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Executives

Richard Handler – President, Chief Executive Officer

Peregrine Broadbent – Chief Financial Officer

Brian Freedman – Chairman Executive Committee

Analysts

Daniel Harris – Goldman Sachs

Lauren Smith – Keefe, Bruyette & Woods

Steve Stelmach – FBR Capital Markets

[Casey Ambrecht – Millenium]

Michael Hecht – JMP Securities

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

Operator

Welcome to the Jefferies year end financial results conference call. A question and answer period will follow management’s prepared remarks. (Operator Instructions)

A press release containing Jefferies 2009 financial results was distributed via business wire before the market opened today and can be accessed at Jefferies website www.jefferies.com. Some of the comments made in this 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 27, 2009 and in Jefferies Forms 10-Q and 8-K’s for discussion 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 Chief Executive Officer of Jefferies Group.

Richard Handler

Good morning and thank you for joining Jefferies 2009 year end results discussion. I am Rich Handler, CEO of Jefferies and with me on the call today are Brian Freedman, Chairman of our Executive Committee and Peg Broadbent, our Chief Financial Officer.

For the fourth quarter ended December 31, 2009 we posted net revenues of $532 million, net income to common shareholders of $94 million and earnings per share of $0.46. This represents a quarterly record for Jefferies on both a net earnings and earnings per share basis.

For the full year 2009 we are pleased to report record net revenues of over $2.1 billion, record net income to common shareholders of $280 million and record earnings per share of $1.38.

Peg will take you through further details of our results in a moment.

We were successful in managing our full year end compensation ratio to 55%, well below the target ratio of 60% we indicated at the beginning of 2009. In determining our final 2009 compensation expense, we notionally absorbed the impact of proposed U.K. bank tax that the U.K. tax payroll tax rules, that if enacted, will be expensive compensation in 2010.

We are pleased with the strong contribution the fourth quarter made to the best annual performance in Jefferies history and the strong momentum we carry into 2010.

Our results for the quarter and for the full year continue to underscore the benefits derived from the diversified operating businesses which we have worked hard to significantly enhance and develop over the last 18 months as we battled through the crisis period and its aftermath.

Our full year banking investment net revenues of $474 million are a function of the deal market shut down in the first quarter which was followed by slow selling and then an acceleration of activity into the fourth quarter.

In fact, our fourth quarter 2009 capital markets net revenues exceeded $100 million for the first time since the second quarter of 2007. This combined withy more robust M&A and advisory activity and most importantly, a growing pipeline for 2010 mean we are excited about the prospects for investment banking business as we enter this year. Brian will go into more detail later.

After unusually strong activity in the third quarter the trading market experienced an above normal year end seasonal trading slowdown. However, for the full year 2009, our recently expanded sales and trading businesses led by fixed income, generated combined net revenues of more than $1.6 billion, more than 2.5 times the $649 million reported in 2008.

We are very pleased but by nor means are we complacent with the significant gains in our market share of secondary trading activities which enabled these results. We have yet to see a full year of mature benefit from many of the businesses we added to the global sales and trading platform during these past 18 months including global rates, global mortgages, global corporate, equity and secondary loan trading.

Assuming normal market conditions, we hope to build on prior 2009 trading performance in 2010. To support our expected growth in 2010 and beyond, in October we further enhanced our liquidity and long term capital base by issuing a #345 convertible senior bond issue. The convertible bond has a coupon of 3 7/8 and is convertible at a price of $39.20 per Jefferies share.

During the last seven months of 2009, we increased our capital base in aggregate by over $1 billion or over 20% in keeping with our philosophy of building long term capital when the markets are attractive, but we have no urgent need to spend it.

Our cash balance exceeded $1.8 billion at year end. We continue to have zero bank debt drawn and the weighted average life of our long term debt is over 11.5 years.

As has been our goal forever, we do our best to deploy our capital costs cautiously and prudently for the long term expansion of our firm. Given our solid liquidity position, our performance over the last year and our earnings potential for next year, we are pleased to resume our dividend with our Board’s declaration of $0.075 per common share this quarter.

