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Executives

Richard Handler – Chairman & CEO

Peg Broadbent – EVP & CFO

Analysts

Ryan O'Connell – Citigroup

Patrick [ph] – BOA / Merrill Lynch

Steve Stelmach – FBR

Lauren Smith – KBW

Horst Hueniken – Thomas Weisel Partners

Jefferies Group, Inc. (JEF) Q4 2008 Earnings Call Transcript January 20, 2009 9:00 AM ET

Operator

Welcome to the Jefferies 2008 fourth quarter financial results conference call. A question-and-answer period will follow management's prepared remarks. (Operator instructions). As a reminder, this conference call is being recorded. A press release containing Jefferies' 2008 fourth quarter financial results was distributed via BusinessWire before the market opened today and can be accessed at Jefferies' web site, www.jefferies.com.

Some of the comments made in this conference call may include forward-looking statements. These forward-looking statements may contain statements about management's current expectations, strategic objectives, growth opportunities, business and prospects. These forward-looking statements are not statements of historical fact and represent only Jefferies' beliefs as to future performance. They usually include the words continue, will, believe, should, or other similar expressions. Actual results could differ materially from those projected in these forward-looking statements. Please refer to Jefferies' annual report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2008, and in Jefferies' Forms 10-Q and 8-K for discussions of important factors that could cause actual results to differ materially from those projected in these forward-looking statements.

I would now like to introduce your host for today's conference, Mr. Richard Handler, Chairman and CEO of Jefferies. Mr. Handler, you may begin your conference.

Richard Handler

Good morning and thank you for joining our discussion of Jeffries results for 2008. I am Rich Handler, Chairman and CEO of Jeffries, and with me on the call today are Brian Friedman, Chairman of our Executive Committee, and Peg Broadbent, our Chief Financial Officer. I do apologize for the lateness in our release as the newswires were very busy this morning, it took about 25 minutes to get it out, so I apologize for the delay.

On December 3, we announced changes designed to restore profitability for Jeffries in 2009, an estimated what the impact of these changes would be on our fourth quarter results. We also described how the extraordinary and unprecedented market conditions of October and November were severely affecting our fourth quarter results and how most likely December would be no better. Today with 2008 thankfully behind us, we can confirm that while our fourth-quarter numbers were indeed as poor as we predicted, we firmly believe Jefferies is positioned for much improved results in 2009.

As expected, Jeffries posted a loss for the fourth quarter of $443 million or $2.41 per share. 75% of this loss derives from the $320 million in exceptional items, the largest of which as previously disclosed was the noncash impact of modifying the terms of prior-year’s employee stock awards. Peg will provide the details on these finalized numbers in a moment.

As we all know, 2008 was the most challenging year for our industry in living memory. The market instability reached a crescendo in the fourth quarter, and we avoided the collapse of the global financial system as a result of the dramatically expanded government intervention. As we see here today, our common equity base of $2.1 billion is the highest it has ever been at the start of a new year. On top of that foundation, we have $1.9 billion of long-term debt and preferred stock with an average life of 14 years.

As introduced in detailed fourth-quarter pre-announcement conference call, we have now completed the next level of our action plan to embrace the new reality of our financial world. We completed a significant painful reduction in personnel, the closing of marginal officers and adjusting of our compensation payouts, all in addition to our previously discussed expensing of historical stock compensation.

We do not know what the future holds regarding the health of the global financial system and the world economy. We have always been well positioned in terms of the quality of our human capital, the diversity of their products and services. Now we also have the right cost structure as well as the best competitive position we have ever experienced.

Peg will now briefly go through some of the operating details of our terrible fourth quarter which is fortunately behind us.

Peg Broadbent

Thank you, Rich. As Rich mentioned, we posted a loss of $443 million or $2.41 per share, including the $328 million of exceptional items on a post-tax bases that we announced and discussed on December 3. I will remind you of the composition of these exceptional items shortly. Excluding exceptional items, our operating loss for the fourth quarter was negative $114 million, driven by a significant decline in revenues, a portion of which is mark to market unrealized losses as a result of the market turmoil.

