Thomas Weisel Partners Group, Inc. Q3 2008 Earnings Call Transcript

Thomas Weisel Partners Group, Inc. (TWPG)

Q3 2008 Earnings Call Transcript

October 29, 2008, 5:00 pm ET

Executives

Tom Weisel – Chairman and CEO

Shaugn Stanley – CFO

Lionel Conacher – President and COO

Analysts

Bill Tanona – Goldman Sachs

Lauren Smith – KBW

Presentation

Operator

Good afternoon and thank you for joining the TWP earnings conference call. I have been asked to remind you that today’s call includes forward-looking statements and those statements represent beliefs regarding future events, backed by their nature, are uncertain. Actual events may differ, possible materially, from what is indicated or implied in those forward-looking statements, and no commitment is made to update them. For a discussion of some of the factors that could affect those statements, please see the risk factors set forth in TWP’s most recent report filed with the SEC. This audiocast is copyrighted material of TWP and may not be duplicated, reproduced or re-broadcast without consent.

As a reminder, today’s call is being recorded. We will be taking live questions at the end of today’s presentation. (Operator instructions)

I will now turn the call over to the Chairman and CEO, Mr. Weisel.

Tom Weisel

Thank you and good afternoon. I will provide some opening comments, and then Shaugn Stanley our CFO will give details on the financials, followed by Lionel Conacher, our President and COO, who will provide an update on the firm.

The third quarter proved again to be very challenging for the capital markets, given unprecedented events on Wall Street that led to increased uncertainty and turmoil in the U.S. economy and global financial markets. These events directly affected our earnings results. We are focused on making necessary adjustments to our business and adapting to the current environment. We are planning for the remainder of 2008 and all of 2009 to be a continuation of the current environment and are actually focused on three areas. Number one, preserving capital and retaining key people in order to emerge as a strong player once market stability returns; two, reducing compensation and non-compensation expenses in order to operate at a breakeven on a cash basis or better; and three, enhancing the value of our franchise with opportunistic hires, particularly in the advisory business and to be ready to build market share when stability returns.

Now let me provide a few details on these points. With the demise of several large Wall Street firms and the redirection of business models of others, opportunities in investment banking have never been greater. On the brokerage side based on U.S. trading, we estimate that the average middle market firm could see brokerage revenue grow incrementally by up to 20%. This presents opportunities for TWP to gain market share in both investment banking and brokerage and we expect to capture these opportunities. To weather this downturn, we have initiated further non-compensation reductions, expected to meaningfully reduce 2009 expenses by approximately $10 million. This is in addition to the $3 million in non-comp reductions we are on target to realize by the end of 2008.

Through a combination of attrition and targeted layoffs, our headcount will be reduced additionally by approximately 60 employees, or 10% by the end of the year. As a result, our workforce will be approximately 550 going into 2009, down from 757 on January 1 of this year. These reductions are mainly in areas that continue to under-perform and non-revenue producing areas. Savings related to headcount reductions, benefit reductions in base salary reductions of 10% for Vice Presidents and above, are estimated to reduce compensation expense by approximately $10 million in 2009. Total 2009 savings, therefore, are projected to be approximately $20 million. Furthermore, these cost saving steps allow us to manage through a prolonged economic downturn, while maintaining adequate cash and capital to operate our business.

As of September 30, our cash and cash equivalents were $110 million versus $127 million in the second quarter, of which approximately $100 million was being used to capitalize our broker dealer. With our current initiatives to reduce compensation and non-compensation expenses, we are managing our business toward a cash breakeven level at $63 million per quarter in revenue. The volatility and uncertainty in the financial markets has had an effect on our stock price, leading us, based on accounting standards, to take an estimated non-cash goodwill impairment charge of $93 million, or $2.89 per share during the quarter. This non-cash charge-off of goodwill associated with our Westwind acquisition, does not affect our reported regulatory capital or our tangible book equity.

Looking forward, the TWP brand is a category leader in growth investment banking, research, sales and trading, is in a strong position to gain market share when conditions improve. The acquisition of Westwind significantly contributes to the diversification of our business, with energy and mining activity contributing 40% of our investment banking revenues during the first nine months of this year.

