Jefferies Group, Inc. (JEF) Q4 2007 Earnings Call January 23, 2008 9:00 AM ET
Richard B. Handler - Chairman of the Board, President, Chief Executive Officer
Brian P. Friedman – Chairman, Executive Committee
Peregrine C. De M. Broadbent - Chief Financial Officer, Executive Vice President
Welcome to the Jefferies 2007 fourth quarter and year end financial results conference call. (Operator Instructions) A press release containing Jefferies 2007 fourth quarter and year end financial results was distributed via Business Wire before the market opened today and can be accessed at Jefferies website at www.Jefferies.com.
Some of the comments made in this conference call may include forward-looking statements. These forward-looking statements may contain statements about management’s current expectations, strategic objectives, growth opportunities, business and prospects. These forward-looking statements are not statements of historical fact and represent only Jefferies beliefs as to future performance.
They usually include the words continue, will, believe, should, or other similar expressions. Actual results could differ materially from those projected in these forward-looking statements. Please refer to Jefferies annual report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2007 and in Jefferies Form 10-Q and 8-K for a 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 B. Handler
Good morning and thanks for joining our discussion of Jefferies fourth quarter and full year results for 2007. I am Rich Handler, CEO of Jefferies, and with me on the call today are Brian Friedman, Chairman of our Executive Committee, and Peg Broadbent, our Chief Financial Officer.
On January 7 we issued preliminary results for the fourth quarter and full year 2007, provided background on those results and answered all of your questions. The final results we released this morning are consistent with our expectations as disclosed on January 7, with net revenues of $349 million and a loss of $24 million or $0.17 per share for the quarter.
Therefore, we won’t reiterate the substance of that call, but rather I will turn the call over to Peg to review our final numbers, after which Brian and I will provide some further color on current market conditions in our outlook.
Peregrine C. De M. Broadbent
Thank you, Rich. For the fourth quarter, net revenues were $349 million versus $374 million in the fourth quarter of 2006, which is a decrease of about 7%. The decline in revenues can primarily be attributed to lower results in equities and fixed income, and decreased overall performance of our asset management businesses.
In aggregate, the difference in revenue across these business lines was about $58 million. These decreases were partly offset by continued strong performance of our investment banking business, which was up $22 million or 15% as compared to the same period in the prior year.
We had a net loss of $24 million or $0.17 per share as compared to net earnings of $56 million or $0.38 per share for the fourth quarter of 2006.
As to our individual revenue lines, equities had solid performance despite challenging markets during the quarter, with revenues of $139 million versus $152 million in the last year’s fourth quarter.
Fixed income and commodities revenues were $36 million versus $33 million, primarily driven by continued growth of our commodities derivatives trading platform. High yield revenues were negative $3 million versus positive $10 million, and asset management revenues were negative $6 million versus positive $29 million last year.
Investment banking revenues were $167 million compared to $145 million for the same period last year.
For the full year, net revenues increased to $1.57 billion versus $1.46 billion in 2006, an increase of $110 million, or 8%. The increase is primarily attributable to increases in our investment banking results which improved 39% to $750 million and our equities revenues, which increased over 10% to $597 million.
There are a number of things that impacted these results that Rich and Brian will address shortly. As we said on January 7, as a result of losses and overall revenue shortfall, as well as a mix of revenues which impact the flexibility of the year end compensation process, compensation and benefits as a percentage of net revenues were significantly higher as compared to historical rates and were 81.2% for the quarter versus last year’s 52.8%. For the full year 2007, this rate was 60% versus 54.3% last year.
Non-comp expenses, excluding interest expense, were $107 million for the quarter versus $83 million for the same quarter last year. Non-comp expenses were higher in support of growth in equity, investment banking and operations outside the U.S. As we have mentioned before, we are in the process of meaningful space build-outs in York in London which will be concluded early next year.