Our fourth quarter net revenues were $148 million. The decrease from $274 million in the third quarter of 2008 was mostly driven by markdowns across all inventory classes and significantly reduced capital market activity. Our core equity division performed well and consistent with results from other quarters. However, we recognized significant realized losses in certain block trading positions due to the extreme volatility. As a result, our equity trading revenues for 4Q08 was $79 million. Just as we have cautioned you from time to time when we have recorded positive quarterly results from block trading activities, we caution you to not necessarily factor in these losses when considering our future equity trading results.

Our revenues from fixed income commodities ex high yield continued to grow to $80 million in 4Q08. As in the third quarter, our corporate bond trading business performed strongly due to reduced competition and a strengthened sales and trading team. Jefferies high yield trading revenues were negative $92 million in the fourth quarter. The losses were attributed to the significant markdowns in positions that we still hold.

For the year, Jefferies high yield trading was down about 20%. Investment banking revenues were $87 million for the quarter. Almost 90% of these revenues were from our advisory business, as the capital markets virtually shut down. Our asset management revenues were negative $35 million for the quarter. As with other business lines, our asset management business suffered from writing down positions in the market turmoil. Today we have $132 million of capital in this business.

Our compensation charges for the quarter were $739 million and $1.52 billion for the year. These numbers include exceptional items that we described in our call on December 3. They were, A, severance costs that were $32 million and $57 million for the quarter and year respectively, and B, the modification during the fourth quarter to the terms of our employee stock awards such the previously granted awards are written off and current year employee stock compensation awards are expensed in the year in which this is provided. These charges totaled $318 million for the quarter and $427 million for the year on a post tax bases.

Our non- compensation expenses were $147 million for the quarter. These include $15 million of exceptional items relating to Lehman, Landesbanken, and other matters for which we have fully reserved. Our non-compensation costs were also increased by $11 million of other receivable write-offs, mostly related to our investment banking business and $8 million of non-recoverable legal fees related to investment banking deals that did not close.

We believe the fourth quarter was unique from a non-comp operating cost perspective and believe 2009 should be more similar to the range of our first three quarters. We had anticipated the cost of closing several officers and agents to be in recorded in the fourth quarter. However, because of timing issues, these costs will be incurred in the first quarter of this year and will total $2 million.

We started and ended this year with 2,555 and 2,214 direct employees respectively. On December 3, we indicated a post reduction employee level of 2,150, which is still accurate when you remove 50 or so employees who are still transitioning out, primarily as we complete the legalities of transitioning our offices. As Rich mentioned, Jefferies’ shareholders equity at year end was $2.13 billion compared to $1.76 billion at December 31, 2007. During the quarter, we repurchased about one million shares. The book value per share was $13.05 based upon 163 million shares outstanding. We estimate our year end gross leverage ratio will have fallen to 8.9% from 15.8% last year, and on an adjusted basis, it has decreased to 5.1% versus 6.9% a year earlier.

We estimate that at December 31, 2008, our level three assets after accounting for minority interest were about $330 million. We estimate our cash balances of December 31 have increased since the third quarter to $1.3 billion from about $1 billion.

Now I'll turn back to Rich.

Richard Handler

Thank you, Peg. Jefferies has just experienced the most incredible stress test imaginable for a financial services company. We have emerged as one of the strongest, independent, non-governmental subsidized securities firms in the United States. We like our capital base, our improved and more flexible and transparent cost structure, the businesses we operator, and and most importantly our employee partners on our team. We are now more important and relevant to our clients that at any time in our 47-year history.

The opportunities for our core trading businesses in 2009 are large. With reduced risk profile and expanded client base and share of the market, and hopefully even in a slightly more stable environment, we believe the contribution from both our core equity and fixed income sales between platforms would be significant in 2009. Our investment bank is also robust and competitively positioned to take advantage of the recapitalization cycle as it emerges.

The market has indeed been relatively stable for the first few weeks of 2009, and as a result we have made a very positive start to the year. That being said, we have no choice but to continue to be prepared for future turmoil and volatility since none of us know what the future holds. We can only promise that we'll work tirelessly and to the best of our ability to protect Jeffries, serve our entire client base and do our absolute best for our shareholders and debt holders.

Thank you and we’ll now answer any questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from the line of Ryan O'Connell with Citigroup.

Ryan O’Connell – Citigroup

Recognizing that this was a very, very difficult month, December, my recollection, Peg, is that when we talked on the pre announcement call, I think you all were looking toward an operating loss ballpark in line with the first quarter of 2008, which is about $60 million. So based on a quick review of the press release today, it looks like the operating loss exceeded exceptional items, which is about 115. So could you walk through what caused the delta there?

