given commodity or index plus a spread or fee (“fee”). The fee is meant to compensate JFP for the costs of replicating the commodity or index exposure in the underlying exchange traded futures markets. The floating return can be either the total return on the index (inclusive of implied collateral yield), or the excess return. JFP also enters into swap, forward and option transactions on foreign exchange, individual commodities and commodity indices.

Generally, the swap and option contract tenors range from 1 month to 2 years, and in some transactions both parties may settle the changes in the mark-to-market value of the transaction on a monthly basis. Where appropriate, JFP utilizes various credit enhancements, including guarantees, collateral and margin agreements to mitigate the credit exposure relating to these swaps and options. JFP establishes credit limits based on, among other things, the creditworthiness of the counterparties, the transaction’s size and tenor, and estimated potential exposure. In addition, swap and option transactions are generally documented under International Swaps and Derivatives Association Master Agreements. JFP believes that such agreements provide for legally enforceable set-off and close-out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, JFP is permitted to set-off its receivables from a counterparty against its payables to the same counterparty arising out of all included transactions. As a result, the fair value represents the net sum of estimated positive fair values after the application of such netting. JFP has determined that the fair value of its swaps and options approximated $(141.7) million and $(26.4) million, respectively at September 30, 2005 and $17.3 million and $(6.5) million, respectively at December 31, 2004.

The following table sets forth the fair value of JFP’s outstanding OTC positions and exchange-traded futures and options by remaining contractual maturity as of September 30, 2005:


	0 — 12			1 — 5			5 — 10
(in millions)	Months			Years			Years			Total

Swaps	$	(141.7	)	$	—		$	—		$	(141.7	)
Options		—			(25.7	)		(0.7	)		(26.4	)
FX forwards		—			(0.1	)		—			(0.1	)
Exchange—traded futures and options		182.0			1.8			—			183.8

Total	$	40.3		$	(24.0	)	$	(0.7	)	$	15.6

In July 2004, JFP entered into a credit intermediation facility with an AA-rated European bank (the “Bank”). This facility allows JFP customers that require a counterparty with a high credit rating for commodity index transactions to transact with the Bank. The Bank simultaneously enters into a back-to-back transaction with JFP and receives a fee from JFP for providing credit support. Subject to the terms of the agreement between JFP and the Bank, JFP is generally responsible to the Bank for the performance of JFP’s customers. The Company guarantees the performance of JFP to the Bank under the credit intermediation facility. JFP also provides commodity index pricing to the Bank’s customers and JFP earns revenue from the Bank’s hedging of its customer transactions with JFP.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Company determines counterparty credit quality by reference to ratings from independent rating agencies or, where such ratings are not available, by internal analysis. The maximum potential loss will increase or decrease during the life of the swap and option commitments as a function of maturity and changes in market prices.

At September 30, 2005 and December 31, 2004, the counterparty credit quality with respect to the fair value of commodities and foreign exchange futures, options and swap portfolios were as follows:


	Fair Value
	September 30,			December 31,
(in millions)	2005			2004
Counterparty credit quality:
A or higher	$	(168.2	)	$	17.3
Exchange-traded futures and options (1)		183.8			(6.0	)

Total	$	15.6		$	11.3


(1)		Exchange-traded commodities and foreign exchange futures and options are not deemed to have significant credit exposures as the exchanges guarantee that every contract will be properly settled on a daily basis.

At September 30, 2005 and December 31, 2004 the counterparty breakdown by industry with respect to the fair value of JFP’s commodities and foreign exchange futures, options and swap portfolio was as follows:


	Fair Value
	September 30,			December 31,
(in millions)	2005			2004

Foundations, trust and endowments	$	(22.2	)	$	—
Financial services		(45.2	)		—
Collective investment vehicles (including pension plans, mutual funds and other institutional counterparties)		(100.8	)		17.3
Exchanges (1)		183.8			(6.0	)

Total	$	15.6		$	11.3


(1)		Exchange-traded commodities and foreign exchange futures and options are not deemed to have significant credit exposures as the exchanges guarantee that every contract will be properly settled on a daily basis.

Note 14. Derivative Financial Instruments

Our derivative activities are recorded at fair value in the Consolidated Statement of Financial Condition. Acting in a trading capacity, we enter into derivative transactions to satisfy the needs of our clients and to manage our own exposure to market and credit risks resulting from our trading activities.

Derivatives are subject to various risks similar to other financial instruments, including market, credit and operational risk. In addition, we may be exposed to legal risks related to derivative activities. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with our other trading-related activities. We manage the risks associated with derivatives on an aggregate basis along with the risks associated with proprietary trading as part of our firmwide risk management policies.

We record trading derivative contracts at fair value with realized and unrealized gains and losses recognized in principal transactions in the Consolidated Statement of Earnings on a trade date basis.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Company has also entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200.0 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200.0 million aggregate principal amount of unsecured 7³/4% senior notes, after giving effect to the swaps, is 6.0%. The fair value of the mark to market of the swaps was positive $13.9 million as of September 30, 2005, which was recorded as an increase in the book value of the debt and an increase in derivative assets classified as part of other assets.

The following table presents the fair value of derivatives at September 30, 2005 and December 31, 2004. The fair value of assets/liabilities related to derivative contracts at September 30, 2005 and December 31, 2004 represent the Company’s receivable/payable for derivative financial instruments before consideration of securities collateral.


