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Cowen Group, Inc. (NASDAQ:COWN)

Q4 2008 Earnings Call Transcript

February 18, 2009 9:00 am ET

Executives

Greg Malcolm – President and CEO

Tom Conner – CFO

Analysts

Horst Hueniken – Thomas Weisel Partners

Lauren Smith – KBW

Operator

Ladies and gentlemen, and thank you for joining the Cowen Group Incorporated Conference Call to discuss the financial results for the fourth quarter and twelve months ended December 31st 2008.

By now, you should have received the copy of the company's earnings release, which can be accessed at the Cowen Group Inc. website at www.cowen.com. If you do not have Internet access and would like a copy of the press release, please call (inaudible) at 646-562-1154.

Before we begin, the company has asked me to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC. Cowen Group Inc. has no obligation to update the information presented on the call. A more complete description of these and other risks, uncertainties and assumptions is included in the company's filings with the SEC, which are available on the company's website and on the SEC website, at www.sec.gov.

Also on today's call our speakers’ will reference certain non-GAAP financial measures, which the company believes will provide useful information for investors. Reconciliation of those measures to GAAP is consistent with the company's reconciliation as presented in today's earnings release.

Now, I would like to turn the call over to Mr. Greg Malcolm, Chief Executive Officer, who is joined today by Mr. Tom Conner, Chief Financial Officer.

Greg Malcolm

Thank you very much, operator. Welcome to our 2008 earnings call and thank you for your interest in our firm. We are going to cover a number of topics today that I hope will be of interest to you. These are the most unusual of times and I want to be sure that each of leave this call with an appreciation for our firm’s positioning to deal with both the challenges these times present and the opportunities that they afford us.

I’m going to change our format a bit in this call, and if everyone thinks it’s an improvement, we’ll keep it for future calls. In the past like others, our practice has been to recite the quarter and full year numbers in quite some detail. I listened to a tape of call summer’s call and I must say that the detail was quite tedious and difficult to follow. We released all the numbers in the 2007 comparisons this morning, so I’ll let you analyze the details at your leisure and we’ll just review the highlights on this call.

Our 2008 revenues were $217.3 million, down 17% or $44.3 million from 2007’s $261.6 million. As you will recall in the third quarter, we wrote off $50 million of legacy goodwill and the numbers – operating numbers which I’m going to discuss are exclusive of that write off.

Our operating loss, exclusive of IPO award effects was $15.7 million, an increase of $4 million from 2007’s loss of $11.7 million. Our 2008 operating loss, exclusive of non-cash items was just $1.1 million versus cash income of $400,000 in 2007. Therefore on a cash operating basis, we were nearly breakeven in ‘08.

Excluding the effects of the IPO awards, our compensation to revenue ratio was 62% in ‘08 versus 65% in ‘07. I’m pleased to note that while our revenues were down $44 million, our cash operating loss only increased $1.5 million.

Now, let me turn to some commentary about how each of our business lines performed in ‘08. And I think it will come as no surprise to any of you that our short comings were due almost entirely to a lack of any new issue activity in our sectors during the year.

Our core brokerage revenues year over year increased 2% to almost $156 million. This is a tremendous effort from light of the headwinds facing that business, generally. Our floor and our research department are to be congratulated.

Our strategic advisory revenues increased 37% from $29 million to $39 million. In 2008, we advised on 18 transactions with an aggregate value of $2.2 billion. Again this is a great performance driven primarily by our Healthcare vertical.

And I’ll turn our asset management business. Our Cowen Healthcare Royalty fund got off to a great start, closing on an initial fund of $500 million in July and deploying over half that capital during the year. This life science’s financing product enjoys great competitive advantage with the new issue markets essentially closed.

Our start-up loan-only asset managers faced the headwinds of all equity managers during the year and we continue to look at that business with an eye toward better aligning the team’s economic interest more directly with our shareholders’.

Our lagging business line was public and private equity new issuance. Our 2008 new issue revenues were $11.7 million, down $61.8 million in – from 2007, pardon me. This disappointing performance was however in line with the general decline in public equity new issuance in our gross sectors.

As an additional note, I would point out that the 2007 revenues were down in turn $84 million from 2006’s $146 million. I noted earlier that the lack of a new issue calendar was a principle problem, but you can also see from these numbers the leverage and potential profitability in our firm when markets reopen.