Peg Broadbent

Yes, certainly. We referenced, as you indicated, that we are expecting at the beginning of December a fourth quarter operating loss similar to that of the first quarter, which was about $60 million. Included in our first quarter results were revenues of about $200 million, and I just mentioned that we have revenues in the fourth quarter of about a little less than $150 million. So that was one sort of major factor that drove the discrepancy between what we were expecting at the beginning of December from an operating loss perspective and what actually came through. We incurred a number of mark to market writedowns during the course of December on several positions that we hold across our high yield business and some of our equity block trading positions, where we continue obviously to be mark to market and continue to be conservatively mark to market. In addition to that, we had some one-time unusual additional operating expenses that we weren’t necessarily anticipating in the beginning of December, and I referenced some of those during the course of the script.

Ryan O’Connell – Citigroup

Okay. So again bearing in mind that it was a tough month, so basically if I heard you right, it sounds like the real differences here were just you got off a high yield market and maybe some unusual for you all mark to market [ph] trading funds and equities. Is that fair?

Peg Broadbent

That's correct, yes.

Ryan O’Connell – Citigroup

Okay. Then I guess the other question, just on our old friends, the managed funds, what do you think the outlook is there? I mean just you know there has been one quarter of profit over the last six quarters I think.

Peg Broadbent

I think there the good news is that we continue to reduce our capital that is at risk. The fourth quarter particularly reflected poor performance in one fund where continuing 0capital commitment at this point is very small, so we would like to think that the worst of that is behind us and we shouldn't have the kind of drag that we had in 2008 but obviously no one knows for sure. But I think that reduced capital commitment and the concentration to a very small handful of funds that had performed better than the average over the last year or two, we’re slightly optimistic we will be in a better place with them.

Ryan O’Connell – Citigroup

Okay, thank you very much.

Operator

Your next question comes from the line of Guy Moszkowski with BOA / Merrill Lynch.

Patrick – BOA / Merrill Lynch

Hi. It's actually Patrick [ph]. Good morning guys. Could you give us an idea of the size of the unrealized losses embedded in your high yield business that could possibly reverse the spreads tightening?

Richard Handler

It is hard to say that we are not heavily invested. We are at the class where we now have lots of cash and no leverage in the actual fund and that is basically a free flow which shows the marked securities based upon where we thought there would ways to move them. So we market appropriately just about all the loss (inaudible).

Patrick – BOA / Merrill Lynch

Right. And so you are still – they are still unrealized and reversible?

Richard Handler

They are unrealized and hopefully with the market they would be reversible.

Patrick – BOA / Merrill Lynch

Okay, great. And outside of the high yield business, could you give us an idea of what were the key drivers of the strength in the fixed income business, what asset classes or businesses?

Peg Broadbent

As I indicated earlier, one of the key drivers is our corporates business as it was in the third quarter. We also had a strong emerging market result and our mortgage business continues to perform well.

Patrick – BOA / Merrill Lynch

Great, okay. And post the employee reductions that you’ve made, could you give us an idea of what you feel like a minimum comp level would be if the revenue environment remained this weak outside of the mark to market losses?

Richard Handler

Look, we are trying to target a 60% comp ratio to get back to our foundation and improve it from there, but until there is a relative calm in the world, we can't promise anything.

Peg Broadbent

And in addition to that, as we have indicated on previous calls, we have a very good chance of hitting that 60% comp ratio. We have revenues evenly distributed across all our major business lines. One of the problems we’ve passed from this year was taking losses in a couple of business lines and reasonable strength in others.

Patrick – BOA / Merrill Lynch

Okay, great. Thanks a lot, guys.

Peg Broadbent

Thank you.

Operator

(Operator instructions) Your next question comes from the line of Steve Stelmach with FBR.

Steve Stelmach – FBR

Hi, good morning. Steve Stelmach. Rich, you mentioned I believe that 90% of your investment banking came from advisory in the quarter, any feel for the pipeline, is that a decent run rate going into the new year or is the visibility just not that great this point?

Richard Handler

The pipeline and the ability to execute pipelines are two extremely different things. There are many companies who are clients of ours who want access to capital markets. The problem is there really isn't a capital market today. So historically our businesses have been half M&A and restructuring or advisory and half capital markets. Your guess is as good as mine. When the markets are going to open up, eventually these companies will have to refinance. There's a lot of recapitalization that will occur, but until there is some stability, we can't project.

