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Executives

Richard Handler - Chairman and CEO

Joe Schenk - CFO

Brian Friedman - Executive Committee Chairman

Analysts

Douglas Sipkin

David Trone

William Tanona

Joseph Dickerson

Arbi Gosh

Ryan O'Connell

Corey Gelormini

Erin Caddell

Jefferies Group Inc. (JEF) Q3 2007 Earnings Call October 16, 2007 9:00 AM ET

Operator

Welcome to the Jefferies 2007 Third Quarter and year-to-date 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 2007 third quarter year-to-date financial results was distributed via Business Wire before the market opened today. It can be accessed at Jefferies website www.jefferies.com.

Some of the comments made in this conference call may include forward-looking statements. These forward-looking statements may contain expectations regarding revenues, earnings, operations and any other financial projections and may include statements of future performance, plans and objectives. These forward-looking statements usually include the words continue, will, believe, should or other similar expressions.

Actual results could differ materially from those projected in these forward forward-looking statements. Please refer to the Jefferies Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 1st, 2007 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 CEO of Jefferies. Mr. Handler, you may begin your conference.

Richard Handler

Good morning and thanks for joining our discussion of Jefferies' 2007 third quarter and nine months results. With me on the call today are Brian Friedman, our Executive Committee Chairman and Joe Schenk, our Chief Financial Officer. As always, each of us will be happy to answer your questions after our prepared remarks.

Before discussing the financial and business highlights for the quarter, I would like to take a moment to highlight our announcement last week of the appointment of Mr. Peg Broadbent as our next CFO. Peg joins us from Morgan Stanley, where he has worked for 16 years, most recently worked as a controller of the institutional securities and investment banking business. Peg's background experiences are perfect for where Jefferies is today and how we see our business growing and developing.

As most of you know by now, Joe Schenk, our CFO for the past eight years has decided for family reasons to move back to Chicago. Joe has played an important role in the build-out of Jefferies this decade. We all owe him a great debt of gratitude for his time, commitment and attachment for our firm. As we begin transition of CFO role at Jefferies to Peg from Joe, we all wish Joe and his family the best of luck in the return to the Midwest and offer him our sincerest thanks.

I expect most of you have had a chance to review this morning's press release. Needless to say, this was the toughest quarter, our industry and the markets have experienced in a long time. Although Jefferies did not have any direct exposure to subprime mortgages or any meaningful exposure to fringe loans or unfunded debt commitments, our businesses were certainly impacted by the general market downdraft and the extreme volatility across most of the markets.

The fact that our net earnings during the quarter were a mere $7 million below last year's comparable period, it confirms our belief that the breadth and depth of our platform will always perform across the cycle. While we must prefer to be announcing continued all-time record numbers, we view these third quarter results as solid core from relative to the environment as we weather the storm and remain in a very strong position to continue our growth in global expansion.

Our third quarter earnings per share were $0.26 versus last year's record third quarter of $0.32. Net revenues were $334 million versus last year's $341 million. Net income was $39 million versus $46 million.

Although it was an outright brutal environment for most of the thirteen weeks in the quarter, we are proud that we protected our platform, managed our overall risks and worked extremely hard for the benefit of our clients and our shareholders.

We did not have any one-time write-downs to announce as all from mark-to-market are included in our normal operating results. This is also worth noting, like many of our competitors, we have not recorded any gains and we expected decreases in value of our outstanding liabilities.

For the first nine month, Jefferies posted a record net earnings of $160 million, record earnings per share of $1.12, record net revenues of $1.2 billion and record investment banking revenues of $583 million.

We are pleased to note that this year-to-date investment banking number already exceed banking revenues for all of 2006.

Now I could turn over to Joe to review some of the financial highlights.

Joe Schenk

Thanks Rich. We've covered our overall results, and now we will talk to our individual revenue lines. Equities had a solid performance during the quarter, with revenues of a $140 million versus a $113 million in last year's third quarter. These incoming commodities, excluding high yield, were $17 million versus $51 million. High yield revenues were negative $7 million versus positive $11 million and asset management revenues were negative $6 million versus positive $17 million last year.

Our record third quarter investment banking revenues are $119 million compared to $145 million for the same period last year.

As you would expect there are a number of things that impacted these results that Brian and Rich will discuss shortly.

For the nine month period, equity revenues totaled $458 million, fixed income and commodity revenues totaled $103 million, high yield revenues totaled $37 million, investment banking, $583 million and asset management, $30 million.

Comp and benefits, as a percentage of net revenues, were 54.9% for the quarter versus last year's 54.1%. For the first nine months, this rate was 54.4% versus 54.8% last year.

Non-comp expenses, excluding interest expense, were $95.6 million for the quarter versus $80 million for the same quarter last year.

Non-comp expenses have been driven primarily by higher occupancy and technology costs, as well as legal and compliant costs associated with the growing firm.

As we have mentioned before, we are in the process of a meaningful build-out in both New York and London, which will be concluded early next year.

Our average headcount was 2,472 employees for the period, up 12% versus the same period a year ago.

Our effective tax rate for the quarter was 39.1% versus the same as the third quarter last year.

Our pre-tax operating margin for the quarter was 16.5% versus 22.4% last year.

Stockholders' equity at the end of the third quarter was approximately $1.8 billion or $14.58 per share.