Now, I’d like to turn over to Peg.

Peregrine Broadbent

Thank you Rich. As Rich mentioned, our net revenues for the quarter were $532 million and for the full year 209 we recorded record net revenues of $2.13 billion. For 2009 fixed income and commodities net revenues were $978 million and equities net revenues were $468 million. High yield net revenues were a solid $207 million for the year. 2009 investment banking revenues were $474 million, an increase of 11% over the 2008 revenues of $426 million.

Full year 2009 asset management revenues were $36 million compared to a loss of $53 million for 2008. Non compensation expenses were $422 million for 2009, down 6% compared to the $449 million incurred during 2008. However, as a function of the expansion of our banking sales and trading platforms undertaken during 2009, our non compensation costs for the fourth quarter of $123 million were up 15% versus the third quarter of 2009 and are more indicative of the potential run rate as we enter 2010 given our broad human capital and infrastructure investment throughout the firm.

As Rich mentioned, for the full year compensation expenses were 55% of our record net revenues of $2.1 billion, below the 60% we anticipated at the beginning of the year. Compensation expense for the quarter was $239 million or 45% of net revenues and was materially reduced by an annual fourth quarter true up of the compensation accrual taken in prior quarters of 2009.

Despite our not being a commercial bank, or not being funded by government insured deposits, or are not having ever received a penny of funding from any government including the U.K., we believe that we may be subject to this U.K. employee reference tax if and when it is enacted.

The compensation expense for the quarter and the full year was further lowered to make room to absorb the impact of the U.K. bank payroll tax which will be recognized next year. We estimate that the cost of this tax may be as much as $20 million. Effectively we have notionally spread this cost across our 2,628 global employees primarily on the senior ones, which resulted in the decrease of our 2009 comp rate by roughly one point even though the actual timing of the potential payment will mostly likely be in 2010.

To be clear, under U.S. GAAP, the compensation expense impact of the proposed U.K. bank payroll tax legislation if enacted will be recorded in the period of enactment in 2010. Assuming normal market conditions and depending on our revenue mix, our 2010 compensation rate can be expected to be between 56% and 59%. The tax rate for the full year and the fourth quarter were 39.6% and 40.7% respectively.

Earnings per common share for Q4 were $0.46 and for the full year were $1.38. During the fourth quarter, we repurchased as previously disclosed four million shares at an average price of $24.94 per share.

During the year, we repurchased an aggregate of 12.1 million shares at an average price of $19.75. We currently have authority to repurchase up to another 15 million shares. Book value per share was $13.94 at year end based on 166 million shares outstanding. Our adjusted book value per share was $11.96 based on 193 million shares outstanding including restricted stock units.

We estimated that our gross adjusted asset leverage ratios are still low on a relative and absolute basis at 10.7 times and 8.9 times respectively. These estimated ratios are approximately flat with those at the end of the third quarter and well below our historical peak levels of 16 times gross assets before the market dislocations.

We estimate our level three assets after accounting for non economic interest were $477 million at the end of 2009 or approximately 5% of our total assets at fair value. We estimate that our average par for the quarter was approximately $6.46 million, down compared to the $7.4 million for the third quarter of 2009 and versus our peak average operating par level of $9.5 million set during the fourth quarter of 2007.

We ended the year with 2,628 employees, a net increase of 115 people since the end of the third quarter of 2009. This increase is driven by the continued development of our sales and trading platform, our expanded investment banking and capital markets franchise and the associated additional legal risk management, compliance, technology, operations and general support staff.

Brian will now address in more detail our investment banking results.

Brian Freedman

As Peg indicated, investment banking revenues for the year were $474 million. $283 million were capital market revenues and $191 million were M&A and advisory revenues.

$105 million or 37% of our capital markets revenues were recorded in the recently completed fourth quarter of 2009. The flow of public equity transactions was much stronger in Q4 in which we completed 42 deals of which roughly two-thirds were sole led or co-led by Jefferies.

In contrast to the improving capital markets flow, M&A and fund placement revenues were markedly down in 2009 primarily as a result of the essential halt in activity in Q1 2009 after which the pipeline slowly began to rebuild.