	September 30, 2005					December 31, 2004
(in thousands)	Assets		Liabilities			Assets		Liabilities

Futures contracts	$	276,214	$	(94,285	)	$	338	$	(10,239	)
Commodity related swaps		171		(141,938	)		20,497		(3,531	)
Option contracts		28,705		(44,258	)		22,775		(18,044	)
Foreign exchange forward contracts		81		(64	)		¾		(27	)
Interest rate swaps		13,926		¾			22,209		¾

Note 15. Commitments, Contingencies and Guarantees

Standby Letters of Credit. In the normal course of business, the Company had letters of credit outstanding aggregating $47.3 million at September 30, 2005 ($25.0 million in letters of credit were added since quarter-end), mostly to satisfy various collateral requirements in lieu of depositing cash or securities. These letters of credit have a current carrying amount of aggregate liability of $0. As of September 30, 2005, there were no draw downs on these letters of credit.

Undrawn Bank Credit. As of September 30, 2005, the Company had outstanding guarantees of $24.0 million relating to undrawn bank credit obligations of two associated investment funds in which the Company has an interest. Also, the Company has guaranteed obligations of Jefferies International Limited (“JIL”) to various banks which provide clearing and credit services to JIL and to counterparties of JIL.

Equity Committments.

On October 7, 2004, the Company entered into an agreement with Babson Capital and MassMutual to form Jefferies Babson Finance LLC, a joint venture entity created for the purpose of offering senior loans to middle market and growth companies. Jefferies Babson Finance LLC will be capitalized over time with $250 million in equity commitments, provided equally by Jefferies Group, Inc. and Babson Capital’s parent, MassMutual, and will be leveraged. Loans are expected to be originated primarily through the investment banking efforts of Jefferies & Company, Inc. with Babson Capital providing primary credit analytics and portfolio management services. As of September 30, 2005, the Company funded $12.0 million of its aggregate commitment leaving $113.0 million unfunded.

On May 12, 2005, the Company committed to invest an aggregate of $34.4 million in Jefferies Capital Partners IV L.P. and its related parallel funds. As of September 30, 2005, the Company funded approximately $1.2 million of its aggregate commitment leaving $33.2 million unfunded. See Note 18 for additional information.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Jefferies Financial Products, LLC. In July 2004, JFP entered into a credit intermediation facility with an “AA”-rated European bank (the “Bank”). This facility allows JFP customers that require a counterparty with a high credit rating for commodity index transactions to transact with the Bank. The Bank simultaneously enters into a back-to-back transaction with JFP and receives a fee from JFP for providing credit support. Subject to the terms of the agreement between JFP and the Bank, JFP is generally responsible to the Bank for the performance of JFP’s customers. The Company guarantees the performance of JFP to the Bank under the credit intermediation facility. JFP will also provide commodity index pricing to the Bank’s customers and JFP will earn revenue from the Bank’s hedging of its customer transactions with JFP. The Company also guarantees the performance of JFP to trading counterparties of JFP and various banks and other entities which provide futures clearing to JFP.

High Yield Loan Commitments. From time to time the Company makes commitments to extend credit to investment-banking clients in loan syndication and acquisition-finance transactions. These commitments and any related drawdowns of these facilities typically have fixed maturity dates and are contingent on certain representations, warranties and contractual conditions applicable to the borrower. The Company defines high yield (non-investment grade) exposures as securities of or loans to companies rated BB+ or lower or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans that, in management’s opinion, are non-investment grade. Although the Company had commitments to non-investment grade borrowers during the first nine months of 2005 the Company did not have any commitments outstanding to non-investment grade borrowers as of September 30, 2005 and December 31, 2004.

Other Commitments. As of September 30, 2005, the Company had commitments to invest up to $13.8 million in various other investments.

Other Guarantees. In the normal course of business the Company provides guarantees to securities clearinghouses and exchanges. These guarantees generally are required under the standard membership agreements, such that members are required to guarantee the performance of other members. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. The Company’s obligations under such guarantees could exceed the collateral amounts posted; however, the potential for the Company to be required to make payments under such guarantees is deemed remote. The Company has guaranteed certain of the obligations of an employee parallel fund to Jefferies Capital Partners IV L.P., including a guarantee of up to an aggregate of approximately $30 million in bank loans committed to such employee fund.

Note 16. Segment Reporting

The Company’s operations have been classified into a single business segment, a securities broker-dealer, which includes several types of financial services. This segment includes the traditional securities brokerage and investment banking activities of the Company. Traditional securities brokerage and investment banking activities account for over 90% of total revenue for the nine months ended September 30, 2005.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 17. Goodwill

The following is a summary of goodwill as of September 30, 2005 (in thousands of dollars):


	2004		2005			2005		Acquisition
Acquisition	Balance		Activity			Balance		Date

Broadview International LLC	$	48,827	$	(1,243	)	$	47,584	Dec. 2003
Randall & Dewey		¾		45,325			45,325	Jan. 2005
Helfant Group, Inc.		26,062		¾			26,062	Sept. 2001
Quarterdeck Investment Partners, LLC		25,170		5,025			30,195	Dec. 2002
Bonds Direct Securities LLC		20,943		¾			20,943	Sept. 2004
The Europe Company		11,123		¾			11,123	Aug. 2000
Helix Associates		¾		25,307			25,307	May 2005
Other		2,811		226			3,037	Aug. 2000

	$	134,936	$	74,640		$	209,576

The Company acquired Helix Associates for approximately $9.5 million in stock and $27.0 million in cash. The acquisition was accounted for as a purchase and preliminarily resulted in approximately $25.3 million in goodwill. There is also a five-year contingency for additional consideration, based on future revenues.