During the quarter, we repurchased approximately 1.1 million shares at an average price of $26.17, $1 million of which were purchased in the open market, our first meaningful open market purchase in several years.

Now, I would like to turn it over to Brian Friedman to talk about investment banking and asset management.

Brian Friedman

Thanks, Joe. As Joe mentioned, the Jefferies investment bank with $190 million in revenues for the quarter recorded a second best quarter ever. We are particularly proud of this accomplishment as the summer is often a slower banking period and this was further complicated by more challenging environment in which to close deals. In fact we achieved these results despite a number of our banking transactions being postponed due to market conditions.

We believe our ability to generate our second best banking quarter ever, is a result of our diversified, full service and increasingly global platform, the loyalty of our client base and the capabilities and focus of our employee partners.

Our total banking revenues for the first nine months were a record $583 million, and as in recent quarters, we had great contributions from Jefferies Randall & Dewey in energy, Jefferies Broadview in technology and some of our newest partners, Jefferies LongAcre in media. As well the significant deals in the aerospace and defense and maritime sectors.

Thorough the quarter, capital markets transaction represented approximately 49% of our investment banking revenues. Equity and equity-linked represented 26% of total banking revenues and fixed income was 23% of the total. Approximately 51% of our revenues were M&A or advisory related. We worked on over a 140 M&A or advisory transactions, totaling nearly $46 billion in value and will lead or co-lead on 14 equity, 6 convert and 17 leverage financed transactions, collectively totaling more than $4 billion in value.

There are a number of third quarter transactions that clearly demonstrate Jefferies ability to serve dynamic companies and their investors, some of which we'd like to highlight. Specifically, we provided full service solutions to a number of clients during the quarter. Two examples of which are our role in providing both M&A advice and acquisition capital in respect of the sale of Scitor to the Leonard Green buyout firm. And our advising MIPS in this acquisition of Chipidea Microelectronica and providing MIPS a related bridge facility.

In addition, during this extremely challenging time for the debt markets, Jefferies was sole manger on senior note offerings for a long time clients Leucadia and Vector, 500 million and 160 million respectively. As well as $105 million of floating rate notes for MasterCraft. In one of the only high yield deal to get down in late July, we were joint book runner on $150 million of senior notes for parallel petroleum.

In the equity capital markets, Jefferies participated in many third quarter transactions, including jointly running the books for a $297 million follow-on offering for Genco. One of our many co-manager roles included the $212 million IPO for WuXi PharmaTech, our second china-based healthcare transaction this year.

Also in equity, we sole managed the $130 million block trade for Eagle Bulk Shipping, which facilitated a $1.1 billion acquisition of Anemi Maritime, which our firm also represented as M&A advisor.

In other advisory work, Jefferies again represented Vertrue, this time in their $830 million sales to one equity partners, bulk investment partners and real ventures. Our private equity fund placement group, Jefferies Helix was also active, managing a $1 billion fundraising for European private equity fund, focused on mid-market companies in the U.K.

Finally, in a transaction that demonstrates the leverage of combining our industry expertise with Jefferies strong restructuring group, Jefferies advised TriNet resources in its $104 billion Canadian dollar debt and preferred equity restructuring and then arranging its $120 million credit facility.

As we head into the fourth quarter, our partner, backlog remains robust, both in terms of products and industries. As always, strong corporate capital markets and a healthy economic environment, our major drivers for us and the industry, as they effect our ability to successfully close on our backlog.

Turning to Jefferies Finance, our joint venture with MassMutual. Jefferies Finance was impacted only slightly by the harsh liquidity crunch during the third quarter, completing 10 transactions, seven of which lead- managed. The portfolio of mostly senior secured loans held out very well, enabling this business to remain profitable during the quarter. The quality of opportunities we are seeing is better than ever, and pricing has become significantly more attractive, as we continue to grow our assets under management at Jefferies Finance.

Asset management had negative revenues of $6 million, versus a positive $17 million in last years third quarter. Total assets under management for the firm are approximately $4.9 billion. As most of you are aware, we do have a series of CLO funds that we manage as part of our asset management business and we have equity investments in these CLO's. Although we have no direct exposure to sub-prime mortgages, we did record write downs to these CLO investments to reflect current market values. While these asset management results on a relative basis are consistent with the environment, on an absolute basis we are not satisfied and we do expect to do better. We are confident in our team and our investment strategies and believe we are on our way to creating a solid long-term business for Jefferies.

As Joe mentioned earlier, in this fourth quarter, we are consolidating our five offices in London into one new trading, banking and asset management headquarters.

As we announced last week, David Weaver will become President of our international operations at year end. David joined us earlier this year after a long and successful career with Deutsche Bank and its predecessors. We believe David brings the experience and breadth to lead our efforts in Europe, as we seek to accelerate our growth there. David will replace Cliff Siegel, who plans to retire from Jefferies at year end, after 17 years with our firm. We thank Cliff for his enormous effort and contribution, and we wish him and his family much continued success.

Now, I would like to turn it back to Rich.

Richard Handler

Thanks, Brian. First, I would like to make a few comments on our equity, fixed income and commodity, and high yield and distressed trading businesses and their performance for the quarter. In terms of equity sales and trading, we had a solid quarter with a $140 million in revenues. We continued to invest heavily in additional equity-related products and services, including equity derivatives, prime brokerage, special situations, and our new consumer trading among others.