Let me turn to compensation. Obviously, 2008 was a difficult year across the Street for compensation and rightly so. We believe that our 62% comp rate ratio reflects our strong efforts to create the best balance possible between out bottom line and the preservation of our franchise.

Even in these times we do need to be mindful of the competitive pressures for our very best people. As the years passed, part of 2008 comp was comprised of deferred awards vesting over time. I would like to talk to the current environment for a bit to describe what we believe are the challenges we face and the opportunities that are presented to us. It is truly a time to play both offense and defense.

The issues we faced are as follows. There is no new issue calendar on the near-term horizon. Having said that, we believe and generally history shows that when the market does open, it will be with a bang. Corporate decision making is frozen just like the credit markets. This has and will affect the M&A business.

Volumes on the floor are slow due to our buy-side customers’ having fewer assets under management, utilizing less leverage in their daily business. Both of these issues are compounded like managers staying in cash until the smoke clears a bit.

On the other side of the coin, we are benefitted by a number of factors in today’s market. Many in our industry are burdened by significant legacy issues. Their balance sheets are stressed by poorly or non-performing assets though levering exacerbates the problem. And they have been forced to address those balance sheet issues with head count reduction.

Many are looking inward to these problems, and that is distracting them from client facing initiatives. We don’t have these problems. Our balance sheet is cash, and that cash will see us do this valley and the next if need be.

These substantial headcount reductions combined with elimination of competitors through merger of otherwise, particularly at our largest competitors mean less competition for us with both our corporate and our buy-side accounts.

Our customers’ and clients are for the first time in my memory questioning, if it is really necessary or even desirable to do business with the bullish or with Wall Street’s firms. As a boutique firm, we have always faced the issue of clients growing in size and scope and they are wanting to migrate to bigger firms for countless reasons, reasons by the way with which we have never agreed.

It seems now that the reverse may be underway a bit, as we are seeing more and more evidence that our clients are attracted to a clean balance sheet and our service oriented culture. As a simple anecdote, we hired a very senior financial advisor [ph] few weeks ago, a non-traditional sector for us.

He told me that he called one of his most important accounts to tell him the news, the account said I hope we are not going to a big firm. We opened a new account that day.

Lastly and most importantly, we are seeing a steady stream of talented people who in past years we would not have expected to able to hire much less afford. Our challenge is too full. First, to be careful to pick the right partners for our business plan and our culture. And second, to carefully balance the need for controlled costs and headcount with the opportunity to grow the drives from these difficult times.

Let’s move on to some strategy that we have to deal with these issues and opportunities. First and foremost, we need to be sure that we are as clean and efficient as we can be. To that end, since I become CEO, we have reduced our headcount by 148 employees, added 78 of whom 25 are officers resulting in a net headcount reduction of 70 people or 14% from a starting base of 520.

These numbers include the addition of 18 people in China from the acquisition of Latitude Capital, our Asian investment banking unit. Excluding Latitude, our US and European headcount would be down 88 people or 17%. We will continue to pay close attention to headcount as the year unfolds and we see how the markets develop.

We have and are paying significant attention to our non-compensation costs. In 2008, we were able to reduce these costs by $8.7 million or 8%. This excludes the non-recurring charges of $3.7 million of fund raising fee we paid to secure the $500 million of royalty capital, a fee I would happily pay everyday if I could, actually.

This reduction in our non-comps is actually quite an accomplishment. 20% of our non-comps were trade related or market data services. After we cut the best deals that we can on those fees, we really don’t want them to go down as they reflect volumes on the floor and are more than offset by revenues.

Then when you take into account pure fixed cost like real estate, then we only get to address periodically. The pool that we have the ability to address becomes much smaller. The reductions in 2008 taken against the addressable pool represented 15% reduction in costs. My thanks to all in our firm who worked so hard to preserve our cash and lower our expenses.

Single best opportunity that this market gives us is to hire talented people. People of a caliber that we generally have not seen in these numbers before and at costs that are both affordable and prudent. Here is some of things that we think about when considering additional hires.

First, avoid guarantees at all costs. We have all been settled [ph] by legacy guarantees from better times and they are painful. We had our share in 2008, and we want to do anything we can to avoid getting caught in that trap again.

However, as a side note, we had 14 guarantees in 2008 that we consider significant. All 14 employees voluntarily gave concessions on their contracts without any quit probe from us. I think it speaks volumes about our culture and I’m grateful to all.