Our current mix of business on total revenues for the first nine months is 85% US, 12% Canada, and 3% Europe. Over the course of the year, we have strategically hired six senior professionals in our sales trading and research efforts and six other senior investment banking calling officers. Three of these hires have been the direct result of the dislocation at Bear and Merrill. These hires bring extensive expertise to our platform and significantly enhance the breadth and depth of our business. We remain committed to our growth initiatives in order to strengthen the firm. We have continued to build out the advisory business, our electronic trading platform, and our European operation, all of which contributed to this quarter’s results. We also continue to be successful in raising assets for our asset management products.

Now I’ll turn the call over to Shaugn, who will give you details on our earnings.

Shaugn Stanley

Thanks, Tom. We reported a net loss of $109.2 million and a diluted loss per share of $3.41 in the third quarter. Adjusting for the non-cash charge of $93 million or $2.89 per share related to the goodwill impairment charge-off and the non-cash after-tax charges of $1 million, or $0.03 per share related to our initial public offering and $2.2 million or $0.07 per share related to the amortization of intangible assets acquired in the Westwind Partners transaction, we recorded a non-GAAP net loss of $13.4 million, and a non-GAAP diluted loss per share of $0.42.

Our operating cash loss in the quarter was approximately $7 million, after adjusting for non-cash items included in our pretax loss. Our broker dealer entities maintained capital in excess of regulatory requirements of approximately $73 million as of September 30, an increase from $68 million as of June 30. We continue to operate our broker dealer subsidiaries with adequate capital. As Tom mentioned, we expect the steps that we are taking to reduce non-comp expenses, as well as the steps to increase the variability of our compensation expenses to significantly improve our operating results.

On this call, we are comparing current results against the corresponding unaudited 2007 pro forma combined third quarter results for Thomas Weisel Partners and Westwind Partners. In our press release, we also disclosed these pro forma amounts, and on our website we are posting pro forma results for each quarter of 2007.

Our total net revenues were $49 million in the third quarter of 2008 compared to $81 million in the year ago quarter and down from $60 million in the second quarter of the year. Investment banking revenues were $17.5 million in the third quarter, compared to $38.4 million in the third quarter of 2007, and down from $22.9 million in the second quarter. We completed 13 transactions in the third quarter compared to a combined total of 32 in the third quarter of 2007 and 32 in the second quarter of this year. Of our investment banking revenues, we generated $3.9 million in capital raising and $13.6 million in M&A. Investment banking revenues were broadly diversified by industry, led by energy representing 40%, followed by 25% in consumer, 18% in mining, 12% in technology, and 5% in healthcare.

Brokerage revenues were $33.7 million in the third quarter, which included $1.6 million in convertible trading losses. We have reduced the inventory positions we maintained in our convertible principal trading operations and as a result, we do not expect these losses, which totaled $4.1 million for the first nine months of 2008, to recur in 2009. The $33.7 million in third quarter brokerage revenues compares to $32.9 million in the third quarter of 2007 and $34.9 in the second quarter of this year. Of these revenues, $5.7 million, $7.4 million, and $5.8 million were related to our private client services business in the third quarter, year ago quarter, and second quarter of this year, respectively.

Asset management net losses were $2.3 million in the third quarter, compared to net revenues of $8.7 million in the year ago quarter and $1.9 million in the second quarter of this year. Compensation and benefits decreased 27% in the third quarter to $36.9 million, compared to $50.4 million in the third quarter of 2007. Our non-GAAP compensation ratio increased to 68% in the third quarter, from 62% in the year ago quarter and from 67% in the second quarter of 2008. Our third quarter non-GAAP ratio is above our goal of 60%, due to lower than expected revenues, combined with fixed elements of compensation, such as salaries, guarantees, taxes, benefits, and equity award expense.

Non-compensation expenses were $39.1 million in the third quarter, excluding the goodwill charge off. We incurred $5 million of nonrecurring expenses in the third quarter that we do not expect to incur in 2009, including $2.4 million in lease charges and $2.7 million in extraordinary legal expenses. Excluding these one-time items, our non comp expenses would have been $34.1 million. This compares to $34.7 million in the third quarter of 2007.

Occupancy and equipment increased $2.1 million in the third quarter compared to the year ago quarter, mainly due to a facilities charge in connection with downsizing our office space in San Francisco. As we reduce our headcount, our real estate needs are also reduced. We continue to look at ways to rationalize our real estate and we could have a similar charge in the fourth quarter. Brokerage execution and clearing expenses increased $1.8 million compared to the third quarter of 2007, due to additional floor brokerage execution expenses, trading errors, and the reclassification of regulatory fees from the year ago period. Other expenses increased $1.1 million, $9.4 million in the third quarter compared to the year ago quarter, due to higher investment banking legal expenses on broken deals.