Steve Stelmach – FBR

Okay. And on the fixed income side, and maybe correct me if I'm wrong, I would assume after the mark (inaudible) profitability should be relatively strong once you get through the inventory mark –

Peg Broadbent

On the entire –

Steve Stelmach – FBR

Should that be relatively sustainable do you think coming out of this after you get to your mark, or do you think that is where the profitability comes in pretty quickly?

Peg Broadbent

I mean there's a couple of things. First of fall, our customers flow business in high yield as well as fixed income across the board has never been stronger, both from a competitive perspective as well as the people that we brought in. And we believe there is a huge opportunity for us once we and hopefully we are through the mark to markets in terms of where the high yield market has collapsed to. So, we are pretty optimistic on all those businesses. There's fewer people to compete against and the clients are embracing us as a liquidity provider.

Steve Stelmach – FBR

So, we should be looking at this as sort of (inaudible) but going forward things look pretty good from our perspective?

Peg Broadbent

We hope so and we feel that's the case.

Steve Stelmach – FBR

Great, thank you very much guys.

Operator

Our next question comes from the line of Lauren Smith with KBW.

Lauren Smith – KBW

Hi, good morning.

Richard Handler

good morning.

Lauren Smith – KBW

Couple of questions. One, apologies if you noted this already, but could you help size for us what the losses in block trading were in the quarter, even if it is a range, what equity has been versus 3Q given volatility in volume, or just any guidance there would be helpful?

Richard Handler

I think you have assumed our equities business is performing well and the core business for the quarter is consistent and perhaps possibly better than historical quarters. So it was a reasonable quarter for our core equity business.

Lauren Smith – KBW

Okay, that's helpful thanks. And on just shifting gears to investment banking, could you give any color on your restructuring business, and are you starting to see that really begin to ramp or where do you think we are in that part of the cycle?

Peg Broadbent

We are getting a lot of traction on the restructuring side of the business. We are somewhere between 25 and 30 assignments that we have – that we are actively working on. We have been working with transitioning a lot of our industry expertise to work hand-in-hand with the restructuring department where we have got the rest of the relationships in the organization. I think we are early in that cycle. The default rate really hasn't gotten to where we believe it is going to go, and we believe they are pretty well situated to take a good share of market share in that business. By the same token, that that does not completely pay for the core capital markets business which has disappeared but it's a good offset.

Lauren Smith – KBW

Okay. And just one last question, you guys have really taken the team to put a lot more flexibility and variability into your comp structure, is it fair to say that moving into 2009 or back half by the end of 2009, any sort of residual or legacy guarantees or anything along the lines of sort of fixed comp would pretty much roll off or are we already there?

Peg Broadbent

We think we are pretty much there. We decided in the fourth quarter to look at our entire business and figure out everything that we had to do to the best of our abilities to clean up anything that we could find to stop and give us much flexibility and transparency and traction to hit 2009 running and that's really what we did.

Lauren Smith – KBW

Okay, thanks very much.

Peg Broadbent

Thank you.

Operator

The next question comes from the line of Horst Hueniken with Thomas Weisel Partners.

Horst Hueniken – Thomas Weisel Partners

Thank you. Good morning. Peg, I'm just wondering whether you could clarify the revenue shortfall versus expectations, you had expected $200 million in the quarter, you reported something like 142 million, how much of that could be due to mark, and how much of that would be due to simply lower volumes?

Peg Broadbent

A significant portion of it was due to lower mark. I would point out that we did say at the beginning of December that it will be no better than the first quarter of 2008, but it’s virtually all mark.

Horst Hueniken – Thomas Weisel Partners

That's great. That’s all for me, thank you.

Operator

At this time, there are no further questions. I will turn the call back over to Mr. Handler.

Richard Handler

Thank you for listening to the call. I would like to add one fact that will update the market. In the first few weeks of 2009, we did repurchase an additional 4.3 million shares of Jeffries stock in the open market at $13 per share. This will help offset the shares that were issued to employees for their work in 2008 and will not have any material effect on our cash balance or liquidity. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.

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Source: Jefferies Group, Inc. Q4 2008 Earnings Call Transcript

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