Deal activity has however picked up and we expect improved advisory revenues in 2010. Not only is there now more activity, but the size and scope of our deal flow has evolved along with our platform.

For example, Jefferies is representing XTO Energy in its $41 billion sale to Exxon which is expected to close in the first half of 2010. We also represent Chesapeake Energy in its $2.25 billion joint venture with Total of France.

In our capital markets business last week we priced a $2 billion sole managed senior notes offering for Icon Enterprises, the largest sole managed bond offering completed in the high yield market in over 20 years.

These transactions and others are testimony to our increasing involvement in industry transforming events. The fees from these transactions will be recorded in 2010.

Consistent with the environment our restructuring advisory revenues were solid throughout the year and we are currently working on more than 30 different assignments globally.

Our asset management revenues of $36 million for 2009 are a significant improvement over last year’s loss of $53 million. This was driven by excellent results in our global convertible bond asset management business as well as solid results in our two long/short equity hedge funds which focused on financial services and technology respectively.

Now I’ll hand it back to Rich.

Richard Handler

With our fourth quarter trading results we effectively impact a lighter secondary trading volumes across all markets. The secondary market slowed down before Thanksgiving much sooner and more significantly in this fourth quarter than in prior years.

It was clear that many of our clients chose to lock in solid performance before year end. That being said, we are very pleased with our full year results and assuming normal market conditions, we believe we are very well positioned to continue to grow both our market share and to fully realize the impact of our expanded sales and trading business.

For the year, our fixed income net revenues were just shy of $1 billion. We believe this is a solid accomplishment given the fact that this business had $128 million in net revenues in 2007 as the financial crisis began.

In fact, all of Jefferies had $1 billion of net revenues in 2008, so it’s clear that we have benefited from our substantial investment throughout fixed income while the financial world was in distress.

As Peg mentioned, our high yield revenues were $207 million for 2009. A much stronger and upbeat environment drove these results and our strategic trajectory for this business remains positive.

Our equity revenues were $468 million for 2009, down 12% from 2008. We believe 2009 was a transition year for our equity business and in 2010 we hope to see the results of the significant investments we have made in equity algorithmic trading, EPF, prime brokerage and our European and research platforms.

In summary, we are pleased with the momentum, competitive position, increased diversification and overall positive energy that permeates Jefferies today. Our focused strategy has allowed Jefferies to emerge as a much stronger firm and we have never been so well positioned to serve our global client base.

The markets have stabilized. Our balance sheet and liquidity have never been stronger and we are extremely pleased with the talent and commitment of our 2,628 employee partners as we enter 2010.

Today our focus is on execution and integration as we do our best to increase our market share and better serve an ever increasing client base. We are committed every day to serving our clients, shareholders, employee partners and bond holders.

Thank you and we’re now available for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Harris – Goldman Sachs.

Daniel Harris – Goldman Sachs

I was hoping you could go into a little more in the fourth quarter with regards to the fixed income numbers. You mentioned the client flow was much lower but can you give us a little bit more color on that versus what you were generating in terms of benefiting from spread tightening during the first few quarters in the year versus what happened in the fourth?

Richard Handler

I think you probably hit the points there. On the one hand the second half of the fourth quarter simply saw a slowdown in client activity and that felt then to be seasonal and now that we’ve started into January we can say that with hindsight it would appear to have been seasonal in that over the last two and a half weeks activities have returned to the levels we would have expected them to be for January.

Separately, there’s no question and we indicated it in our third quarter call back in October that our third quarter results in particular benefited from what we saw as episodic trading opportunities that gave us extra opportunities in the third quarter. If you look across 2009 at our second quarter, third quarter and fourth quarter and what we have said essential is our third quarter had the benefit of some unique opportunity. The fourth quarter had some seasonal slowdown. That’s the course of 2009.