The Company acquired certain assets of Randall & Dewey for approximately $17.5 million in stock and $27.2 million in cash. The acquisition was accounted for as a purchase and preliminarily resulted in approximately $41.5 million in goodwill. There is also a five-year contingency for additional consideration, based on future revenues.

The acquisitions of Bonds Direct, Broadview International LLC and Quarterdeck Investment Partners, LLC all contained a five-year contingency for additional consideration, based on future revenues.

The 2005 activity for Quarterdeck Investment Partners, LLC represents additional contingent consideration. The 2005 activity for Broadview International LLC represents an adjustment to goodwill.

None of the acquisitions listed above were considered material based on the small percentage they represent of the Company’s total assets, equity, revenues and net earnings.

Note 18. New Purchase Agreement

In July 2005, the Company entered into a Share and Membership Interest Purchase Agreement (“Purchase Agreement”) with Brian P. Friedman (one of our directors and Chairman of the Executive Committee of the Board of Directors of Jefferies & Company, Inc.), 2055 Partners L.P., James L. Luikart, and the manager and general partner of Jefferies Capital Partners IV L.P. Jefferies Capital Partners IV L.P., together with its related parallel funds (“Fund IV”), is a private equity fund managed by a team led by Messrs. Friedman and Luikart. The Company agreed to purchase a 49% interest in the manager of Fund IV and an amount, not less than 20% and not more than the percentage allocated to Mr. Friedman, of the carried interest attributed to Fund IV. In addition, the Company will have the right, subject to certain conditions, to receive similar interests from future private equity funds overseen by Mr. Friedman. The Company agreed to issue an aggregate of between 400,000 to 650,000 shares of common stock to Messrs. Friedman and Luikart. The actual number of shares of common stock to be issued is subject to the receipt by Fund IV of threshold levels of committed capital at the final closing of the fund, and is further subject to clawback provisions based upon the size of a subsequent fund as well as certain other conditions.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations

Special Note on Forward-Looking Statements

This report contains or incorporates by reference “forward-looking statements” within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include statements about our future and statements that are not historical facts. These forward-looking statements are usually preceded by the words “believe,” “intend,” “may,” “will,” or similar expressions. Forward-looking statements may contain expectations regarding revenues, earnings, operations and other financial projections, and may include statements of future performance, plans and objectives. Forward-looking statements also include statements pertaining to our strategies for future development of our business and products. Forward-looking statements represent only our belief regarding future events, many of which by their nature are inherently uncertain and outside of our control. It is possible that the actual results may differ materially from the anticipated results indicated in these forward-looking statements. Information regarding important factors that could cause actual results to differ from those in our forward-looking statements is contained in this report and other documents we file. You should read and interpret any forward-looking statement together with these documents, including the following:

	•		the risk factors contained in this report under the caption “Factors Affecting Our Business”;

	•		the discussion of our analysis of financial condition and results of operations contained in this report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”;

	•		the notes to consolidated financial statements contained in this report; and

	•		Cautionary statements we make in our public documents, reports and announcements.

Any forward-looking statement speaks only as of the date on which that statement is made. We will not update any forward-looking statement to reflect events or circumstances that occur after the date on which the statement is made.

Analysis of Financial Condition

Total assets decreased $223.0 million, or 2%, from $13,824.6 million at December 31, 2004 to $13,601.6 million at September 30, 2005. Securities borrowed decreased $1,819.2 million and securities loaned decreased $1,322.4 million. The decreases in securities borrowed and securities loaned are mostly related to a change in the financing of the Bonds Direct securities inventories.

The decrease in securities borrowed was partially offset by increases in the following asset categories; $497.7 million in receivable from customers and $419.6 million in securities owned and securities pledged to creditors.

The decrease in securities loaned was partially offset by increases in the following liability categories; $505.9 million in payable to customers and $251.0 million in accrued expenses.

A substantial portion of our total assets consists of highly liquid marketable securities and short-term receivables, arising principally from traditional securities brokerage and investment banking activity. The highly liquid nature of these assets provides us with flexibility in financing and managing our business.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

The following table sets forth book value, pro forma book value, tangible book value and pro forma tangible book value per share (dollars in thousands, except per share data):


	September 30, 2005			December 31, 2004

Stockholders’ equity	$	1,201,860		$	1,039,133
Less: Goodwill		(209,576	)		(134,936	)

Tangible stockholders’ equity	$	992,284		$	904,197

Stockholders’ equity	$	1,201,860		$	1,039,133
Add: Projected tax benefit on vested portion of restricted stock		121,673			99,057

Pro forma stockholders’ equity	$	1,323,533		$	1,138,190

Tangible stockholders’ equity	$	992,284		$	904,197
Add: Projected tax benefit on vested portion of restricted stock		121,673			99,057

Pro forma tangible stockholders’ equity	$	1,113,957		$	1,003,254

Shares outstanding		58,083,213			57,289,309
Add: Shares not issued, to the extent of related expense amortization		9,804,151			8,065,362
Less: Shares issued, to the extent related expense has not been amortized		(1,455,257	)		(2,006,365	)

Adjusted shares outstanding		66,432,107			63,348,306

Book value per share (1)	$	20.69		$	18.14

Pro forma book value per share (2)	$	19.92		$	17.97

Tangible book value per share (3)	$	17.08		$	15.78

Pro forma tangible book value per share (4)	$	16.77		$	15.84


(1)		Book value per share equals stockholders’ equity divided by common shares outstanding.