Fixed income and commodity revenues at $9 million were negatively impacted by a number of factors. Our investment grade fixed income group was leveraged to the credit market meltdown and to the number of associated write-downs, which reduced their results.

Our commodity trading will be difficult trading conditions in very volatile commodity markets we introduced results for the quarter. These businesses are well positioned for the fourth quarter and have performed well so far this month to remain important components of our trading platform.

Our high yield and distressed trading group also had a very challenging quarter. Trading was meaningful, highly effective but a virtual stance though in secondary activity into the credit crunch, as well as the reductions value of the equity and debt of leverage companies.

Our positions were all marked to proper evaluations that reflected for our environment. Fortunately, we had been concerned about the opportunity environment and leverage finance for a while, so we only through down a position of the available capital of our high yield trading vehicle and we employed no leverage at all during the quarter. While we are not pleased with losing money, be it only $7 million, we are clearly in a good position to take advantage of current and future opportunities, which are already presenting themselves.

On the positive side, our high yield group will be able to complete a number of new issues, helping to generate $43 million in high yield capital markets revenues, which are included in our investment banking results, already reviewed by Brian.

As a result of this activity, Jefferies strike number one during the quarter for high yield transaction under $1 billion, both in terms of the value and the number of deals, which again speaks of the relationships, structuring ability and tenacity of our team.

Finally, I'd like to restate the obvious. We are very happy that the third quarter is behind us. It was extremely painful, the volatility was off the chart and the final results did not reflect how hard we overworked. The good news is that we protected our platform, performed for our clients, and remained extremely well positioned for the future. We are clearly experiencing a return to what we hope is normalcy, a list of businesses of Jefferies, and starting with the last two weeks of September, we have regained much of the momentum Jefferies experienced in the first half of this year.

As we have seen over the last seven years -- as we have over the last seven years throughout this quarter, we continue to invest in our firm and remain committed to our long-term and strategic goals. We are continuing to integrate many of the great people of businesses that have joined our platform and we continue to review strategic opportunities and look for great partners in all of our businesses. We have a conservative balance sheet, as a variable cost structure, if possible, high employee ownership, and a diverse and complementary slate of products and services. While we prefer our markets to remain stable, as it appears today, our promissory stakeholders is to do the absolute price every single day because of certain environment.

And we will be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Douglas Sipkin.

Richard Handler

Hey Doug

Douglas Sipkin

How are you? Two questions. First off, one as it relates to sort of may be compensation, I know you guys continued to be aggressively hiring in the investment banking side arena. I guess compared to historical norms, would you say you have maybe a little bit less comp flexibility going forward if market conditions were to sort of back up and we revert back to what we sort of saw in the last three prior months rather than what we are seeing in September?

Richard Handler

We are thinking of the answer here. I think off the cut, I think we still have a pretty strong variable component to our compensation. I think we have enough flexibility to whether down trust in the marketplace. It's obviously a lot easier in the market rebound, but we have a pretty committed and group of employees and the people coming in are owning stock over a period of time and they are the long-term partners. So I don't think this to be a huge issue.

Douglas Sipkin

Okay. And then secondly, I know it's been -- maybe close to three years with the asset management business, any thoughts to may be rejiggering the strategy a little bit or may be considering an acquisition or may be considering the introduction of long-only more traditional type products, or I guess you guys just going to continue moving forward with more of your, I guess, your blended alternative and convertible strategy push?

Brian Friedman

I think we're committed to continuing the strategy that we're on. I would point out that a majority of the funds that we have operating today began their lives '06 and '07. So it doesn’t go back as far as you're looking. The alternative strategy, the first one goes back as far as late '02, but the bulk of the funds were seeded and started in '06 and '07. So I think the answer is that it's still early and you're get both some start up and some earlier volatility as the managers emerge. On the point of our acquisitions, I think that we are always looking for clever ways to accelerate our growth. It's clearly been beneficial for us in the banking area and it's been beneficial for us across the platform to see individual and associated groups of individuals joins us here. So yeah, our intent are always up and we are expanding our thinking.

Douglas Sipkin

Great. And then just one follow-up as a related equity trading. It seems like you guys continue to do a fairly good job managing that business. Any color on competitive pressures, I know bids which is that block system that all the large investment banks are been putting together had some traction, is that something you guys are seeing on the competitive front trading, blocks or you still feel like there's a lot of room for you guys?

Joe Schenk

I think we've had competitive pressure in that business continually for the last 17 years, but it just had value high before that, before I got here, it’s obviously a business that has new technology, new competitors and we are constantly seeing pressure on that business by the same folk and we think we have a pretty unique niche its been more resilient than some of your competitors and we are constantly investing and improving to maintain that position. So it’s challenging, but we are pretty confident we have a good strategic position.

Douglas Sipkin

Okay, great. And then Rich, I always just like to hear your color on the high yield market, obviously going through one of the most challenging periods in a meaningful amount of years, I mean your perspective I know September is gotten a little bit better, the calendar has come back a little bit, what's your view point for next three to five months out?