And we think about hires on the floor, we want to be sure that the revenue is not cannibalistic to our existing revenue. By that I mean if we are hiring a trader and the only accounts he does businesses with are our existing accounts. We have to believe that we will simply move some of our current trading revenues into his trading path without creating much incremental revenue for the firm.

If we want to see the ability to do business with accounts that we currently don’t cover, we want to grow our core platform. Let me give you a few examples where this strategy is really evident. Historically, we have had a very small electronic trading capability.

In December, we hired a Head of Electronic Trading and in the next few weeks, we’ll announce a number of additions to that team. We believe that in the first 90 days of this new initiative, we will open accounts with 50 customers with whom we have never done business before. We look forward to giving them the same service and attention we do for our long-standing core accounts and we also look forward to offering our existing accounts a new electronic trading venue as well.

As a side note, the fact that our sales and trading effort can generate $156 million of purely cash commissions is a testament to the quality of our effort. We look forward to the development of our electronic trading capability and believe that we’ll generate significant revenue in ’09 and beyond.

In the same thing as I noted, we have hired a senior financial trader who’ll start in a few weeks. This is a sector we have traditionally not covered in researcher banking. He brings sector account relationships’ that we currently don’t transact with. In other words, we will again open 20 plus new accounts within days of his arrival, and we believe this effort will generate significant incremental revenue in ’09 and beyond.

Let me shift to hiring where we already have an existing business. I believe that these markets forward us the ability to expand or improve that business. Historically, we’ve had a robust pipes and registered direct effort. In 2008, that business substantially underperformed and contributed to the shortfall in our issue revenue.

I’m pleased to report that we will announce shortly the hires of two Managing Directors to augment that business. Importantly both have significant experience in healthcare, which is a frequent user of this product and where we saw our most significant weakness last year. We are a looking forward to returning our priced practice to its former profitability.

Additionally, since the New Year we made a significant hire in research, adding to our franchise and establishing a more competitive product to offering healthcare services and further enhancing our already superb healthcare effort.

I’m sure it will add to further talent throughout the firm during the year and in all cases, we need to have clear insight into near-term revenue and cultural fit.

In closing, let me highlight a few things that bring our firm and its positioning into focus. We have tremendous operating leverage. If we return to what in the past we would have considered to be an average year, we would generate significant GAAP and importantly cash profits.

Headcount was down net 70 people, and while we have hired carefully to take advantage of current circumstances, the operating leverage I just spoke to results from a lean headcount in infrastructure. Core brokerage up, strategic M&A up, royalty up and running and 55% invested.

Balance sheet safe and secure in cash. We are well-positioned for the return of new issue markets and expecting to gain market share across our divisions in the process as well as drive significant revenues from new initiatives.

We are pleased to have those on this call who are our shareholders’ as our partners and thank you for your interest in our firm. We would be pleased to take any questions you might have, either Tom or myself. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Your first question is from the line of Horst Hueniken with Thomas Weisel Partners. Please proceed.

Horst Hueniken – Thomas Weisel Partners

Good morning.

Greg Malcolm

Hi, Horst. How are you?

Horst Hueniken – Thomas Weisel Partners

Good. I’m wondering whether you could comment on what you believe is your current breakeven revenue levels?

Greg Malcolm

Actually, it’s a difficult thing. I noticed that you guys spoke to breakeven and I think the notion about cash breakeven revenue levels is a little bit difficult thing to predict. You have to tell me what the environment is in which we’ve earned the money, so I can figure out what the competitive pressures are for compensation. As I suggested on this call, had $271 million, we lost $1.1 million of operating income. So, it’s a question that I find not odd. I understand your question, it’s a question I find difficult to predict because I don’t understand the environment or I don’t know the environment in which –

Horst Hueniken – Thomas Weisel Partners

Just I understand you clearly then it’s partially an issue of next than depending on which businesses are generating that revenue will determine that breakeven level?

Greg Malcolm

I think that’s correct. I think it’s beyond that. It’s the notion of what the environment is across the Street, not just division by division but what’s going on in the world at the time that happens.

Horst Hueniken – Thomas Weisel Partners

That makes sense. Okay. I’ll take it from there and wrestle with it–?

Greg Malcolm

I’m sorry; it’s not the better answer. But it’s a very difficult question.