Marketing and promotion decreased $1.2 million compared to the third quarter of 2007, due to lower travel and entertainment expenses. Our tax benefit was 9% in the third quarter of 2008, compared to a 44% tax benefit – pro forma of 44% tax benefit in the third quarter of 2007. The decrease in our tax benefit rate was primarily attributable to the tax effect of the goodwill impairment. If we exclude the effect of this discrete item, our effective tax rate would have been 38%, which we believe to be our normal effective tax rate. For tax purposes, our acquisition of Westwind Partners did not result in an increase in the tax basis of its net assets and as a result has no effect on our actual tax obligations.

I’ll now turn the call over to Lionel.

Lionel Conacher

Thanks, Shaugn. In the wake of continued headwinds, we are taking aggressive measures to right-size our firm to the current environment. As Tom mentioned, our workforce will be reduced by 10% or 60 employees. This brings total headcount for the year down by approximately 27% or 200 employees, leaving headcount at approximately 550 going into 2009. We’ve also decided to reduce base salaries for VPs and above as of January 1, 2009, in order to increase the variability of our compensation model. As we navigate through this difficult environment, we remain focused on preserving the revenue-generating capabilities of this franchise, while actively managing the costs side of our business.

We continue to selectively add talent to our platform throughout the quarter. We recently hired Seth Ferguson as the Managing Director and Co-Head of Mergers and Acquisitions. Seth is based on the West Coast and brings over 20 years of industry experience. He was most recently with UBS. Chris Poggi joined as Managing Director focused on Investment Banking Software. Chris has 15 years of experience and was previously with JPMorgan. On our brokerage platform, Doug Leo joined as Head of Commission Management. Doug was most recently with Lehman Brothers and brings 13 years of experience to our firm. Also, Bill Verner joined us earlier in the quarter as President of TWP Canada. Bill was previously with UBS Securities and brings over 28 years of brokerage experience to our platform. As a result of the current market conditions, we are well positioned to improve our investment banking and brokerage businesses, with the addition of this exceptional talent.

I will now provide details on the performance of our business. On our banking platform, we’ve experienced continued growth in our strategic advisory business. Compared to the second quarter of 2008, our strategic advisory revenue increased 49% to $13.6 million and was the strongest quarter so far this year. In the third quarter, we advised five companies on their strategic transactions, including advising Saxon Energy Services sale to Schlumberger and First Reserve Corporation for $706 million, Frontier Pacific Mining sale to Eldorado Gold Corporation for CAN$179 million, and the partial acquisition of Not Your Daughter’s Jeans by Falcon Head Capital.

Capital raising revenues decreased by 71% in the third quarter compared to the second quarter of 2008. With the IPO market grinding to a halt, we are turning our efforts towards our private placement business, which, along with our strategic advisory efforts, we see as the most promising areas for the coming year. Our average revenue per transaction increased to $1.3 million in the quarter from $717,000 in the second quarter. In the U.S., the average revenue per transaction was $1 million and in Canada, it was $1.7 million. The increase in Canada was the result of a large fee generated from a single transaction. Our investment banking backlog, which consists of the number of filed, announced, and engaged transactions at the beginning of the fourth quarter, was down from the beginning of the third quarter. While the pipeline numbers may not be a true indication of activity in this market environment on file, we currently have 14 IPOs for which we are book or lead manager on six, and one announced M&A transaction.

In brokerage, growth of our institutional platform, buoyed by the strength in our middle markets efforts, our electronic trading business, improved cross border flows into Canada, and higher revenues in Europe, all contributed to our 10% growth in the first nine months of the year over the same time last year. Our electronic trading business has benefited from a combination of new accounts and an increase in business levels from existing accounts, mostly due to the turmoil surrounding the bulge bracket firms. Sequentially, third quarter brokerage net revenues were down 3%, while we experienced positive results from Europe and growth in our electronic trading platform and solid results from our U.S. institutional business, these increases were offset by a decline in our convertible trading business, which recorded a loss of $1.6 million. This was as a result of higher facilitation losses due to the challenging market conditions.