Richard Handler

Again, this is only for one persons perspective, we were obviously not heavily invested in this period as we've been saying while, we thought that market was just incredibly sloppy. What worries me is that we’ve bounced back so quickly that I just feel like there are still some systemic issues that have to work through the system. So, the world is not coming to an end like it was in August and in September and there is still transaction that will get done, but there is still lot of overhang out there and it’s the choppy environment. So I’m not particularly bullish, but the same token is that chance to actually put some money towards the first time for a while and have useful returns, so on the left hand side there are some opportunities.

Douglas Sipkin

Great, thanks a lot.

Richard Handler

Sure.

Operator

Your next question comes from the line of David Trone.

Richard Handler

Hey Dave.

David Trone

Hi, the loss ratios in equities was that meaningful?

Joe Schenk

Not particularly.

David Trone

Okay, great. And the office consolidation in London that you mentioned did that create any lumpy expenses?

Joe Schenk

Yes, we for a couple of quarters now have been running sort of close double range its not exactly double, but we have been running rent on the new facilities, as well as the old and secondly, we've been taking some modest charges through our occupancy cost for the abandonment of facilities that we’re moving out. So the answer is we are absorbing some cost throughout 2007 and our regular occupancy expense line, all else been equal, our occupancy expense would go down to touch next year, although there are other factors going on such as expansion in New York. So it won't go down fully for the drop at London but it will go surely.

David Trone

Okay, great. And could you help us understand your hedging strategy with your fixed income business?

Joe Schenk

In our investment grade, fixed income business, we tried to run as balanced positions as we can. I think the nature of our business is that, its difficult to maintain in that short position for long period of time, because the nature of customer activity, but we have both long and short positions in that business, both naturally from the activity and because of the risk management strategy.

Richard Handler

And obviously on the high yield side, we do have long and short this kind of facilities and natural hedge, although we will use some indexes at times when are positions are larger.

David Trone

Okay. And then one last question related, I think you mention that your commodities had some challenges this quarter and I know that most on the bulks guys that I covered had a pretty good period, what is -- what do you think the distinction is there?

Richard Handler

I think the distinction would be that our business and commodities is a commodity derivatives business that is focused on large institutional asset exposure to commodities versus a broad-based, particularly energy focused trading operation. A number of larger firms run very active energy and commodity trading, where they are trading with physical users, as well as speculators, ours is a different type of business and whether it was particular to us or whether they in fact to the sense that some of them compete with us in the derivative business have several experiences us we don't know. We do know that our results were not as strong as prior periods.

David Trone

Okay, great. That was helpful. Thank you.

Operator

Your next question comes from the line of William Tanona.

Richard Handler

Hey, Bill.

William Tanona

Hey, good morning guys. Just a question for you, you talked about the CLO funds, can you give us what exactly those write-downs were in this quarter? And then also, what type of exposure you may have in the form of kind of equity tranches remaining for those funds?

Joe Schenk

We invest a comparatively modest amount of dollars in each CLO that we do. It's all invested in the equity tranche. Today, we have, I believe it's four, approximately four, it could be five and we have four, I believe, live CLO’s that we are managing and the investment in each as I said is modest, the aggregate is not a meaningful number for us. The write-down was not, we recognized that when you start to look particularly at our asset management business, we are playing with relatively small number. So, a number that is a modest write-down for Jefferies, in fact, and almost a material write-down, will be material to the asset management number. So, we don't give out specific numbers, but my point is that the actual dollars, the risk is not a large number for us and the write-down was a very tiny number.

Richard Handler

We are talking still millions of dollars, that number.

Joe Schenk

Right.

William Tanona

Okay. That’s helpful. And then I guess, I know a lot of people have already asked the question, but the non comp expenses, given everything is going on with the kind of double occupancy over the Europe, it sounds like there are some one-time expenses, but it also sounds like some of that stuff may be recurring. I mean should we be thinking about what we saw here in the third quarter as kind of a good run rate, or is that a little bit elevated relative to what we should be expecting?

Richard Handler

As Joe indicated, our headcount is up about 13% year-on-year and the expense is pretty much travel with headcount. For obviously the third quarter, we had lower than trend revenues. So I found absolute dollars, the expenses are directionally where they are going to be and where they are going to continue to be. If we saw it for long period of reduced activity, we have some ability to attack those numbers and reduce some, but we are delicately managing and I think everyone appreciates is that our goal is not to maximize the single quarter but to maximize value over an extended period. We do our best for the quarter, while at the same time investing for the long term, and in those non-comp expenses as well as the comp, you have those investment dollars as well.

William Tanona

Okay, thanks. And then I guess finally Jefferies Finance, I mean we've gone through a turbulent time here in the last quarter or so, and we've talked about the environment bouncing back. I guess I am just curious as to how discussions are going with clients, I mean are you finding that people are looking for solutions from you guys more today than they were three months ago and what type of pricing pressure are you facing or is there anything, are you seeing that getting less competitive now given the kind of the dislocations that we have seen in the last three months?

Richard Handler

It's absolutely been better for us as an operator in that market for the last several months. You've had a number of the larger institutions to some degree or even in one or two cases maybe completely shutdown in reaction to their handling their own issues. So for us it's been a better environment in terms of relationships and the opportunities. We also have to take into account the changed environment, both in terms of the service we can offer and in our managing the risks that we are prepared to run, but it is a better environment for us and we think it could play into our hands in terms of our desire to expand the business.

William Tanona

And could you just remind us again a kind of what are your typical deal sizes, or the target market of your traditional Jefferies Finance?