Horst Hueniken – Thomas Weisel Partners

I understand that. That’s fine. I’m wondering whether there’s any severance charges in your fourth quarter results. You did reduce you headcount, but it’s not clear to me whether there’s a severance charge built in based on the press release?

Greg Malcolm

I’ll ask Tom to answer that question for you.

Tom Conner

There is a severance charge related to the people who departed during the fourth quarter, but it’s inside the counter revenue issue that Greg spoke about.

Horst Hueniken – Thomas Weisel Partners

Okay. Are you able to disclose the amount, so I can strip it out?

Tom Conner

No. That’s not something that we plan on disclosing.

Horst Hueniken – Thomas Weisel Partners

Okay. Fair enough. Then regarding – go ahead.

Tom Conner

We wouldn’t consider it to be in very large numbers.

Horst Hueniken – Thomas Weisel Partners

Okay, Fair enough. I obviously have the information as everybody else on what the pipeline currently looks like based on the publicly disclosed information. I’m wondering whether anything in the pipeline that hasn’t been disclosed and whether that would be material?

Tom Conner

No. I don’t think so. We haven’t generally commented on our unfiled pipelines but I would tell you that September to January, the fourth quarter, our unfiled pipeline is relatively constant and our M&A pipeline is very constant. So, there’s nothing of great materiality in the sense – in sense I think you asked that question existing in our unfiled pipelines.

Horst Hueniken – Thomas Weisel Partners

Okay. That’s fine. And I’m – you referenced the new financial sector, traders and that he is expected to help in opening 20 new accounts which obviously is an encouraging thing. I’m wondering whether this could lead to more buildup in the financial sector and more specifically whether financial sector you view is a new vertical for Cowen Group?

Tom Conner

Yes. Let me comment that a little differently and speak about how in the past I think we and people like us have looked adding new verticals. So, I think that the – historically the perspective has been in looking at a new vertical how you bank it. So, you start at try and figure out how to get a banking team together and that requires a Managing Director or two and a couple of officer and a couple of associates and analysts or whatever. And then you move into research because you would need the research product to be able to have avoids [ph] in the marketplace and then you would move to the floor. When we thought about verticals in that context, that’s a really expensive proposition. And it takes banking a long time to get the feet on the ground to settle into a new place and to generate revenue. So, it’s also a very expensive proposition. We are interested in looking at things right now in the reverse. So, we start on the floor and see if we can find traders in verticals that we don’t particularly – certainly that we don’t bank and we trade some financial stock now but not very many. And we try to come to a point of view as to whether or not that would be a profitable endeavor on its own bottom just for that guy. And then looking at that, we want to look at accounts that we don’t cover. So, we look at an account packaging come to understand, let’s look at the ones we currently don’t cover and try to come to point of view as to whether this is a profitable endeavor based on those accounts. And we believe it is here. The next steps will be for us if this turns out to be exactly what we like then we’ll move to research and see if we can accommodate publishing research analysts within this vertical and still maintain a profitable enterprise vis-a-vis the floor, and if that works, then we’ll consider moving into banking because we will have economic reality existing in that business as it stands and the commitment to banking would be substantially less risky then starting at that end of the skill to begin with. So, we’ll see what happens.

Horst Hueniken – Thomas Weisel Partners

Alright.

Tom Conner

It may very well do that. We’ll see.

Horst Hueniken – Thomas Weisel Partners

My final question relates to the attempt by Rodman to acquire your firm. Am I safe to assume that is now dead because there’s been really no press releases to finish that?

Greg Malcolm

I don’t know the answer to that question. It ended up being queued. I think you have to ask someone at Rodman. Our perspective on this transaction has not changed from the press release that we issued at the time that this began. We spoke extensively with our stakeholders’ that is our shareholders’, our customers and clients and our employees. Our position on this transaction has not changed at all.

Horst Hueniken – Thomas Weisel Partners

Fair enough. And yes, I will ask Rodman. Thank you for your time.

Greg Malcolm

You are welcome.

Operator

Your next question comes from the line of Lauren Smith with KBW. Please proceed.

Lauren Smith – KBW

Hi, good morning.

Greg Malcolm

Good morning.

Lauren Smith – KBW

Couple of questions. I guess, first off on headcount resizing and where you think you are relative looking out for the next six months to twelve months at 463 people and you certainly when I look across the sector you have the highest revenue per employee which is a very important metric. In my mind how are you thinking about headcount, do you think you are kind of at your optimal level at least currently as with respect to what you see the environment looking like over the next 6 months to 12 months?