(2)		Pro forma book value per share equals stockholders’ equity plus the projected deferred tax benefit on the vested portion of restricted stock and RSUs divided by common shares outstanding adjusted for shares not yet issued to the extent of the related expense amortization and shares issued to the extent the related expense has not been amortized.

(3)		Tangible book value per share equals tangible stockholders’ equity divided by common shares outstanding.

(4)		Pro forma tangible book value per share equals tangible stockholders’ equity plus the projected deferred tax benefit on the vested portion of restricted stock and RSUs divided by common shares outstanding adjusted for shares not yet issued to the extent of the related expense amortization and shares issued to the extent the related expense has not been amortized.

Tangible stockholders’ equity, pro forma stockholders’ equity, pro forma tangible stockholders’ equity, pro forma book value per share, tangible book value per share and pro forma tangible book value per share are “non-GAAP financial measures”. A “non-GAAP financial measure” is a numerical measure of financial performance that includes adjustments to the most directly comparable measure calculated and presented in accordance with GAAP, or for which there is no specific GAAP guidance. The calculations and descriptions above reconcile these non-GAAP financial measures to their most comparable GAAP financial measures. We consider these non-GAAP financial measures to be useful to investors because it provides investors with an additional metric to comparatively assess the fair market value of our stock. Our management uses these non-GAAP financial measures as an additional tool to analyze us against our competitors.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Revenues by Source

The following provides a breakdown of total revenues by source for the past three years (in thousands of dollars).


	2004		2003		2002
Commissions and principal transactions:
Equities	$	446,565	$	395,375	$	381,622
High Yield		44,884		40,291		26,905
Convertibles		44,989		50,934		50,750
Execution		32,546		23,737		29,310
Bonds Direct		41,023		27,242		11,516
Other proprietary		7,044		13,911		(3,455	)

Total		617,051		551,490		496,648

Investment banking		352,804		229,608		139,828
Asset management fees and investment income from managed funds:
Asset management fees		38,208		17,268		12,026
Investment income from managed funds		42,976		15,501		7,617
Total		81,184		32,769		19,643
Interest		134,450		102,403		92,027
Other		13,150		10,446		6,630

Total Revenues	$	1,198,639	$	926,716	$	754,776

The following provides a breakdown of total revenues by source for the three-month periods ended September 30, 2005 and 2004 (in thousands of dollars).


	Three Months Ended
	September 30, 2005					September 30, 2004
			% of					% of
			Total					Total
	Amount		Revenues			Amount		Revenues
Commissions and principal transactions:
Equities	$	105,360		28	%	$	127,764		43	%
High Yield		20,985		6			10,845		4
Convertibles		9,514		2			9,368		3
Execution		5,074		1			7,989		3
Bonds Direct		7,612		2			11,604		4
Other proprietary		14,027		4			3,462		1

Total		162,572		43			171,032		58
Investment banking		107,556		28			72,122		25
Asset management fees and investment income from managed funds:
Asset management fees		14,239		4			7,990		3
Investment income from managed funds		7,428		2			3,628		1

Total		21,667		6			11,618		4
Interest		81,467		22			35,948		12
Other		4,822		1			2,382		1

Total revenues	$	378,084		100	%	$	293,102		100	%

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

The following provides a breakdown of total revenues by source for the nine-month periods ended September 30, 2005 and 2004 (in thousands of dollars).


	Nine Months Ended
	September 30, 2005					September 30, 2004
			% of					% of
			Total					Total
	Amount		Revenues			Amount		Revenues

Commissions and principal transactions:
Equities	$	292,344		27	%	$	341,969		39	%
High Yield		51,823		5			35,055		4
Convertibles		26,577		3			34,505		4
Execution		17,606		2			25,196		3
Bonds Direct		21,986		2			33,551		4
Other proprietary		36,855		3			7,718		1

Total		447,191		42			477,994		55
Investment banking		327,517		31			247,066		28
Asset management fees and investment income from managed funds:
Asset management fees		42,728		4			25,736		3
Investment income from managed funds		20,657		2			28,294		3

Total		63,385		6			54,030		6
Interest		212,738		20			85,132		10
Other		15,309		1			9,144		1

Total revenues	$	1,066,140		100	%	$	873,366		100	%

Third Quarter 2005 Versus Third Quarter 2004

Overview

Revenues, net of interest expense, increased $45.5 million, or 18%, to $299.3 million, compared to $253.8 million for the third quarter of 2004. The increase was primarily due to a $35.4 million, or 49%, increase in investment banking, a $10.0 million, or 86%, increase in asset management fees and investment income from managed funds, a $6.0 million increase in net interest revenues (interest income less interest expense), and a $2.4 million increase in other revenues, partially offset by a $8.5 million, or 5%, decrease in trading revenues (commissions and principal transactions).

Equity Product Revenue

Equity product revenue is composed of commissions and principal transaction trading revenues, net of soft dollar expenses. Equity product revenue for the third quarter was $105.4 million, down 18% from last year’s third quarter. The decrease in equity product revenue was due to moderate volatility in the market, a decline in block trading volume as a percentage of total volume and decreased block trading opportunities.

High Yield Product Revenue

High yield product revenue for the quarter, not including origination revenues, was $21.0 million, up 93% over last year’s third quarter. This increase was generally due to increased trading activity as a result of significant investment in High Yield Sales, Trading and Research personnel, a strong trading environment in core sectors, and an increase in proprietary trading profits offset by the impact of the roll out of NASD’s Trade Reporting and Compliance Engine (“TRACE”) resulting in tighter secondary trading margins. Revenues were also negatively impacted by rising interest rates and increased competition.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Convertible Product Revenue

Convertible product revenue for the quarter was $9.5 million, up 2% from last year’s third quarter due to increased customer activity.