Richard Handler

The Jefferies finance market is down to say $50 million occasionally even a little bit smaller and up to the $500 million, $800 million dollar level where either a loan or with a partner we will leave co-leader transaction. In some cases, we are firmly committed on an underwriting, in other cases we are working on the best efforts basis. One of the biggest challenges that we faced is as we grow the businesses, keeping up with the volume in terms of just the ability to process as well as the ability to capitalize on Jefferies Finance sufficiently, but we see a broad range of transactions.

Joe Schenk

Those are all good prompts because in realities our bankers are sourcing the enormous amount of paper and opportunities and it was a little eye up and they are familiar with our clients in August and September when they watch number of the biggest players in the world, they were close and we are actually working on in closing transactions.

Richard Handler

Yeah, the Scitor transaction with Leonard agreement we cite is a good example where we were representing Scitor in its sales plus recapitalization. Leonard Green was the ultimate party to engage our man and we provided the debt financing at the same time through Jefferies Finance.

William Tanona

Great. Thanks guys.

Operator

The next question comes from the line of Joseph Dickerson.

Richard Handler

Hello.

Joseph Dickerson

Hello.

Richard Handler

Yes. You're on.

Joseph Dickerson

Yes. I was wondering if you could quantify the markets you took in high yield and distress trading in the fixed income?

Joe Schenk

I think what we said was we had a losses for the quarter of totaling for Jefferies $7 million.

Richard Handler

Yeah. You can compare that to prior quarters to get a sense of what we might in better quarters have reported.

Joe Schenk

And the reality is, as I said in my comments that no one is excited about losing money, but the fact that we were structured the way we were, we have capital at risk and we were able to contain any major losses in this environment while many of our competitors were having massive write downs. Obviously, absolutely we are not pleased, relatively it was a very strong performance.

Joseph Dickerson

Yeah, that’s fair enough. I was just wondering what the actual number was of the mark-to-markets.

Joe Schenk

It's blended within trading and mark to – so I don’t just look at in aggregates in terms of how the performance was? We have a trading business that is combined with some principle position so it's really not possible for us to separate out the individual transaction.

Joseph Dickerson

So if I would say take the average of the past few quarters and then compare this quarter against, is that a fair way to look at for that?

Joe Schenk

Yes.

Joseph Dickerson

Okay.

Joe Schenk

Yes.

Joseph Dickerson

So somewhere in the $60 million number would not be way off?

Joe Schenk

That seems pretty high.

Joseph Dickerson

That seems high, Okay.

Joe Schenk

And then its -- hold on one second.

Joseph Dickerson

Yeah.

Joe Schenk

Well just a second, let me see if we have any numbers that can help you here?

Richard Handler

If you look at the press release we put out today for the five prior quarters, the revenue in high yield ranged from $10 million to as much as $43 million, three other quarters were in the $10 million, $11 million level. So it’s really a business that was averaging, maybe in low 20's overall for say the last five quarters, you can see that in our press release by comparison we were down $7 million. There aren’t differences across those period is to how much capital was deployed.

Joe Schenk

Although, that really -- but we generally have that similar amount of capital at this point. So those are pretty good apples-to-apples.

Joseph Dickerson

Okay, right. I got it on the high yield I was looking at the, kind of a bottom line the $74 million number in the total fig as supposed to the high yield. And would it be..

Joe Schenk

It includes both.

Joseph Dickerson

Okay. Would it be fair on the -- in the fixed income line, the non-high yield line to apply the same analysis?

Joe Schenk

Yes, I mean you can definitely look at – its never exactly, because if you look back four, five, six, eight quarters, whatever range you want to go, you are getting both trend and you are getting averages, yes.

Brian Friedman

I think really think about the risk profile the company is, we didn't had any one area where we had a major loss. We had small manageable mark-to-market in situations across the platform, so when aggregated there is a firm that's pretty well stressed out. If you think about it a year ago, we had a record third quarter and just have the kind of pain that we had and just have remained shy of net earnings and revenues in this environment is a pretty good accomplishment given the risk and in the way we spread out our risk throughout the organization.

Richard Handler

In the most challenging days with the quarter, our focus was not on balance sheet risk being what's troubling us, but rather ability to generate revenue in trading, that's what reflecting in these numbers.

Joseph Dickerson

Okay. No, I thought the overall your numbers were great. I was just trying to quantify the marks. And thanks.

Richard Handler

Okay.

Operator

The next question comes from the line of [Arbi Gosh].

Arbi Gosh

Hello.

Richard Handler

Hello.

Arbi Gosh

Hello.

Richard Handler

Yes, you are on.

Arbi Gosh

Well, thanks. A quick question on your equity trading business, could you shed some color on how you are derivative and prime brokerage business performed versus the core cash business?

Richard Handler

The prime brokerage business is in its maybe third full quarter of operations. In the September quarter they've reached the point of about 90, 90 something clients. It’s not yet having a material impact on our equity results, but it is ramping rather nicely. On the derivative side, we are again probably in our -- we lose track at time, maybe our fifth quarter of live operations. We are doing a reasonable customer business there on the listed side. We are still building out our capabilities in the over-the-counter side. So it's contributing to revenue, but it is also early days, but the bulk of what you are seeing in our equity business is the business that we've been in for the longer term in cash and special trading.

