Thomas Weisel Partners Group, Inc. Q4 2008 Earnings Call Transcript

Thomas Weisel Partners Group, Inc. (TWPG)

Q4 2008 Earnings Call

February 11, 2009 5:00 pm ET

Executives

Thomas W. Weisel – Chairman of the board & Chief Executive Officer

Shaugn Stanley – Chief Financial Officer

Lionel F. Conacher – President & Chief Operating Officer

Analysts

Lauren Smith – Keefe, Bruyette & Woods

Chris [Donut] – Sandler O’Neill

Presentation

Operator

Thank you for joining the Thomas Weisel Partners’ 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 that by their nature are uncertain. Actual events may differ, possibly materially from what is indicated or implied in those forward-looking statements and TWP makes no commitment to update them.

For a discussion for some of the factors that could affect those statements please see the risk factors set forth in TWP’s most recent reports filed with the SEC. This audio cast is copyrighted material of TWP and may not be duplicated, reproduced or rebroadcast without consent. As a reminder, today’s call is being recorded.

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

Thomas W. Weisel

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

The challenging market environment and the reshaping of the competitive landscape over the past year have led us to make significant changes to our operations from the top down. While we are not pleased with our fourth quarter results we have moved swiftly and taken aggressive steps to reduce our cost structure. These steps will enable us to operate at a cash breakeven based on the fourth quarter revenue rate and restore profitability once the capital markets return and we begin to realize meaningful revenue growth.

Our goals remain the preservation of capital, operating on a cash breakeven basis at current revenue run rates and build the value of our franchise so that when the capital markets turn we are a market leader.

We have matched our expenses with our current revenue levels. We started 2008 with a combined workforce of 757 employees. Through targeted layoffs offset by selective additions we began 2009 with 556 employees. We recently took additional measures to reduce our workforce by 50 people leaving headcount at approximately 500. This represents a 34% net reduction in our workforce. In addition, we have established a more variable business and compensation model going forward.

Last quarter we stated that we were managing our business towards a cash breakeven level of $63 million per quarter in revenues. With the additional reductions we’ve recently taken we have reduced our quarterly cash breakeven revenue to approximately $50 million per quarter. Shaugn will provide further details on these reductions.

After adjusting our fourth quarter revenues for non-recurring and non-cash items, our revenues would have been close to our 2009 quarterly cash breakeven level. We continue to maintain adequate cash and capital to operate our business. As of December 31^st our cash and cash equivalents were $117 million versus $110 million in the third quarter. Our cash balance after accrued expenses paid in February 2009 will be approximately $102 million.

With the significant changes that have taken place in the competitive marketplace, we see unprecedented opportunities in both investment banking and institutional brokerage. Last year’s acquisition of Westwind has significantly contributed to the diversification of our business. The breadth of geographies and industries of our combined firm today is greatly enhanced our client offering with investment banking revenues from energy and mining sectors contributing 35% to 2008.

2009 has also started out strong with several gold deals completed so far from our Canadian team. Our current mix of business on total revenues for the full year was 80% US and 20% Canada and Europe. As we enter 2009 we have enhanced the franchise through key senior hires with proven track records. Even though we reduced our headcount we have increased the number of investment banking call in officers by seven.

We continue to focus on high quality growth companies that we believe will need to access the capital markets or need strategic advice. As we navigate through these volatile times, our focus remains on superior client execution while building our growth platform. With a well diversified platform, a strong brand and hardworking employees, we are in a premier position to gain market share when conditions improve.

This was never more evident this week as we hosted over 1,200 people and 218 companies and conducted 1,900 one-on-one meetings at our annual technology conference. I will now turn the call over to Shaugn who will give you details on our earnings.

Shaugn Stanley

We recorded a GAAP net loss of $21.5 million and a GAAP diluted loss per share of $0.67 in the fourth quarter of 2008. Adjusting for the non-cash after tax charges of $700,000 or $0.02 per share related to our initial public offering and $2.1 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 $18.7 million and a non-GAAP diluted loss per share of $0.59.