Execution Product Revenue

Execution product revenue was $5.1 million, down 36% from last year’s third quarter. The decrease in execution revenue was due to declines in volume traded by our hedge fund customers, our sell-side $2 broker customers, and our Canadian-US arbitrage trading customers.

Bonds Direct Product Revenue

Bonds Direct product revenue was $7.6 million, down 34% from last year’s third quarter. The decrease was driven by the decreased demand for “odd lot” corporate bonds, reduced client activity in treasuries and the impact of the roll out of TRACE resulting in tighter spreads.

Other Proprietary Revenue

Other proprietary includes revenues from the commodity index swap, option and futures transactions of Jefferies Financial Products, LLC (“JFP”), correspondent clearing and stock lending related activities as well as non-core revenues from other sources. Other proprietary revenue was $14.0 million for the quarter, up 305% from last year’s third quarter. The increase in other proprietary revenue this period was primarily the result of the increase in the notional amount of JFP’s commodity index swap, option and futures transactions and related trading and arbitrage activity over the period and as well as proprietary gains on private equity and other funds, offset by an extremely difficult trading environment resulting from Hurricanes Katrina and Rita.

Investment Banking Product Revenue


	Three Months Ended
	September 30,		September 30,		Percentage
	2005		2004		Change
	(Dollars in Thousands)
Capital markets	$	51,463	$	43,405		19	%
Advisory		56,093		28,717		95	%

Total	$	107,556	$	72,122		49	%

Capital markets revenues, which consist primarily of debt, equity and convertible financing services were $51.5 million, an increase of 19% from the comparable period in 2004. The increase in capital markets revenues can be attributed primarily to the increase in lead or co-manager assignments for high yield offerings in the consumer, energy and financial service sectors.

Revenues from advisory activities were $56.1 million, an increase of 95% from the comparable period of 2004. The increase can primarily be attributable to services rendered on assignments in the technology, energy and fund placement sectors. In addition, the acquisitions of Randall & Dewey and Helix Associates in the first half of 2005 generated increased revenue in the exploration & production and fund placement sectors.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Factors Affecting Our Business

The following factors describe some of the assumptions, risks, uncertainties and other factors that could adversely affect our business or that could otherwise result in changes that differ materially from our expectations. In addition to the factors mentioned in this report, we are also affected by changes in general economic and business conditions, acts of war, terrorism and natural disasters.

Changing conditions in financial markets and the economy could result in decreased revenues.

As an investment banking and securities firm, changes in the financial markets or economic conditions in the United States and elsewhere in the world could adversely affect our business in many ways, including the following:

•		A market downturn could lead to a decline in the volume of transactions executed for customers and, therefore, to a decline in the revenues we receive from commissions and spreads.

•		Unfavorable financial or economic conditions could likely reduce the number and size of transactions in which we provide underwriting, financial advisory and other services. Our investment banking revenues, in the form of financial advisory and underwriting or placement fees, are directly related to the number and size of the transactions in which we participate and could therefore be adversely affected by unfavorable financial or economic conditions.

•		Adverse changes in the market could lead to a reduction in revenues from principal transactions and commissions.

•		Adverse changes in the market could also lead to a reduction in revenues from asset management fees and investment income from managed funds and losses from managed funds. Continued increases in our asset management business, including increases in the amount of our investments in managed funds, would make us more susceptible to adverse changes in the market.

Our proprietary trading and investments expose us to risk of loss.

A significant portion of our revenues is derived from proprietary trading in which we act as principal. Although the majority of our trading is “riskless principal” in nature, we may incur trading losses relating to the purchase, sale or short sale of high yield, international, convertible, and equity securities and futures and commodities for our own account and from other program or proprietary trading. Additionally, we have made substantial investments of our capital in debt and equity securities, including investments managed by us and investments managed by third parties. In any period, we may experience losses as a result of price declines, lack of trading volume, and illiquidity. From time to time, we may engage in a large block trade in a single security or maintain large position concentrations in a single security, securities of a single issuer, or securities of issuers engaged in a specific industry. Any downward price movement in these securities could result in a reduction of our revenues and profits. In addition, we may engage in hedging transactions that if not successful, could result in losses.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Increased competition may adversely affect our revenues and profitability.

All aspects of our business are intensely competitive. We compete 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, including automated trading and other services based on technological innovations. We believe that the principal factors affecting competition involve market focus, reputation, the abilities of professional personnel, the ability to execute the transaction, relative price of the service and products being offered and the quality of service. Increased competition or an adverse change in our competitive position could lead to a reduction of business and therefore a reduction of revenues and profits. Competition also extends to the hiring and retention of highly skilled employees. A competitor may be successful in hiring away an employee or group of employees, which may result in our losing business formerly serviced by such employee or employees. Competition can also raise our costs of hiring and retaining the key employees we need to effectively execute our business plan.

Operational risks may disrupt our business, result in regulatory action against us or limit our growth.

Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies, and the transactions we process have become increasingly complex. If any of our financial, accounting or other data processing systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, we could suffer an impairment to our liquidity, financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more of our buildings. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.

We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions. Any such failure or termination could adversely affect our ability to effect transactions and manage our exposure to risk.

In addition, despite the contingency plans we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our businesses and the communities in which they are located. This may include a disruption involving electrical, communications, transportation or other services used by us or third parties with which we conduct business.

Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Asset management revenue is subject to variability.

Asset management revenue includes revenues we receive from management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees we receive from third-party managed funds, and investment income from our investments in these funds. Some of our revenues from management, administrative and performance fees are derived from our own investments in these funds. We experience significant fluctuations in our quarterly operating results due to the nature of our asset management business and therefore may fail to meet revenue expectations. Asset management revenue may not be sustainable as it is highly dependent on performance that is likely to vary.

We face numerous risks and uncertainties as we expand our business.

We expect the growth of our business to come primarily from internal expansion and through acquisitions and strategic partnering. As we expand our business, there can be no assurance that our financial controls, the level and knowledge of our personnel, our operational abilities, our legal and compliance controls and our other corporate support systems will be adequate to manage our business and our growth. The ineffectiveness of any of these controls or systems could adversely affect our business and prospects. In addition, as we acquire new businesses, we face numerous risks and uncertainties integrating their controls and systems into ours, including financial controls, accounting and data processing systems, management controls and other operations. A failure to integrate these systems and controls, and even an inefficient integration of these systems and controls, could adversely affect our business and prospects.

Our business depends on our ability to maintain adequate levels of personnel.

We have made substantial increases in the number of our personnel. If a significant number of our key personnel leave, or if our business volume increases significantly over current volume, we could be compelled to hire additional personnel. At that time, there could be a shortage of qualified and, in some cases, licensed personnel whom we could hire. This could hinder our ability to expand or cause a backlog in our ability to conduct our business, including the handling of investment banking transactions and the processing of brokerage orders, all of which could harm our business, financial condition and operating results.

Extensive regulation of our business limits our activities, and, if we violate these regulations, we may be subject to significant penalties.

The securities industry in the United States is subject to extensive regulation under both federal and state laws. The Securities and Exchange Commission is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally NASD and the securities exchanges, are actively involved in the regulation of broker-dealers. Securities firms are also subject to regulation by regulatory bodies, state securities commissions and state attorneys general in those foreign jurisdictions and states in which they do business. 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, anti-money laundering, record-keeping and the conduct of directors, officers and employees. Broker-dealers that engage in commodities and futures transactions are also subject to regulation by the Commodity Futures Trading Commission (“CFTC”) and the National Futures Association (“NFA”). The Commission, self-regulatory organizations, state securities commissions, state attorneys general, the CFTC and the NFA may conduct administrative proceedings which can result in censure, fine, suspension, expulsion of a broker-dealer or its officers or employees, or revocation of broker-dealer licenses. Additional legislation, changes in rules or changes in the interpretation or enforcement of existing laws and rules, may directly affect our mode of operation and our profitability.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Our business is substantially dependent on our Chief Executive Officer.

Our future success depends to a significant degree on the skills, experience and efforts of Richard Handler, our Chief Executive Officer. We do not have an employment agreement with Mr. Handler which provides for his continued employment. The loss of his services could compromise our ability to effectively operate our business. In addition, in the event that Mr. Handler ceases to actively manage the three funds that invest on a pari passu basis with our High Yield Division, investors in those funds would have the right to withdraw from the funds. Although we have substantial key man life insurance covering Mr. Handler, the proceeds from the policy may not be sufficient to offset any loss in business.

Legal liability may harm our business.

Many aspects of our business involve substantial risks of liability, and in the normal course of business, we have been named as a defendant or co-defendant in lawsuits involving primarily claims for damages. The risks associated with potential legal liabilities often may be difficult to assess or quantify and their existence and magnitude often remain unknown for substantial periods of time. Our expansion into private client services involves an aspect of the business that has historically had more risk of litigation than our institutional business. Additionally, the expansion of our business, including increases in the number and size of investment banking transactions and our expansion into new areas, imposes greater risks of liability. In addition, unauthorized or illegal acts of our employees could result in substantial liability to us. Substantial legal liability could have a material adverse financial effect or cause us significant reputational harm, which in turn could seriously harm our business and our prospects.

Our business is subject to significant credit risk

In the normal course of our businesses, we are involved in the execution, settlement and financing of various customer and principal securities transactions. These activities are transacted on a cash, margin or delivery-versus-payment basis and are subject to the risk of counterparty or customer nonperformance. Although transactions are collateralized by the underlying security or other securities, we still face the risks associated with changes in the market value of the collateral through settlement date or during the time when margin is extended. We seek to control the risk associated with these transactions by establishing and monitoring credit limits and by monitoring collateral and transaction levels daily. We may require counterparties to deposit additional collateral or return collateral pledged. In the case of aged securities failed to receive, we may, under industry regulations, purchase the underlying securities in the market and seek reimbursement for any losses from the counterparty.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We use a number of quantitative tools to manage our exposure to market risk. These tools include:

	•		inventory position and exposure limits, on a gross and net basis;

	•		scenario analyses, stress tests and other analytical tools that measure the potential effects on our trading net revenues of various market events, including, but not limited to, a large widening of credit spreads, a substantial decline in equities markets and significant moves in selected emerging markets; and

	•		risk limits based on a summary measure of risk exposure referred to as Value-at-Risk (VaR).

Value-at-Risk

In general, value-at-risk measures potential loss of trading revenues at a given confidence level over a specified time horizon. We calculate value-at-risk over a one day holding period measured at a 95% confidence level which implies the potential loss of daily trading revenue is expected to be at least as large as the value-at-risk amount on one out of every twenty trading days.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Value-at-risk is one measurement of potential loss in trading revenues that may result from adverse market movements over a specified period of time with a selected likelihood of occurrence. As with all measures of value-at-risk, our estimate has substantial limitations due to our reliance on historical performance, which is not necessarily a predictor of the future. Consequently, this value-at-risk estimate is only one of a number of tools we use in our daily risk management activities.