Arbi Gosh

Right. That’s great. Thanks. And on the investment backlog, I think you said it was pretty robust. Could you compare that versus say year ago levels and your end of June levels?

Richard Handler

Well, if you look at a year ago versus today, as has been true for the last several years, we are yet a larger and more robust investment banks. In other words, we are -- we have today versus one year ago, off the top of my head I would say 20% more professional investment bankers on the team. So we are a larger investment bank today versus a year ago, and the backlog is definitely larger and more diverse today than it was a year ago. On a period to period basis, I would say the momentum continues, while there are transactions that have been delayed, and, in some cases, postponed for extended periods of time because of the environment. There is a truly robust level of activity.

Joe Schenk

Which is particularly encouraging after having already $230 million for the second quarter, now a $190 million a quarter, the fact that we still have a robust and growing backlog says that we are making progress.

Arbi Gosh

Great. And I guess, as a follow-up, I mean how much of that has been a non-US kind of build because obviously I know you made a lot of investments in Europe. So I was just trying to get a sense of the mix of revenues, and I know you won't give me the actual number, but some kind of direction as to how important your non-US business is?

Richard Handler

Yeah. If we actually have in hand it we would give it to you, but we don't have it in our hands right now. The European build-out, particularly, really accelerated in the second quarter with David Weaver coming on Board, the LongAcre acquisition, which closed in June. You are really going to see the benefits of that, we believe, in '08 and then in the future beyond that. So, I would say that a lot of the drive that you are seeing in the second quarter numbers and in this third quarter banking number is domestic. There is growth in Europe, but I think when we talk about sort of next level of growth in Europe, that is to come.

Arbi Gosh

And I guess, finally just looking at your leverage ratios which are much lower than what the big buzz bracket firms have. You still have been kind of increasing over the last I guess six months or so I mean just what on a net and on a gross basis. I think at the end of Q2 it was around 18 times or so. Can you give us a sense of where that number is, how comfortable you are with that increase, whether you are trying to kind of dial it back a little now?

Richard Handler

The bulk I think of what you are looking at is the securities finance, which is almost completely match book. So when I firstly look at our balance sheet, we often will net the liability on the match book from the asset side because it really is a direct trade-off. We've also increased our repo activity, so a lot of that is pure financing transactions and the general leverage has not really increased meaningfully.

Arbi Gosh

Okay, great. Thanks a lot.

Operator

Your next question comes from the line of Ryan O'Connell.

Ryan O'Connell

Start up by something if you could just go back to the investment management operation. With regard to the decline in investment income, I think what you said is that the write-down from the CLO’s was a factor there, but then later on the call I think you have also described that as in modest write-down single amounts of dollars. So first question I guess is were there other factors that led to basically the $12 billion negative number there?

Joe Schenk

No, they were in terms of again majority the biggest impact surely was the CLO’s that are part of that and again remember for the whole group we were down $11 million, $12 million. So when we suggest that the CLO was down a single million, that's obviously still a big component of it, surely some of our other asset classes, as we talk about, we do have some distressed trading within that. Obviously, we've got equity, long, short equities and again each one of them had sort of this Rich and Brian referred to each of them had little beats and pieces and it added up.

Richard Handler

Yeah, I mean it's pretty simple to think about that typically with several million of our capital as risk, we are making some amount of millions of dollars and you can see that in the historic numbers ranging from $7 million or $6 million to $15 million. This quarter away from the CLO, which in the past has always been profitable for us, we lost truly a tiny amount of money, that tiny amount plus the CLO adds up to the $11.6 million. Again these are very small numbers being added together.

Ryan O'Connell

No, I understand. That's helpful. And then also you may have talked about this in the past, but how larger component are the CLO funds if your assets under management?

Richard Handler

Comparatively -- they are about, when we look at 1.4, I am sorry, $4.9 billion in terms of total, if we added them up, they are roughly give or take between $1.3 billion and $1.4 billion to that total.

Joe Schenk

They are also recognized in the assets under management, if that includes the high-yield operation which is separate for our private equity business which is separate?

Ryan O'Connell

Okay, fair enough. And then I guess just and this is I know topic -- just looking forward, what are your thoughts on the CLO market going forward?

Richard Handler

Yeah, we have never been large players in the marketplace. We have opportunistically taken advantage of arbitrage opportunities. I think it will be a tough marketplace to originate prior income from, I think a lot of people who are out there, and it’s very difficult to mark. Fortunately, we don't have a bunch of it and I think we are going to slow down that component of the capital markets for quite a while.

Ryan O'Connell

Okay, thanks. It's very helpful.

Richard Handler

Thank you.

Operator

Your next question comes from the line of Corey Gelormini.

Corey Gelormini

Thank you. A few follow-ups on the last question please. I don't know if I heard that right, but in terms of your equity type investments in the CLO’s, not the amount of assets you've managed in the CLO’s, but the equity investments in the CDO-CLO stuff that's on your books. And may be the low investment great tranche, if you do have those as well, but I am sure this is mainly fund stuff. How much is that is on your books right now?

Joe Schenk

That totals in the tens of millions.

Corey Gelormini

Okay.

Joe Schenk

In the order of magnitude, it's again tens of millions, not a bigger number.

Corey Gelormini

And I guess in aggregate, what would be sort of the total equity type stuff on your balance sheet, either that's proprietary, not so much the daily trading stuff, but stuff where you made, I mean obviously the financing stuff, you got a commitment there, but what would be the aggregate?