Our operating cash loss in the quarter was approximately $7 million after adjusting for non-cash items included in our pre-tax loss. Our broker dealer entities maintained capital in excess of regulatory requirements of approximately $53 million as of December 31. After netting our 2008 compensation expense accrual from our yearend cash balance of $117 million, our cash and capital will be more than adequate to see us through the current environment.

As Tom mentioned, 2008 was a year in which we restructured our operating expenses to reflect current market conditions. In order to achieve our cash breakeven levels on annual revenues of $200 million in 2009, we lowered our compensation and non-compensation expenses by a total of $65 million. This includes non-compensation expense reductions of $30 million compared with 2008 excluding the goodwill impairment charge.

Of the $30 million, $18 million relates to expense reductions and $12 million to non-recurring items. Additionally, savings related to compensation expenses reductions mainly due to headcount reductions totaled $35 million in 2009 compared to 2008 of which $4 million was non-recurring. On this call we are comparing current results against the corresponding unaudited 2007 pro forma combined fourth 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 $31.5 million in the fourth quarter of 2008. This includes $16.4 million related to non-cash losses and items we do not expect to recur in 2009 including among other items, $5.7 million in non-recurring net convertible trading losses, $900,000 in non-cash net warrant write downs and $9.3 million in non-cash and mark-to-market private equity downward adjustments.

Excluding these items, revenues would have been $48 million which is close to our quarterly revenue level to achieve cash breakeven in 2009. This compares to net revenues of $102.6 million in the year ago quarter and $49 million in the third quarter of this year. Investment banking revenues were $11.3 million in the fourth quarter compared to $48.7 million in the fourth quarter of 2007 and down from $17.5 million in the third quarter of this year.

We completed 14 transactions in the fourth quarter compared to a combined total of 48 in the fourth quarter of 2007 and 13 in the third quarter of this year. Brokerage revenues were $27.3 million in the fourth quarter which includes $5.7 million in convertible trading losses. Excluding these losses revenues would have been $33 million. This compares to $40.3 million in the fourth quarter of 2007 and $33.7 million in the third quarter of this year.

Asset management net losses were $7 million in the fourth quarter excluding mark-to-market losses in private equity and other securities, revenues would have been $3.8 million in the fourth quarter. This compares to net revenues of $11.2 million in the year ago quarter and net losses of $2.3 million in the third quarter of this year.

Compensation and benefits decreased 67% in the fourth quarter to $28.1 million compared to $84.9 million in the fourth quarter of 2007. Our non-GAAP compensation ration increased to 66% in the fourth quarter from 60% in the year ago quarter and down from 68% in the third quarter of 2008. Non-compensation expenses were $36.1 million in the fourth quarter compared to $36.5 million in the year ago quarter and compared to $39.1 million in the third quarter of this year excluding one-time charges.

During the fourth quarter we incurred $4 million of non-recurring expenses that we do not expect in 2009 including $3.5 million in lease charges and $400,000 related to closing two asset management products. Excluding these one-time items, our non-comp expenses would have been $32.1 million.

Occupancy and equipment increased $2.7 million in the fourth quarter compared to the year ago quarter mainly due to a $3.5 million facilities charge in connection with downsizing our office space in San Francisco and New York which partially offset by consolidating offices in Canada and London and reduced facilities expenses.

Brokers execution and clearing expenses increased $900,000 compared to the fourth quarter of 2007 due to outsourcing our four brokers expenses and increased clearing expenses based on increased volume. Marketing and promotion decreased $3 million compared to the fourth quarter of 2007 due to our cost saving initiatives.

Communications and data processing decreased $650,000 compared to the fourth quarter of 2007 due to our cost reduction measures. Our tax benefit rate was 34% in the fourth quarter of 2008 compared to 43% in the fourth quarter of 2007. The decrease in our tax benefit rate is due to the addition of international operations that have a lower statutory tax rate.

I will now turn the call over to Lionel.