The VaR numbers below are shown separately for interest rate, currency, equity and commodity products, as well as for our overall trading positions using a historical simulation approach. The aggregated VaR presented here is less than the sum of the individual components (i.e., interest rate risk, foreign exchange rate risk, equity risk and commodity price risk) due to the benefit of diversification among the risk classes. Diversification benefit equals the difference between aggregated VaR and the sum of VaRs for the four risk categories. The following table illustrates the VaR for each component of market risk.


	Daily VaR ⁽¹⁾
	(In Millions)
	Value at Risk in trading portfolios
	Var at						Ave VaR 3 Months Ended
Risk Categories	9/30/05		6/30/05		12/31/04		9/30/05		6/30/05		12/31/04

Interest Rates	$	0.49	$	0.95	$	0.55	$	0.50	$	0.81	$	0.54
Equity Prices	$	2.40	$	2.25	$	1.23	$	2.72	$	2.02	$	0.90
Currency Rates	$	0.19	$	0.18	$	0.03	$	0.15	$	0.11	$	0.12
Commodity Prices	$	1.83	$	0.92	$	0.02	$	1.52	$	0.79	$	0.21
Diversification Effect²	-$	1.72	-$	1.68	-$	0.47	-$	1.73	-$	1.33	-$	0.69


Firmwide	$	3.18	$	2.62	$	1.35	$	3.16	$	2.40	$	1.08


	Daily VaR ⁽¹⁾
	(In Millions)
	Value at Risk Highs and Lows for Three Months Ended
	9/30/05				6/30/05				12/31/04
Risk Categories	High		Low		High		Low		High		Low

Interest Rates	$	0.79	$	0.35	$	1.49	$	0.43	$	0.85	$	0.31
Equity Prices	$	3.16	$	1.84	$	2.64	$	1.51	$	1.43	$	0.58
Currency Rates	$	0.45	$	0.06	$	0.29	$	0.03	$	0.60	$	0.02
Commodity Prices	$	2.45	$	0.16	$	1.85	$	0.31	$	0.55	$	0.01


Firmwide	$	3.89	$	2.46	$	3.09	$	1.75	$	1.49	$	0.81


⁽¹⁾		VaR is the potential loss in value of our trading positions due to adverse market movements over a defined time horizon with a specific confidence level. For the VaR numbers reported above, a one-day time horizon and 95% confidence level were used.

⁽²⁾		Equals the difference between firmwide VaR and the sum of the VaRs by risk categories. This effect is due to the market categories not being perfectly correlated.

We continue to enhance our VaR methodology as the diversification of our products expands. Therefore, certain reclassifications and adjustments to prior period information have been incorporated into our VaR methodology and are reflected in the tables set forth above. Average VaR of $3.16 million during the third quarter 2005 increased from the $2.4 million average during the second quarter due to an increase in exposure to commodity and equity prices. In addition to the average daily VaR increase over the past quarter, our portfolio’s diversity has continued to increase which is shown in the average diversification benefit from -$1.33 million for the second quarter to -$1.73 million for the third quarter.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

The following table presents our daily VaR over the last three quarters:

VaR Back-Testing

The comparison of daily revenue fluctuations with the daily VaR estimate is the primary method used to test the efficacy of the VaR model. Back testing is performed at various levels of the trading portfolio, from the holding company level down to specific business lines. A back-testing exception occurs when the daily loss exceeds the daily VaR estimate. Results of the process at the aggregate level demonstrated two outliers when comparing the 95% one-day VaR with the back-testing profit and loss in the third quarter 2005. An efficient model for the one-day, 95% VaR should not have more than twelve (2 out of 20) back-testing exceptions on an annual basis. Back-testing profit and loss is a subset of actual trading revenue and includes only the profit and loss effects relevant to the VaR model, excluding fees, commissions, certain provisions and any trading subsequent to the previous night’s positions. It is appropriate to compare this measure with VaR for back-testing purposes because VaR assesses only the potential change in position value due to overnight movements in financial market variables such as prices, interest rates and volatilities. The graph below illustrates the relationship between daily back-testing profit and loss and daily VaR for us in the third quarter 2005.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

VAR is a model that predicts the future risk based on historical data. We could incur losses greater than the reported VAR because the historical market prices and rates changes may not be an accurate measure of future market events and conditions. In addition, the VAR model measures the risk of a current static position over a 1 day horizon and might not predict the future position. When comparing our value-at-risk numbers to those of other firms, it is important to remember that different methodologies could produce significantly different results.

Daily Trading Net Revenue
($ in millions)

Trading revenue used in the histogram below entitled “Third Quarter 2005 vs Third Quarter 2004 Distribution of Daily Trading Revenue” is the actual daily trading revenue, which includes not only back-testing profit and loss but also fees, commissions, certain provisions and the profit and loss effects associated with any trading subsequent to the previous night’s positions. The histogram below shows the distribution of daily trading revenue for substantially all of our trading activities.