Our average headcount was 2,521 employees for the quarter ended December 31, 2007, up 13% versus the same period a year ago. With limited headcount growth currently anticipated for 2008, we believe our operating costs should remain at current levels, and possibly decline as a result of cost reduction efforts we have undertaken.
Our effective tax rate for the quarter was 34% as compared with 40% for the fourth quarter of 2006. The rate for the quarter was impacted by a one-time tax incurred on the dividend transfer between international entities, which increased our net loss by approximately $2 million. We expect this rate to return to normal levels going forward.
Now I would like to hand it over to Brian Friedman to talk about investment banking and asset management.
Brian P. Friedman
As Peg noted, investment banking was up approximately 39% in 2007 to over $750 million, as compared to $541 million in 2006. This is solid progress for our platform and testifies to the breadth and depth of our capabilities and the value we add for our clients.
Jefferies has achieved a unique market position in investment banking. We have gained share consistently over the past seven years as we have invested heavily in our platform from both an industry and product perspective. We continue to build on our position in 2007 as we joined forces with the LongAcre Media Team in London and the Platinum Level Financial Institution Group in the U.S. and Europe.
We essentially opened in October our 12-person office in Delhi, India and our 22-person Frankfurt office. Primarily during the latter half of the year, we also assembled what is now a 22-person consumer investment banking team based in New York and Charlotte. Much of this development occurred in the second half of 2007.
Similar to our past growth and acquisition initiatives, there is a ramp-up period following a new team joining Jefferies before they become fully results generating. We are optimistic their contributions will grow throughout 2008 and we will achieve similar results over time as we have with our past acquisitions and sector investments such as Jefferies Broadview, Jefferies Randall and Dewey, and Jefferies QuarterDeck.
The beginning of 2008 clearly has been fraught with uncertainty. The capital markets are in turmoil and while corporate buyers may step up their activity, private equity is currently cautious and many sellers have paused to assess the new reality and the prospects for a better environment ahead.
Our banking backlog is solid. However, unless market conditions stabilize, the conversion rate of backlog to closed transactions will remain difficult to predict. While the environment in which we operate is challenging, the market for our sector-focused, full service investment banking offering is not disappearing. We will need to be more creative and work even harder for our clients, but we have an incredibly capable team that is up to this challenge.
Despite a leveraged lending environment that left many with unsold and mispriced inventory, Jefferies Finance, our joint venture with Mass Mutual, had a solid quarter and finished 2007 in a strong and liquid financial condition. During the fourth quarter, Jefferies Finance completed eight transactions, seven of which were lead-managed. For the full year, we closed 41 transactions, including 32 as lead or co-lead arranger, aggregating approximately $2.5 billion of loans for the year.
Our portfolio of mostly senior secured loans held up well and Jefferies Finance was profitable during every quarter of 2007. Looking forward, the quality of opportunities we are seeing is better than ever, and pricing, leverage and covenants have become significantly more attractive for lenders.
Turning to asset management, we spoke at length and in detail on our last call about our U.S. hedge fund seating platform and its recent results. While we are committed to this business and mindful of the current volatile and negative market conditions, we are focused on protecting our and our clients’ capital. As has been reported in a newsletter recently, since January 1 one of our funds suffered losses in consumer equities. Jefferies direct loss in this fund, through the close of business yesterday, was $6 million. Since its inception in early 2003 through the end of 2007, this fund generated a compounded net return of 26% per annum.
Given this nearly five-year track record, we have confidence in this team but as is the case with every one of our sponsored funds, we are closely monitoring the risk and the results.
Since the middle of Q4 we have been working to reduce the amount of our capital at risk in U.S. hedge funds as we reassess our strategy to ensure we have a sustainable plan that will meet our objectives. At December 31, 2007 firm capital invested in our U.S. hedge fund platform was $391 million. Since year end, we have reduced our investment by approximately 20% or $77 million. We may further reduce our capital committed to this business to the extent fund performance is disappointing, while at the same time we fully intend to continue to support those that are succeeding.