Lionel F. Conacher

The completion of 2008 marks the first full year of combined operating results from TWP and the former Westwind. The diversification of revenues geographically in to Canada and Europe and sectorally in to energy and money contributed significantly to our results in 2008. Today we have a fully integrated platform and we are now benefitting from the cross selling of our products. We’ve also taken great strides in aligning our businesses for maximum productivity as well as improving our compensation model to create a more variable pay for performance system.

While market activity remains suppressed, we continue to manage a leaner business while keep intact the revenue generating capabilities of the firm. As Tom mentioned, we have reduced our workforce by eliminating 250 employees on a net basis year-over-year. However, we continue to selectively add talent to areas we believe that have the potential to grow future revenues. Over the past quarter we added senior talent to our investment banking and brokerage platforms. Mark Dempster joined the firm as a managing director in investment banking focused on biotechnology and specialty pharmaceutical subsectors. Mark brings over 15 years of experience in both investment banking and consulting to our team and joins us from Bank of America Securities.

We hired Steven Halper as managing director institutional sales in Toronto. Steven brings over 14 years of industry experience to the firm and was most recently a director of institutional equity sales at Merrill Lynch Canada. Kevin Tscherne joined the firm as a director in trading focused on healthcare. Kevin was most recently head of healthcare sector trading at Citigroup and brings 17 years of experience with him.

I will now turn to the performance of our investment banking and brokerage departments. Due to continued headwinds in the equity capital markets, we shifted our focus towards M&A and private capital products resulting in a change in our business mix. For 2008 M&A comprised 56% or our revenues versus only 31% in 2007. We expect this trend to continue well in to 2010.

We experienced a challenging investment banking quarter however, our focus on strategic advisory assignments contributed 74% to our total investment banking revenues with $8.4 million in revenues for the quarter. This compares to $13.6 in the third quarter where we recognized a significant fee from a single client. We advised eight companies on their strategic transactions including advising [Phenomix] on its sale to [Asmetrics] and Motive in its sale to Alcatel Lucent. During the year we also advised on key transactions including Saxon Energy’s sale to Schlumberger, Nuance's acquisition of eScription and PlateSpin sale to Novell.

Capital raising revenues decreased 25% in the quarter compared to third quarter of 2008. With the equity markets essentially closed, we continue to focus our efforts on private placement business. We completed four private transactions including private placements for Pioneer Surgical Technology and also for [Argos].

In the fourth quarter investment banking revenues were led by technology representing 46%, followed 34% in healthcare, 7% in both mining and consumer and 5% in energy. For the full year revenues were comprised of 35% from technology, 26% from energy, 18% from healthcare, 11% from mining and 10% from consumer.

Our average revenue per transaction decreased to $800,000 in the fourth quarter from $1.3 million in the third quarter. In the US the average revenue per transaction was $1 million and in Canada it was $400,000. Our investment banking backlog which consists of a number of filed, announced and engaged transactions at the beginning of the first quarter was down from the beginning of the fourth quarter. On file, we currently have 12 IPOs for which we are book or lead manager on five, one follow on and one announced M&A transaction.

At this time the realization of our pipeline remains hard to predict. However, in Canada we are witnessing an opening in the commodity sector specifically in gold as evidenced by closing a $23 million sole book managed follow and offer for [Samnifo] in December, a $69 million joint managed offering for [Sentiment] Egypt Limited in February and a $415 million [inaudible] offering for [Ken Roscoe] Corporation, also in February.

In brokerage for the year we experienced strong results on our core institutional platform and in Europe as well as positive results in our middle market sectors. We also recognized solid growth on our electronic trading platform due to more aggressive marketing efforts resulting in a 12% increase in new clients at the end of 2008 compared with the end of 2007.

Total revenues in 2008 were down 3% compared to 2007. However, excluding our convertible trading losses, our revenues would have increased 4%. Over the past few quarters we announced we had significant reduced our convertible trading book. Notwithstanding these efforts, we experienced sizeable net losses totaling $8.4 million for the full year. We do not expect to incur these losses in 2009 as a result of having significantly reduced our exposure to convertible securities.