On our last call, we announced that we had wound down our convertible principal trading operations and refocused our trading effort to support our investment banking business. In the second quarter, we successfully reduced our convertible trading book from net long of $63 million, down to $22 million, effectively reducing our regulatory capital exposure from $32 million down to $11 million. Notwithstanding these efforts, we still experienced losses in the third quarter. However, we have continued to reduce our net long exposure since the end of the quarter and now have net long of $12 million and a capital allocation of $2 million deployed in the convertible area. As we manage through this downturn, we are addressing underperforming areas and reducing nonessential costs, while building our overall platform to be in the best competitive position to gain market share. I will now turn the call back to Thom who will give additional details on our asset management business and closing remarks.

Tom Weisel

Thanks, Lionel. I’d like to give you an update on our asset management business. In the third quarter, our asset management net losses were $2.3 million. The management fees were $3.8 million, which were offset by private equity and other security net losses of $6.1 million. These losses were mainly attributable to downward valuations of our warrant portfolio of $2.8 million, mark to market losses in two public portfolio companies in our healthcare venture partner’s fund of $1.1 million, write-downs in our venture partners fund of $0.8 million, and declines in other securities of $1.4 million.

Our warrant portfolio, most of which was acquired as part of the Westwind transaction, was valued at the date of acquisition using fair value model, resulting in a portfolio value at $7.7 million on January 1. As of September 30, our warrant portfolio has been valued at $1.7 million, which was primarily the result of decreases in fair values and the expiration of out-of-the-money warrants. We do not expect to incur similar fair value declines in 2009. Three incubation funds totaling $3.2 million in pretax losses will be sold or closed down by the end of the year. Outside of mark to market exposure or any realizations, the asset management business in 2009 has projected a breakeven on its management fees.

We added $100 million of assets on our management to our global growth partners fund to fund’s program in the third quarter, bringing assets under management to $1.4 billion. In addition, we recently closed a $10 million institutional account for our small cap growth strategy run by Ken Korngiebel in Portland. In a tough environment, our small cap growth team posted second quartile returns among their institutional account manager peers for the third quarter year to date and 12 months ended September 30. We continue to be optimistic about raising additional funds for our asset management business in the future.

In closing, I want to reiterate that management and right-sizing the business for the current environment and building the earnings power to the company has taken the necessary steps to protect the long-term viability of the TWP franchise and position ourselves for the recovery in the market. We have a strong brand and a much more diversified platform and the highest caliber of professionals. When stability in the market returns, growth companies will have a need for capital and we will be well positioned to capitalize on this condition. Now we’ll open this up for questions.

Question-and-Answer Session

Operator

(Operator instructions) The first question comes from Bill Tanona from Goldman Sachs. Your line is open.

Bill Tanona – Goldman Sachs

Hey, good evening guys. Just – thanks for the details in terms of what you guys are targeting. Just want to make sure that I understand them. The $63 million is kind of what you’re looking for in terms of the breakeven revenue and as you think about the $63 million, how should I be thinking about the non-comp, just given some of the one-timers? Is the right way to look at it to say that this full year kind of non-comp should just exclude the $5 million that you talked about here in the third quarter and if we assume a similar level, you’re talking about $138 million roughly for full year 2008? And if that’s the right number, then we should be taking the $10 million off of that?

Shaugn Stanley

That’s right. You’ve got it right, exactly right.

Bill Tanona – Goldman Sachs

So in that scenario, if the $63 million is right, you guys are looking to target about a 50% comp to net revenue ratio. Is that about right as well?

Tom Weisel

I think it would be higher than that, Bill. Yes, it’d be more like $60 million, low 60s I think. Shaugn?

Shaugn Stanley

Yes, we’re right at $63 million, Bill.

Bill Tanona – Goldman Sachs

Okay, I guess I’ll just follow up to understand that one just a little bit better. The warrants, in terms of the remaining warrants, I know you said that obviously you don’t expect any type of write-downs on those as it relates to 2009, primarily because the warrants are good for, I believe, 12 months. But is it safe to assume that that $1.7 million, we should be assuming if the markets don’t recover here that that should also be written down in the near term?

Tom Weisel

Well, they’re basically mark to market, but those securities could go down further and therefore we could have further exposure. Correct.

Bill Tanona – Goldman Sachs

Okay, and then just lastly, in terms of cash earnings you guys talked about, just want to make sure I’m on the same page in understanding how you guys are thinking about cash earnings. Is it everything including non-cash compensation, as well as amortization depreciation and IPO awards? Just trying to get an understanding exactly what you guys are benchmarking as far as the cash earnings.