Richard Handler

If you look at the managed fund line where there is $11.6 million loss for the quarter versus positive numbers in the past, our dollars at risk there is in the 400 something million level. It's plus or minus $450 million, that's invested there.

Corey Gelormini

Great. And just to get a sense of you guys are very good with your disclosing talking about your VaR and also your number of trading day losses and the magnitude of those losses. Could you give us a sense of what that was like in the third quarter and basically compare that, I guess in the second quarter. Did you do anything different as certainly as the liquidity in the market certainly became tougher?

Richard Handler

Our VaR for the third quarter is pretty consistent with second quarter. I mean until we actually put out our Q is not final, final but call it approximately $8 million, which is consistent with the second quarter. If I understood your second question was what sort of actions that we took during the quarter?

Corey Gelormini

I guess that the number of trading day losses increase did it take less positions that you saw where things are going so you are trading losses stayed the same or I would think given the environment you may had a few more days of trading losses but…

Joe Schenk

We don't have this specifics data right in front of us, but there is obviously extreme volatility and we spent much of the quarter trying to minimize those swings and they could as expensive as possible. So the VaR was consistent with historical numbers, the swing seem to be up and down a 150 points every other day having, you watch as much as we did and we basically strive try to limit our position and managed risk and get to the store.

Richard Handler

And this is -- as you might have a manager in a firm our size and with the transparency that we have internally, this was a significant focus for senior management on a literally constant basis.

Corey Gelormini

So I guess in terms of the equity business, the cash equity were you basically try to be a middleman, although you have to take some positions over days to effect transactions. Did that segment take disproportion head or folks pretty good, if there are levels out there that folks were committing to or what did you just take less in that position as the market was more volatile?

Joe Schenk

We did take our positions, we saw opportunities where we felt we had hedge or client that need to facilitate something that we saw as a smart trade and we made money during the quarter doing it. So it wasn’t – it was a mine field, but we navigated it very carefully and actually tackled that.

Richard Handler

If you looked at our results, the equity result at a $140 million is pretty in line with, its little below, but pretty in line with the 144, 173, 151that we had the last three quarters. The brunt of the summer issues were felt by us and clearly the asset management as we've talked about the lot here, high yield obviously and as we said a bit in fixed income and commodities, banking actually felt it a bit but still had an incredible period and equities felt it a bit and came through with quite well.

Joe Schenk

And it’s also complicated by the fact that this summer quarter we are trading and banking and as a matter we were generally slow to begin with. So we had everything going against this quarter as with everybody else.

Corey Gelormini

Thank you.

Richard Handler

And remember, ours is a September quarter here.

Corey Gelormini

Yeah. Thank you.

Richard Handler

So didn’t had a, didn’t have the benefit of June.

Corey Gelormini

Well. That's right. Thanks you.

Operator

The next question comes from the line of Erin Caddell.

Richard Handler

Go ahead.

Erin Caddell

Just a couple of questions and some of this might be, I think you addressed before I didn't catch everything. But, with regards to the non-comp expense, what would be kind of a normalized trade and when do these double running cost run off, and how much are those right now for the, I guess the New York and London offices, specific to I guess occupancy and equipment, as well as, technology communications like that stuff?

Richard Handler

The London access cost for this year is probably a bit over $5 million. The…

Erin Caddell

For the year, not for per quarter?

Richard Handler

For the year, I mean.

Erin Caddell

Right.

Richard Handler

It’s more than $5 million number for the year. It's recognized and I did say this earlier that while that duplication cost will go away in 2008 and the dilapidation and other charges go away. We are taking more space or have taken more space in New York. So as a growing firm, our occupancy is going to trend upward, it's aberrationally higher for 2007 because of a large overlap period. So, occupancy should be down modestly in '08. The rest of our expenses do tend to trend with headcount and activity levels. Again the third quarter, we hope is operational in terms of the revenue trend. So, we are not making any meaningful changes in our cost structure as a result of the third quarter. So I would say, you can look at the third quarter and or the last couple of quarters as trend/norm.

Erin Caddell

Okay. And then with the thing kind of regarding the, Richie just a question before I guess about comp flexibility, but the comp ratio obviously kind of picked up. Would you kind of care to comment on what are normal, or what the kind of comp ratio range is going to be, given the level of headcount that you expect given you are still adding people?

Richard Handler

I think, we said to people we are committed to constantly improving and at the same time paying our fairly to balance the business mix. So I can't tell you the exact target that we have, but it's come down considerably over the years. We are committed to that, at the same time we want to make sure given the mix of business that we pay our people fairly.

Erin Caddell

So would you say between 50 and 55? Could it be even that wider range, or as a percent of revenue?

Richard Handler

Even if you look at the history for the last year or two, we have been in the 54, 55 range. And the reality is that we have been adding people on a relatively constant basis for the last five, six, seven years. So, we are experienced and adapt at managing the growth. Again this period, the third quarter, where you have a relatively sharp production in activity and trading potential in a couple of your businesses, you can't react on any side to that. It does reduce the comp you pay up, because the results are less, a lot is going to depend on the fourth quarter and into next year if things are back at trend levels, and this won't be a factor.

Erin Caddell

Okay. One other one, maybe understood to see, what were the assets under management at the end of the period?