Daniel Harris – Goldman Sachs

In terms of the head count you have added and it seems like it’s been across most categories and areas this year, when we think about a lot of the banking teams that you’ve hired throughout the course of the year, when you look into 2010 would you say that relative to 2009 they are fully ramped up now versus halfway coming into the middle part of last year with the number of hires so you should expect if the industry growth in M&A activity and ECM activity is going to X that you would be above X given that growth rate that you’ve experienced?

Richard Handler

We’re not going to project specific X’s and Y’s but what we can tell you is that we feel that the health care bankers that joined us in the course of 2009 are fully engaged and well on the ramp. At the same time, we’ll tell you that we made that move and we may continue to add to our platform because we would like to not just participate in the cyclical recovery but we would like to gain market share off the strength of our existing platform and the addition of strong performers.

Operator

Your next question comes from Lauren Smith – Keefe, Bruyette & Woods.

Lauren Smith – Keefe, Bruyette & Woods

A little more color please on investment banking if you can. I know you gave us Cap markets in May but within that could you just break down the mix of Cap markets by equity and fixed income. And then I just want to get a better sense, I know you don’t explicitly break it out but even if you could size it a little bit for us that within the advisory, share plain manila advisory restructuring versus fund placement because you’re investment banking revenues were much stronger than I would think forecasting and when I look at it relative to your prior peak, you’re only 13% or 14% below your prior quarterly peak and we’re kind of still very early in the recovery of M&A. So I’m just trying to get a better sense of how to think about your mix.

Richard Handler

Actually the one thing that you didn’t mention that may be one of the most significant things to note is that our investment banking revenues in 2009 include our traditional corporate investment banking business as well as investment banking in the municipal public finance area as well as mortgage banking.

So the diversification and breadth of what we reported as investment banking has changed in 2009 to be broader and deeper. Obviously that’s additional market that we’re working in additional market share opportunity.

So starting with that, the second thing that can be noted is that clearly we added health care investment banking at a meaningful higher level than our prior participation, so again we’ve added market and market share opportunity there.

Beyond that, it’s really what I said before. It’s a combination of cyclical recovery as well as sector or market share gain. Our prior peak period, you’re right in making the comparison, but keep in mind the diversification as well as the deepening of the spread.

Peregrine Broadbent

With respect to our capital markets revenues which for the fourth quarter were about $105 million or so, about $30 million of that $105 million related to fixed income primary activities and of the remaining $75 million, about 75% of that was equity capital markets activities with balance being high yield.

Richard Handler

I think the way to think about it, when you look at 2000, we really were in 2007 versus where we are today from a banking franchise, there is a lot more breadth and a lot more depth and we’re just beginning to gain additional market share is the sense that we get today as opposed to 2007 when we had a feeling of being at a cyclical high in the marketplace and operating on all cylinders.

So we feel that there is real capacity and operating room to grow in our bank. By the same token, we need the financial markets to participate.

Lauren Smith – Keefe, Bruyette & Woods

I personally think the opportunity is huge and we’re seeing momentum build, but just trying to scale out what we can think about the next two, three, five years is how I’m trying to think about it because the company today versus three years ago is very different on the banking side.

Richard Handler

On every side.

Lauren Smith – Keefe, Bruyette & Woods

Maybe just a little color, I’m just curious how your business in growing on the prime brokerage front and if you’re seeing any particularly notable trends in that regard as far as market share gain.

Peregrine Broadbent

I think momentum is very strong there. I don’t have exact numbers but last I checked we were up to 370 clients in that business. I think the size and scale is increasing as we go through and add new people and we’re getting very, very positive feedback from our client base in terms of our systems and our support so we’re pretty pleased. It’s still the early stages, but our high service model seems to be gaining traction.

Operator

Your next question comes from Steve Stelmach – FBR Capital Markets.

Steve Stelmach – FBR Capital Markets

My first question is on capital and as you mentioned you never took any government money. You’re not a bank holding company and you’re not subject to the same regulations as a lot of your peers, but could you give us some framework on how you think about capital, excess liquidity relative to your peers, your more regulated peers. Do you have more capital flexibility or less?