It should be noted that our global convertible bond asset management business, based in London and Zurich, now manages approximately $2.9 billion in assets. We achieved solid performance in 2007 with both our global and European funds comfortable ahead of their respective benchmarks, and assets under management grew 16% over the course of the year.
Now I would like to turn it back to Rich.
Richard B. Handler
Thanks, Brian. First, I would like to make a few comments on our equity, fixed income and commodity, and high yield trading businesses and their performance for the quarter. Our equities business continues to perform well and we believe there is potential for growth in 2008. Consistent with the reality of the trading environment, we will be focused heavily on improving efficiencies and controlling our costs.
We are in a much stronger position today than we were just two years ago. We have meaningfully developed our platform to consolidate and enhance our sector trading, improve and expand our research product and research sales effort, rationalize our compensation structure and develop our presence in algorithmic trading, derivatives and prime brokerage.
Despite the challenging environment we have had since mid last year, we are confident in our people and our strategy as we navigate forward. Our convertibles business in both the U.S. and London performed well in 2007. Our investment grade fixed income business increased its revenues considerably in the second half of 2007 and is well-positioned to add value in an increasingly illiquid marketplace.
Our four-year-old commodities business achieved outstanding results for the fourth quarter of 2007 and delivered a solid full year performance.
Jefferies high yield trading performed well for the first six months of 2007 and disappointed in the second half, as liquidity left this market and sentiment turned negative, all making for a difficult environment. We at Jefferies have been a meaningful leader in the business for 18 years, and as in prior downturns, our plan to take advantage of opportunities as they are presented and create long-term value for our partners and Jefferies. Results are likely to continue to be lumpy. With our depth of experience and commitment, we are confident in the Jefferies high yield trading team.
The second half of 2007 presented the most challenging six months in the financial markets that we have experienced in a very long time. The first 14 trading days of 2008, in many ways, feel even worse. We do not know when we will see an improvement in the environment, and recognize that things can even get worse before they ultimately stabilize.
With a poor start to this quarter, it is difficult to be optimistic at this time about our first quarter potential. That being said, our firm is unique in its positioning and strategy, our balance sheet is in excellent shape, our culture is strong and our ability to add value to our increased client base has never been better.
We believe the opportunity ahead of us is enormous. Our investment banking business is diversified and our product mix is rich and extremely scalable as we have proven when the environment allows.
Our equity business has never been stronger or more diversified. Our convertible fixed income and commodity businesses are well-positioned and becoming of increasing importance to our clients. Our research and research sales efforts has never included better professionals. The high yield and distressed market is getting uglier. We have long-term, committed capital that we have only begun to deploy and we have an incredible team that has faced tough environments before and navigated our way through significant value creation.
We have always recognized the cyclicality and volatility that can arise in our business, therefore have sought ways, always, to take measured and worthwhile risks that do not jeopardize our financial condition or long-term prospects.
We have reduced the risk in those areas of our business that produced the bulk of the recent negative revenue. We are working actively to compress our operating costs to maximize the flexibility in our structure. As we have said repeatedly, our balance sheet is in excellent shape with over $3.5 billion in equity and long-term debt capital. We will focus on enhancing our market position in 2008 as many of our larger competitors are distracted with balance sheet and business line issues, and many of our narrower competitors feel the constraints of a limited product or industry focus.
Our challenge is clear and it is not going to be easy, but we will drive our firm to maximize revenues and achieve the best margin we can under the circumstances. Our stock is trading just above our $1.8 billion book value. We announced today that our board of directors has authorized the repurchase from time to time of up to an aggregate of 15 million additional shares. Together with the 1 million shares remaining under our prior authorization, we may repurchase up to 16 million shares over time.
Our employees collectively own, by far, the largest equity stake in Jefferies and we are a committed, tenacious and capable team. We will continue to do the right thing for our clients, our employees, our shareholders and our bondholders.
Now I would be happy to take any questions.
(Operator Instructions) There are no questions at this time.
Richard B. Handler
Thank you and have a good day.