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2005. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of September 30, 2005 are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

No change in our internal control over financial reporting occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Many aspects of our business involve substantial risks of liability. In the normal course of business, we have been named as defendants or co-defendants in lawsuits involving primarily claims for damages. We are also involved in a number of regulatory matters arising out of the conduct of our business. Our management, based on currently available information, does not believe that any matter will have a material adverse effect on our financial condition, although, depending on our results for a particular period, an adverse determination or settlements could be material for a particular period.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities


					(c) Total Number of
	(a) Total		(b)		Shares Purchased as		(d) Maximum Number of
	Number of		Average		Part of Publicly		Shares that May Yet Be
	Shares		Price Paid		Announced Plans or		Purchased Under the
Period	Purchased (1)		per Share		Programs (2)		Plans or Programs
July 1 — July 31, 2005		1,263,784		38.49		625,000		3,000,000
August 1 — August 31, 2005		27,322		40.63		—		3,000,000
September 1 — September 30, 2005		—		—		—		3,000,000

Total		1,291,106		38.54		625,000


(1)		We repurchased an aggregate of 666,106 shares other than as part of a publicly announced plan or program. We repurchased these securities in connection with our stock compensation plans which allow participants to use shares to pay the exercise price of options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. The number above does not include unvested shares forfeited back to the Company pursuant to the terms of our stock compensation plans.

(2)		On October 24, 2002, we issued a press release announcing the authorization by our Board of Directors to repurchase, from time to time, up to 1,500,000 shares of our stock. As of June 30, 2005, we were authorized to repurchase, from time to time, up to 953 ,600 shares under our publicly announced program, after adjusting for the 2-for-1 stock split effected as a stock dividend on August 15, 2003. On July 19, 2005, we repurchased 625,000 shares from John C. Shaw, Jr., at a per share price of $35.40. On July 26, 2005, we issued a press release announcing an amendment to our repurchase program and the authorization by our Board of Directors to repurchase, from time to time, up to an aggregate of 3,000,000 shares.

Item 6. Exhibits


Exhibits
2		Share and Membership Interest Purchase Agreement dated as of July 18, 2005, by and among Brian P. Friedman, James L. Luikart, 2055 Partners L.P., Jefferies Capital Partners IV LLC, JCP IV LLC, and Jefferies Group, Inc. is incorporated herein by reference to Exhibit 2 of the Registrant’s Form 8-K filed on July 21, 2005.

3.1		Amended and Restated Certificate of Incorporation of Jefferies Group, Inc. is incorporated herein by reference to Exhibit 3 of the Registrant’s Form 8-K filed on May 26, 2004.

3.2		By-Laws of Jefferies Group, Inc are incorporated herein by reference to Exhibit 3.2 of Registrant’s Form 10-K filed on March 28, 2003.

10		Summary of the Total Direct Pay Program from Brian P. Friedman is incorporated herein by reference to Exhibit 10 of the Registrant’s Form 8-K filed on August 16, 2005.

31.1*		Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer.

31.2*		Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer.

32*		Rule 13a-14(b)/15d-14(b) and Section 1350 of Title 18 U.S.C. Certification by the Chief Executive Officer and Chief Financial Officer.


*		Filed herewith.

Page 47 of 48


	3rd Quarter			3rd Quarter
	2005			2004

Stock based compensation (1)	$	16,030		$	16,206
Net revenues	$	299,280		$	253,786
Compensation and benefits	$	167,033		$	141,434
Average employees		2,001			1,749

Stock based compensation / net revenues		5	%		6	%
Stock based compensation / compensation and benefits		10	%		11	%
Annualized average net stock based compensation / employee	$	19		$	23


	Page

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Statements of Financial Condition (unaudited) — September 30, 2005 and December 31, 2004		3

Consolidated Statements of Earnings (unaudited) — Three Months and Nine Months Ended September 30, 2005 and 2004		4

Consolidated Statement of Changes in Stockholders’ Equity (unaudited) — Nine Months Ended September 30, 2005 and Year Ended December 31, 2004		5

Consolidated Statements of Cash Flows (unaudited) — Nine Months Ended September 30, 2005 and 2004		6

Notes to Consolidated Financial Statements (unaudited)		8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		29

Item 3. Quantitative and Qualitative Disclosures About Market Risk		43

Item 4. Controls and Procedures		46

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		47

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		47

Item 6. Exhibits		47

Signature		48
EX-31.1
EX-31.2
EX-32


	Page

Note 1 Summary of Significant Accounting Policies		9
Note 2 Asset Management Fees and Investment Income From Managed Funds		16
Note 3 Cash, Cash Equivalents, and Short-Term Investments		19
Note 4 Securities Owned, Securities Pledged to Creditors and Securities Sold, Not Yet Purchased		19
Note 5 Bank Loans		20
Note 6 Long-Term Debt		20
Note 7 Pension		21
Note 8 Minority Interest		21
Note 9 Earnings Per Share		21
Note 10 Other Comprehensive Gain (Loss)		22
Note 11 Net Capital Requirements		23
Note 12 Quarterly Dividends		23
Note 13 Jefferies Financial Products, LLC		24
Note 14 Derivative Financial Instruments		25
Note 15 Commitments, Contingencies and Guarantees		26
Note 16 Segment Reporting		27
Note 17 Goodwill		28
Note 18 New Purchase Agreement		28


(1)		Stock based compensation is the pre-tax expense associated with all of our employee stock-based compensation plans, including the discount on DCP deferred shares, restricted stock amortization, discounts on employee stock purchase plans and ESOP contributions.


(1)		Items are included in Securities Owned. Items are financial instruments utilized in the Company’s overall cash management and are readily convertible to cash.


		JEFFERIES GROUP, INC.
		(Registrant)

Date: October 24, 2005	By:	/s/ Joseph A. Schenk

		Joseph A. Schenk
		Chief Financial Officer