Richard Handler

Here’s a subjective way of thinking about it. We like to have ample liquidity, ample capital at all times, and when we see an environment where we’re going to raise capital on attractive terms, we will do it, and we also don’t mind sitting with excess cash and capital because it allows you to be very opportunistic and aggressive in difficult times.

Additionally, we have more and more competing needs for our capital as we build our businesses over the years and we have a long term priority to basically have solid return on equity but we have a long term perspective on that as opposed to quarter to quarter perspective.

Steve Stelmach – FBR Capital Markets

And when you think the regulatory environment and the proposals recently announced, is that something you think you’ll be subject to or do you think you avoid that for the most part?

Peregrine Broadbent

We haven’t concluded on the answer to that question. My expectation is that we will not be subject to it, but we haven’t unequivocally concluded on that at this point.

Richard Handler

We’ve always operated at meaningfully lower levels of leverage than the numbers in the mid to late part of last decade others went to. Between our liquidity cushion as well as the diversification we feel very comfortable with our current balance sheet and our ability to both grow our business as well as grow our balance sheet.

Steve Stelmach – FBR Capital Markets

On the principal trading and fixed income, can you give a little bit of color? It sounds like first quarter is trending better, that there’s seasonality, but also can you take a look at 2010 and how you think it compares to what was a pretty good 2009? Is it flat year over year in your opinion or do you think there’s room to grow that business?

Richard Handler

We’re not going to give projections for 2010, but what we can say is we have a very solid market position that we’ve developed across the board with our client base, and during the course of this year we’ve expanded on a more global basis. So we’re touching our clients globally and by product much more heavily today than we were at the beginning, the first quarter, second quarter and third quarter.

Obviously there was a unique environment during the beginning part of this year. Spreads were particularly wide and we had some very unique opportunities as we highlighted in the third quarter. That being said, I know our team across the board is focused on growth and quality business and serving their clients.

So I think we come into 2010 feeling pretty confident we’ve got a good business.

Operator

Your next question comes from [Casey Ambrecht – Millenium]

[Casey Ambrecht – Millenium]

Can you give us the size of the balance sheet? I don’t see it in the press release.

Peregrine Broadbent

The leverage ratios are about the same as last year. Our equity base increased but our balance sheet is about the same.

Richard Handler

I think if you looked at our balance sheet at the end of the third quarter there wouldn’t be a whole lot of surprises relative to the fourth quarter.

[Casey Ambrecht – Millenium]

Leucadia, do they get unlocked this year?

Richard Handler

In March of this year.

[Casey Ambrecht – Millenium]

Do you know what they plan on doing with their stock?

Richard Handler

I think you should call them and ask them.

[Casey Ambrecht – Millenium]

Do you have any view on what the mortgage market will look like when the Fed steps away from the trillion dollars of purchases this year?

Richard Handler

I wish I had the answer to that question. I can debate both side of it that the environment is more stable and it will be a slow return to normalcy or they’re going to have a major dislocation because they subsidized the markets. I don’t have a strong opinion which one is correct.

Our mortgage folks are top notch. I suggest you give them a call and get their perspective.

Operator

Your next question comes from Michael Hecht – JMP Securities.

Michael Hecht – JMP Securities

Just starting out with a big picture question, it seems like there’s a shift in focus at Jefferies with more of the business coming from fixed income, say equities versus past parts of the cycle. Equities people in particular are being paid in base and bonus versus commissions and on the banking side maybe less focus on middle market deals and moving up market to do some large and mega deals. You mentioned Exxon which is a great transaction. What cultural impact does it have on the firm and how are you managing that?

Richard Handler

We consider culture extremely important and there have been shifts that we have had to put in place to navigate the ever changing world that we live in but for example on the equity side of the firm, we still have kept a very strong entrepreneurial focus in terms of creating a pool for all people to share and to best serve the clients and it’s still an entrepreneurial model.

It might not be a specific direct drive but the people who are servicing the clients know how they’re going to get paid in terms of a transparent pool. The same thing across the investment bank. Because we’re doing larger transactions, it doesn’t mean they’re not focusing on our traditional mid size clients who tend to not have a whole lot of strong alternatives to get senior people working on their transaction, get great execution.