As of December 31, 2008 our convertible trading book had a net long value of $6 million which has since been reduced to less than $2 million. Last week our shareholders approved the amendment to increase our equity incentive plan by 6 million shares. Our management team is committed to prudently managing share based equity grants in an effort to minimize dilution. Furthermore, we intend to use the minimum amount of restrictive stock units required for 2008 bonus purposes in order to retain key revenue producing talent and we foresee that the additional shares will last for many, many years.

As we continue through this downturn we have managed aggressively towards operating at a cash breakeven level or better while improving our talent based and strengthening our franchise. I’ll now turn the call back to Tom who will give us additional details on our asset management business and some closing remarks.

Thomas W. Weisel

In the fourth quarter our asset management business generated management fees of $3.8 million which were offset by mark-to-market net losses in private equity and other securities of $10.8 million resulting in a $7 million loss for the quarter. For the full year excluding mark-to-market net losses in private equity and other securities, our revenues in this division would have been $14.7 million.

Our warrant portfolio accounted for approximately $1 million or our net losses as a result of decreases in fair value and the expiration of out of the money warrants. Our remaining warrant portfolio as of December 31^st is valued at approximately $400,000. In the fourth quarter our private equity fund investments accounted for $9 million of our net losses as a result of fair value adjustments that were fairly equally spread between our healthcare and technology venture funds, our LBO fund and our fund-to-fund in venture pools of capital.

Two public companies, Hansen Medical and TransOne accounted for approximately $1 million of the marks. After the fair value and mark-to-market adjustments our investment in private equity funds are valued at approximately $35 million. This year’s results is in contrast to 2006 and 2007 when we had private equity gains of $12.3 and $17.7 million respectively.

Over the course of the past year we were successful in raising $145 million additional assets for our global growth partners venture fund-to-fund program and closed a $10 million institutional account for a our small cap growth strategy which is entering its third year and building a strong track record. In December we transferred our private equity fund-to-fun business in India to Guggenheim. Under the terms of this agreement we will retain an economic interest in the partnership.

In conclusion, 2008 was a year in which we diversified our platform with the acquisition of Westwind and made key hires to enhance our platform. At the same time we faced significant headwinds in the capital markets and took the necessary steps to realign our expenses with the current revenue generated in the fourth quarter. As a result, we believe that we are extremely well positioned to be a market leader as the capital markets recover.

I will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Lauren Smith – Keefe, Bruyette & Woods.

Lauren Smith – Keefe, Bruyette & Woods

If you could just circle back Shaugn, I’m sorry I could write fast enough when you were kind of running through the components of expenses and what was recurring and what was non-recurring. Could you just run through that again please? $65 million for the quarter and then you gave us a couple components.

Shaugn Stanley

Total change year-over-year 2008 versus 2009 of $65 million in comp and non-comp. It includes non-comp expense reductions of $30 million compared with 2008 excluding the goodwill impairment charge. Of the $30 million, $18 million relates to expense reductions and $12 million to non-recurring items. Additionally, savings related to comp expense are mainly due to headcount reductions and totaled $35 million in 2009 compared to 2008 of which $4 million is non-recurring.

Lauren Smith – Keefe, Bruyette & Woods

I guess also just on another one or two number questions, comp ratio adjusted was more like 66 versus 60 if I’m correct. How should we be thinking about – I mean obviously clearly, none of our crystal balls are probably working right now so it’s going to be obviously a function of revenues but how are you going in to ’09 in thinking about comp accrual?

Shaugn Stanley

Well, we ended the year as you know Lauren with a comp ratio of 69% and we’re really focused on trying to live at a 60% comp to revenue ratio in 2009.

Lauren Smith – Keefe, Bruyette & Woods

You think the juncture is still realistic?

Shaugn Stanley

Yes.

Lauren Smith – Keefe, Bruyette & Woods

Looking at the brokerage business Tom, if we normalize it or add back said differently to convert losses the $33 million would have been down year-on-year like everybody else but flat quarter-on-quarter which would stand out relative to some others. So, maybe if you could put a little bit of color around that? Are you seeing any specific market share gain or is it too early to tell or is it increase in the electronic trading side of things that were alluded to in the presentation comments?