Shaugn Stanley

It’s adding back the depreciation amortization, adding back share-based comp, and adding back some of the non-cash losses, particularly the broker warrant losses.

Bill Tanona – Goldman Sachs

And the IPO awards?

Shaugn Stanley

Yes, that’s correct.

Bill Tanona – Goldman Sachs

And just so I’m clear, you’re not just talking about the IPO awards, you’re also talking about the non-cash compensation that would be for ongoing performance?

Shaugn Stanley

That’s correct, Bill.

Bill Tanona – Goldman Sachs

Thank you.

Shaugn Stanley

Yes.

Operator

The next question comes from Lauren Smith from KBW. Your line is open.

Lauren Smith – KBW

Hi guys, how are you?

Tom Weisel

Hi, Lauren.

Lauren Smith – KBW

A couple questions. One, on the – I just want to make sure I got all the numbers right. You said 10% headcount, so pro forma we’re kind of looking at about 550, is that correct?

Tom Weisel

Yes, as of January 1, that’s what we’ll be looking at.

Lauren Smith – KBW

And just to get a sense – I know you gave us the dollar amount of anticipating $20 million in comp savings. I’m just curious as to how many people is driving that savings. So in other words, how many people at the firm do you have that are VP and higher?

Tom Weisel

Yeah, Lauren, it was $20 million in total expense savings, $10 million of which is comp related and $10 million of which is non-comp related.

Lauren Smith – KBW

Okay.

Tom Weisel

And of the reduction in base salaries for VPs and above, is roughly half of the comp reductions.

Lauren Smith – KBW

Okay, and given that you have been taking advantage of the plethora of opportunities out there to hire people, so obviously you’re kind of in the driver’s seat with negotiating comp, but the plan here is to make your comp highly variable going forward, so you can sustain for a protracted downturn. But is there any fixed comp with any of these new hires or can we really think about as we move into ’09 like a truly variable comp ratio?

Lionel Conacher

Lauren, it is Lionel. I think you can look at the compensation system as being highly variable. I mean there is still a base salary component to it that we can give you a ballpark on what that number is based on our current staffing and projected staffing at the 550 person level going forward. In terms of guaranteed component of our compensation, the bulk of our current guarantees roll off in the February bonus period. And so on a go-forward basis, you’ll see that substantively reduced than what it’s been over the past two years. In terms of the people that we’ve hired recently, I can say that as an overall rule, we are not having to pay guarantees right now. And the only thing that we continue to do is if people are coming from other firms where they’ve got RSUs, we are taking on those RSU liabilities. But we’ve been able to structure that very much tied to each individual’s direct performance on revenue generation. So we’ve made our compensation system as direct drive as we possibly can, while still maintaining an overall pool concept and trying to incent teamwork and franchise building.

Lauren Smith – KBW

Great, that’s helpful. And then I guess, you gave us the breakdown by sector, but I don’t think – they don’t add up to 100. So can you, just sorry, quickly just run through them again? The distribution between energy, consumer, et cetera?

Lionel Conacher

Sure, hang on just a second. What, this is in banking now? 40% in energy, 25% consumer, 18% in mining, 12% in tech, and 5% in healthcare.

Lauren Smith – KBW

Great, and then, I mean, I get your – I just want to make sure the – we’re on the same page with backlog numbers. I have that you have currently only two deals that are on the equity backlog side that have been filed, newly filed in the past six months, but a total pipeline of 16 deals on equity. Does that sound about right?

Shaugn Stanley

Yes.

Lauren Smith – KBW

And M&A, two deals.

Tom Weisel

(inaudible) expect any of that in the short term, Lauren.

Lauren Smith – KBW

Yeah, I know. I mean clearly things are…

Tom Weisel

And our bankers are not advising anybody to file right now and get the clock started because we just don’t see the turn.

Lauren Smith – KBW

Yeah, no, I can appreciate that. I’ll get back in the queue. Thanks.

Operator

Again, if you’d like to ask a question, simply press star then the number one on your telephone keypad. I have no further questions at this time.

Tom Weisel

Okay, we thank everybody for attending and let’s hope we have a better quarter ahead of us. Thank you.

Operator

Thanks for joining us. This concludes our program. You may now disconnect from the audio portion of this event.

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