Greg Malcolm

I’m tempted to think back a little bit over the six months ago and six months before that. And I think it’s a dangerous thing to say, you are where you are. We are comfortable with our headcount where we are now but we will continue obviously to look at two things. One, how revenues develop in these markets over the coming months and how that will impact our performance. And if we need to resize, we will, just and I think that’s a fairly standard for anybody. And that’s on the defense side. On the offensive side of the coin, as I noted in my comments, we are really seeing a quite extraordinary flow of people that offer us significant opportunities and we are trying to judge those opportunities very, very carefully. We are not going to make any mistakes here in hiring. But we do have an ability to change the game a little bit here and we are going to carefully address those issues.

Lauren Smith – KBW

So, when we look at I mean your headcount reduction, here and near was 12%, 13%, but you have also been hiring and that’s what your point is in sort of offensive mood given the opportunities. But could you give a sense of what let’s say what the number or percentage was with respect to headcount reductions by design versus say net adds? I just wanted to get a sense of may be how many people have actually come on board over the past 6 months to 12 months versus those that have been either natural attrition or by design headcount reductions?

Greg Malcolm

As I said in my remarks, I had been CEO for about a year, a little bit less. And we – 148 people exited the firm voluntarily or involuntarily during that time, gross. We added 78, and of those 78, 25 were officers. In the US and in Europe, our net headcount reduction was 88 people. Of the 148 gross employees who left, we had some turnover there that as you say it’s quite natural associates coming and going and things like that. But I would say that more than half of those people were involuntary reductions.

Lauren Smith – KBW

Okay. And then one just last headcount type question, really two. One, you said there were 14 guarantees in 2008 that were voluntarily forgone, forgiven if you will. Could you broadly speak into sort of size that for us?

Greg Malcolm

No. That would be difficult for me. But what I said was there were 14 contracts that we consider to be substantial. And all of those 14 people voluntarily gave some portion of their contract up.

Lauren Smith – KBW

Okay.

Greg Malcolm

And I don’t think it would be appropriate for me to discuss them now.

Lauren Smith – KBW

Okay. Do they dwell off this year or is it – I mean so are those – are they –

Greg Malcolm

Our retrench able obligations in 2009 are substantially reduced from 2008 and the fact that while I don’t want to say they are not significant, they are relatively insignificant.

Lauren Smith – KBW

Okay. And then one just one, the comp. Is – pretty impressive actually how you maintained your comp ratio in this pretty dismal revenue environment. Adjusting to the IPO expense, is sort of $63 million to $65 million range still kind of how you are thinking about accrual?

Greg Malcolm

It’s a good question. I have not looked at accruals for the first quarter. But I would assume that they would some place in that range.

Lauren Smith – KBW

Okay. And then one last and I’ll get back in the queue. But can you just put a little more color on the brokerage revenue side in the quarter? I know in the press release you noted these certainly held up well again relative to everybody else, severance [ph] was down Q on Q, but you did options trading in particular, and I’m just wondering if you can add considerable color around just big is that business for you, and if you were to – I know if you can sort of strip that out what was sort of the rest of your equities business performance like in the quarter?

Greg Malcolm

The options business is not a significant business for us. So, our – and it’s one thing that ‘a’ we are proud of and we believe that forwards us great opportunity. Our fundamental core brokerage revenues are cash commissions. It’s a cash commission revenue business. So, as I noted, we have been able to generate this sort of revenue without an electronic platform and we believe that we are doing in electronic program that’s going to add substantially to our revenue base. We have a good options business but it’s not a significant one and we look to continue to build that business. And as we try to find more opportunities like financials and we are looking at two or three verticals in the same way. We think we can add incremental revenue to what is already a relatively outperforming business.

Lauren Smith – KBW

Okay. Thank you. That’s helpful.

Greg Malcolm

(inaudible) quite well.

Operator

At this time, there are no other questions in queue.

Greg Malcolm

Okay. Well, with that – again, thank you all very much for your time and thank you very much for your interest in our firm. We hope to be able to deliver on your interest and support. Thank you very much.

Operator

Ladies and gentlemen, thank you all for your participation in today’s conference call. This concludes the presentation and you may now disconnect. Have a great day.

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