Lionel F. Conacher

The two areas that we saw substantive gains year-over-year were both in electronic trading which was up from virtually zero the year before to north of $10 million in revenues on the year. Then, in addition, our European brokerage commissions grew substantively through the year and contributed significantly. I think in both cases it’s probably just pure market share gains. I mean, that’s really what we’re seeing.

Lauren Smith – Keefe, Bruyette & Woods

So kind of a combination of both market share gain given all the dislocation at the big firms as well as the synergies between the two organizations a year later where perhaps you’re penetrating more accounts than perhaps in the past?

Lionel F. Conacher

Interestingly I would say on the cross border side of things, that’s gone a little bit slower than we thought it would initially but in the fourth quarter it really started to take hold and as you know with particularly the voting accounts most of them vote a couple times a year and so coming in to the back half of the year with our US analyst in Canada and vice versa, the Canadian analyst down in the US we’re starting to see some real traction there.

In addition, our middle markets business has really done well and continues to do well despite the contraction in the hedge fund community. We’re still seeing gains there. Lastly, on the retention side of things from a loss ratio perspective, our loss ratio improved from about 77% down to 74% year-over-year. The combination of all those things has kept that side of our business pretty strong.

Lauren Smith – Keefe, Bruyette & Woods

Then I guess just maybe a little more color if you can around the convert losses for the year seemed to be concentrated in the fourth quarter and you said you reduced the book even from yearend from $6 million to less than $2 million. Any more color there? Why were the losses so huge and should we just be thinking about this book pretty much going to zero?

Thomas W. Weisel

Yes. We enter the year with over a $200 million book and yet the fourth quarter, the bottom fell out of that market, I mean your shorts went up and your longs went down. There’s no bid for anything. As there were forced liquidations in that market it didn’t matter what you were in, it went down. So, that’s why even though we had trimmed that book really substantially, the bottom fell out in the fourth quarter. It’s rebounded a little bit, in January and that’s allowed us to reduce the book to the $2 million net that it is right now. We don’t expect to build that back. That doesn’t mean – we’re going to still be in the convert business but we’re not going to be carrying a book from here.

Lauren Smith – Keefe, Bruyette & Woods

One last question and then I’ll give someone else a turn. You said you just recently had your annual tech conference, a lot of clients, 200 plus companies. Is there any kind of takeaways you can give us in terms of what companies are thinking about in terms of the environment and what ’09 from their view might look like and is there any really hope for a tech rebound any time?

Thomas W. Weisel

This is a personal opinion but I spent three days at the conference and there’s a number of observations. First of all, there are many emerging growth small cap companies in technology that are doing extremely well. We probably got a couple of dozen companies that we took public over the last four years that are continuing to grow at 40% to 50%. They’re in security, they’re in the telecom space, they’re in selective software areas, they’re in storage and so that’s the first takeaway.

Second of all, we had 40 private companies there and we had over 350 one-on-ones with private companies so we have a very strong component of venture capitalist that are looking to deploy capital in private companies. So, we think that the private placement business is going to continue to be strong. The dialog, we had the head of strategy for IBM that spoke at lunch and his whole group is headquartered out here in San Francisco and they have increased the dialog in terms of acquisitions.

So, I think you’re going to see the Ciscos and the ORACLEs and the IMBs becoming much more aggressive because I think the sellers now are starting to be much more realistic about the price they’re willing to sell. I think they held on but now they can’t hold on too much longer. So, I think the second takeaway is I think the private placement and M&A business could very well be on an uptick.

Third, I think you’re starting to see a potential thaw in the capital markets. I mean, you saw both Cisco and [McQueson] due very large debt deals a couple of days ago. You are seeing a number of technology companies filing, whether or not they can get out is another question, [Metadata], Open Data. There are number of companies that got revenue and losing money and look and feel like a couple of years ago. I’m not suggesting they can’t get out but certainly people are willing to put their little toe out.

So, this could very well be the beginning of a trend. Certainly, in some sectors like gold where we’ve done a number of transactions successfully and others have too, that market is absolute wide open. So, in general I believe that technology is either going to be one of the lead groups or the lead group that’s going to take this market from where it is on the upside.