The culture is evolving but the fundamental principals of honesty, integrity, transparency, entrepreneurial attitude and hard work ethic, that’s the cornerstone of Jefferies and that hasn’t changed in the 19 years that I’ve been here.

Michael Hecht – JMP Securities

On the trading side, fixed income in particular, any level three gains or maybe losses which impacted results this quarter? I seem to recall your third quarter numbers had benefited a fair amount from some level three markups based on your Q, so I wondered if there was any big movement there this quarter which contributed or at least helped contribute to the slowdown in

fixed besides the seasonal slowdown you talked about.

Peregrine Broadbent

The disclosures that we make in the Q with respect to P&L generated from level three assets can be a little confusion and I’ll be quite happy to take you through those because it’s really focused on, it requires further explanation. I’ll be quite happy to take you through that, but the point I’m making here is we didn’t actually have any significant increases in value of our level three assets during the course of the third quarter.

During the course of the fourth, there weren’t any significant or material changes to the value of our level three assets which impacted the fourth quarter results.

Michael Hecht – JMP Securities

In terms of just the overall effect of that, what are you seeing in terms of trends of the competitive dynamic and just the overall level of trading spreads? The spreads now are back to pre crisis levels. They’re still relatively wide.

Richard Handler

There’s no question they’ve narrowed a bit. At the same time, there is a focus on value add from fixed income ability to provide liquidity supportability, to provide quality trade ideas, research input and we’ve strengthened our capabilities in those regards and probably favors the growing capability we have versus some of the execution only models that fall away over time as they have in other parts of the business.

Michael Hecht – JMP Securities

I was curious on your thoughts of the state of the value markets here. Spreads continue to narrow quite a bit in fourth quarter. Issuance seems to be surging again. What’s your expectations for the high yield markets for the year?

Richard Handler

Right now it is a new issue period from heaven and we are out there telling all of our clients it’s time to issue. One of the reasons our secondary trading levels slowed down for the fourth quarter was we were so focused on our primary issuance.

You can see clearly that there have been a number of transactions that are on the more aggressive side so I think its buyer beware. Spreads are still relatively attractive from an overall perspective but it’s relatively frothy. There’s no question about it.

Michael Hecht – JMP Securities

On the comp ratio you talked about the 56% to 59%. It sounds like a percentage point or so from the U.K. tax. What should we think about maybe the two, three year goal here? Is it to get X maybe some of these taxes and stuff to the mid to even low 50’s? 2006 I think you were at 54%. Should we see that as an achievable goal over time? Maybe not next year but the next two or three years as you build this business?

Richard Handler

I think you should look at it as we said 60% in the beginning of this year because 2008 was such a crazy period of time. We wanted to draw a line and stand where we’re trying to match the business. Obviously we’ve outperformed our initial predictions in 2008 internally.

As a management team, we walk a balance; try to make sure we get a turn for the shareholders as well as our only asset, our people. We’ve been committed historically to keep the comp ratio at an ever increasing lower rate. We try to do it in terms of scale in the revenue base of the company and from a diversification of our products.

We’d like to have a mid 50’s comp ratio absolutely. We can’t promise exactly when we’re going to know we’re there. We’re pretty pleased this year we were able to get it to the point we got it, but there’s no promises.

Peregrine Broadbent

And we would remind you that as of the end of last year with the changes we made, we expenses 100% of our annual comp in the year in which it relates in terms of there’s no stock overhang going forward from our 2009 compensation.

Operator

That does conclude our Q&A session. I would now like to turn the conference back to your Chairman and CEO, Mr. Richard Handler.

Richard Handler

Thank you for listening to our call today. We’d like to take this opportunity to thank our clients, shareholders and our employee partners for distinguishing themselves by enabling Jefferies to raise $47.5 million for the tragic victims in Haiti. We are first and foremost a for profit business but the humanity of all our constituencies is what makes our firm special.

We look forward to doing our best for all of you in 2010. Thank you.

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Source: Jefferies Group, Inc. Q4 2009 Earnings Call Transcript
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