Richard Handler

$4.9 billion.

Erin Caddell

And so would you view the forgetting the investment income but the rate of asset management fees going forward would be about, what it was in the third quarter, assuming that assets have substantial amount of flows (inaudible)?

Richard Handler

Not necessarily because, remember that we have the opportunity to earn performance fees, so we have the potential to do better on the asset management fee level. You can see that going back to later last year and earlier this year. There are some high water marks so there can be a little bit of earning back before you earn your incentives, but there are incentives attached to a number of dollars we managed.

Erin Caddell

So the investment income from managed funds is all your own investment in those funds?

Richard Handler

That's not our money. The investment income from managed funds is totally returned on our money, asset management fees is received from third parties on their money.

Erin Caddell

Okay. Then a one more and I appreciate the long call today. What's the minority interest are the, there is an element if you divide net earnings by the number of share you get a penny lower but there's some number that fact out there?

Richard Handler

The fact that dividend on the $125 million of preferred stocks, you have to add back our dividends because those shares are in the share count.

Erin Caddell

And what amount is that?

Richard Handler

$1.16 million.

Erin Caddell

Good to hear, thanks. And okay, thanks a lot.

Richard Handler

Take care.

Operator

You have a follow-up question from the line of Douglas Sipkin.

Douglas Sipkin

Thanks Just a follow-up here. When I think about sort of the revenue dynamics of your business, you guys continued to do a great job in equity trading but it's unlikely that business is going to grow dramatically from current levels, fixed income trading you know can bounce around, asset management doesn't appear to be growing at a fast pace. So, I guess my question is while the banking numbers continue to be impressive, do you believe that you can continue to grow that at 15% to 20% clip over the next two to three, four, five because it seems like, if you are going to have revenue growth probably come from there and correct me if you guys don't think the same way?

Richard Handler

Give you a few different costs from what you said, I think we believe that our trading businesses can be grown in two primary ways. One, there are elements to the trading businesses that exist in the marketplace, such as derivatives and prime brokerage that our businesses we can expand in and get share in. So, we think we can broaden ourselves and grow our numbers that way.

Secondly, on the trading side, there is geographic opportunity, while we had trading operations in London for an extended period and we have some operation in Japan. The London operations, in particular, have a chance to grow, both directly and on the back of the development of the derivatives businesses, as well as on the back of the development of the investment banking business in Europe. So, we are far from giving up on the view that we can get straightforward growth through effort and through expansion in trading.

On the banking side, we announced yesterday a significant higher, a very senior guy in the consumer investment banking area. He most recently was one of the senior folks In the Wachovia Consumer Banking effort. We expect to announce several editions to that group over the next couple of weeks. Consumer has been an area of focus for us but not the level that it will now have. We will have a significant dedicated group in that area. We, as you know, acquired the Putnam Lovell folks, we acquired the LongAcre media team. We added a team in Germany. So as I said before, I mean we've expanded our headcount in banking by better than 20% in the last 12 months. We are not going to subscribe to a specific growth rate, but can we have significant growth for the foreseeable future in investment banking? We believe so. We believe the firms that are smaller than us will continue to face challenges and the firms that are larger than us may continue to shift their focus ever larger and ever narrower, the middle market is robust and we think we can take an increasing share.

Richard Handler

Not only that, now we are seeing this quarter on high yield and commodities is extremely challenging. We have more capital in the high yield business. We have more abilities to commit capital and to do transactions. Our commodity business has been growing as well. The fact that they are both retention of period incredible volatility and performed okay is a good thing from our perspective, but we see growth in both those businesses as well. And we are not giving up on active management. We actually have a number of very strong managers who have done decently through a choppy environment and we are committed it.

Brian Friedman

And we are continuing to see new managers that we are considering bringing into the floor.

Douglas Sipkin

So I guess, just based on your commentary as it related to banking, you guys are going to see continue hiring right now and you're sort of viewing the last three months. I am not saying things are going to get back to early '07 levels, but of course team ahead in terms of hiring when you see fit on the banking side?

Richard Handler

Absolutely, we are very keen to bring in additional capable folks, both on the industry side and the product side. Recognize that we were not a direct beneficiary over the last couple of years of the explosion in structured finance activity.

Brian Friedman

Or mortgages.

Richard Handler

Or mortgages and further more while we have a solid effort in the private equity sponsor coverage area, we were not unduly depended on it. So we have an extremely diversified business. One of the most important things I would look at is the level of our M&A activity. If you think about the investment banking business, some of the toughest business to win is M&A and we get a very fair share of the M&A market and there is a lot of leverage that comes through that.

Brian Friedman

First you have our Jefferies Finance platform, which is expanding, which is really helping to drive the bank as well. So we have a lot of components.

Richard Handler

Yeah, you can get a us going on and on, we feel its very good. Our strategy and our potential in banking, as well as in the trading side.

Douglas Sipkin

Okay. Great thanks for taking my questions again.

Richard Handler

Sure Doug.

Operator

(Operator Instructions)

Richard Handler

Operator, I think if we go back and take some, there are shareholders here so can we end this?

Operator

This concludes Jefferies 2007 third quarter and year-to-date financial results conference call. You may now disconnect.

Richard Handler

Thank you.

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Source: Jefferies Q3 2007 Earnings Call Transcript
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