I think people like IBM and [Rory Vallet] who runs [Abnet] that’s a huge middle man in the electronic sector who also felt that the inventory correction that we’ve been going through could very well be bottoming right now, those were his comments, not mine, kind of give us a lot of optimism as we progress in the year about where the fundamentals of tech are and therefore the abilities of those companies that either need to do strategic moves and/or capital moves are going to get a receptive audience.

Operator

Your next question comes from Chris [Donut] – Sandler O’Neill.

Chris [Donut] – Sandler O’Neill

Just one quick follow up on the compensation, just looking at the adjusted compensation of say $27 million for the fourth quarter, if we factor in the headcount should we assume a floor for compensation going forward would be about $25 to $26 million going forward?

Shaugn Stanley

That’s close. I mean we’ve got it down where the fixed elements of comp on a quarterly basis are salaries are $13 million, benefit and taxes are a couple of million so $15 million of kind of hard fixed elements. Then, you’ve got both variable comp in the form of commission and your bonus in there that get you to like you said a $26 to $28 million run rate on a quarterly basis.

Chris [Donut] – Sandler O’Neill

I’m trying to think about worst cases here.

Lionel F. Conacher

Chris, one of the points that I want to make is that we’ve had close to $10 million of fixed guarantees roll off with the end of this current bonus cycle. So, going forward our fixed guarantee component is very, very low and as I’m sure you’re aware in the context of the current market there aren’t very many guarantees flying around.

The quality of the people we’re able to attract to the platform really coming for a base salary and with the changes that we’ve made and continued adjustments that we’ve made to our compensation system which is very much more direct drive oriented than it was a year ago and will be more so this coming year and therefore very much more variable both to the downside and the upside depending on how we do on the gross revenue line.

Chris [Donut] – Sandler O’Neill

Can you remind me, you made a change to your bonus payment structure in the last year or so haven’t you?

Shaugn Stanley

We accelerated the bonus that we normally defer, kind of a part of the 2007 that would have ordinarily been deferred in to 2008 we pulled back in to 2007. For 2008 and going forward we’re just recording a full year of comp expense each year. I think that’s what you’re recalling.

Chris [Donut] – Sandler O’Neill

Think about the sustainability of the asset management revenues, that $3.8 million from asset management fees, is that a pretty good number based on the investor balances or is that something we should see some variability with given things?

Thomas W. Weisel

No, that’s a constant because it’s a fee on assets under management which are roughly $1.4 billion. We share the profitability of that if you will with the managers that are managing those pools of capital. But, that revenue should be pretty well fixed if there is not additional assets which we obviously plan on trying to increase but just for conservative purposes you might want to just flat line that.

Chris [Donut] – Sandler O’Neill

Then in terms of you have been able to raise assets in the last year. Any sense on how that market looks now? Is it as challenged as every other market out there?

Thomas W. Weisel

I think there was a total freeze in the fourth quarter, any RFPs that were potentially in a market they got shut down. We’re slowing seeing RFPs coming back in the market both in small cap as well as our fund-to-fund particularly in the secondary side of our fund-to-fund in the venture world. So, we’re hopeful that we can raise assets for both of those activities.

Chris [Donut] – Sandler O’Neill

One last question on the asset management, I think in prior years you’ve seen more mark-to-market in the fourth quarter. Was that something that also happened this year? I know the markets were real tough on valuation.

Thomas W. Weisel

I think that’s right. I mean as I said it was almost equally split, $2 to $2.5 million per group and I think that the managers take a hard look at the underlying fundamentals of each portfolio company. But, they also have to look at what the comps are and what the multiples on those revenues or earnings are and obviously with the market being down so much that was a big part of what the markdowns were. You’re kind of seeing that kind of across the board with other pools of capital too that the fourth quarter was a big private equity markdown period because people really focused on it whereas in the middle of the year they really don’t.

Operator

There are no further question at this time. Mr. Weisel do you have any closing remarks?

Thomas W. Weisel

We appreciate everybody’s attendance here and look forward to speaking with many of you offline if you have any other questions.

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