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Cowen Group Inc (NASDAQ:COWN)

Q4 2007 Earnings Call

February 28, 2008 9:00 am ET

Executives

Kim Fennebresque - Non-Executive Chairman

Tom Conner - CFO and Treasurer

Analysts

Jeff Harte - Sandler O'Neill

Operator

Good morning, ladies and gentlemen, and thank you for joining the Cowen Group Incorporated conference call to discuss the financial results for the fourth quarter and 12 months ended December 31, 2007.

By now, you should have received a copy of the company's earnings release, which can be accessed at the Cowen Group Incorporated's website, at www.cowen.com. If you do have Internet access and would like the copy of the press release, please call Nicole Keeler at area code 646-562-1796.

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

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

Now, I would like to turn the call over to Mr. Kim Fennebresque, Chairman and Chief Executive Officer, who is joined today by Mr. Tom Conner, Chief Financial Officer. Gentlemen, you may begin.

Kim Fennebresque

Good morning and thank you for joining our call. I'm going to start this morning with our results for the fourth quarter and full year before spending some time discussing the market turmoil on the fourth quarter and its impact on our business. I will then turn the call over to Tom, who will review the financial information for the quarter in greater detail.

For the fourth quarter of 2007, revenue decreased from the fourth quarter of 2006 by $38.1 million to $59.3 million on weaker investment banking results, primarily due to decreased capital raising activity. Our adjusted net operating loss for the fourth quarter of 2007 was $9.2 million compared to adjusted net operating income of $8.3 million in the fourth quarter of 2006.

We recorded a GAAP net loss of $10.7 million for the quarter compared to GAAP net income of $7.2 million in the fourth quarter of 2006. Please note that our 2007 fourth quarter results included a $10.1 million cumulative adjustment to compensation expense to bring our compensation ratio to 65% for the full year.

For the full year, revenue decrease from 2006 by $83.4 million to $261.6 million. Our adjusted net operating loss for 2007 was $7.4 million, within the range of the $6 million to $8.3 million we provided in our December 10 press release. For 2007, we recorded a GAAP net loss of $11.3 million compared to GAAP net income of $37.9 million in the prior year period. Please note that our 2006 full year results included a $25.8 million one-time gain related to sale of seats on certain exchanges.

I'd like to now spend a moment focusing on the market conditions during the fourth quarter and the resulting impact on our business before commenting on the beginning of 2008. I'll then turn the call over to Tom to review our financial information in greater detail.

Though capital market conditions rebounded in October, the positive sediment was short-lived as conditions deteriorated again in early November resulting in challenging market conditions for the final two months of the year. Our sales and trading group continued to perform well throughout the quarter amidst difficult market conditions.

Excluding convertibles, warrant positions and extraordinary items, core brokerage revenue for the fourth quarter of 2007 increased 1% compared to the fourth quarter of 2006. In total, brokerage revenue of 2007 decreased slightly compared to 2006. However, core brokerage revenue increased modestly on a year-over-year basis.

I am also pleased with our continued progress and our strategic advisory practices. Since becoming a public company, we have focused on improving our results in this area. I believe we are beginning to see the return on our efforts as 2007 strategic advisory revenue was up 58% compared to 2006. Our strategic advisory practice has improved substantially and continues to gain momentum.

I would also note that this area of our business has been virtually unaffected by the market turmoil during the second half of 2007.

The increased market volatility resulted in challenging capital market conditions throughout our target growth sectors. During the fourth quarter, street-wide public capital raising activity across our sectors decreased 16% from the same period in 2006 when measured by number of transactions. Similarly, when measured by number of transactions street-wide pipe activity across our sectors was down 22% year-over-year and up only slightly from a difficult third quarter.

As we mentioned in last quarter's call, our business in its current configuration is highly correlated to the activity in our target sector. As a result, the depressed capital raising activity during the fourth quarter had a significant impact on our overall investment banking results. Nevertheless, I believe we have a similar group of highly talented individual that share the firm's entrepreneurial spirit and will drive performance in the near term and beyond.

As I mentioned in the previous quarter's call, we made significant additions to the investment banking department through the first nine months of 2007, including leaders of new industry sectors. These individuals have already made meaningful contributions and I expect the full impact of these additions will be felt this year.

Finally, I continue to be pleased by the rapid progress of both our traditional and alternative asset management businesses. Our traditional asset management business is up and running both in the UK and the US. In addition, Cowen Healthcare Royalty Partners recently completed its first investment. The investment was made in Artes Medical, a company that Cowen took public in 2006, demonstrating the synergies we anticipated between the healthcare royalty business and our existing healthcare franchise.

Turning to 2008, our sales and trading group is off to a strong start. January was our best brokerage month in the last three years. This group continues to demonstrate its ability to execute and generate revenue across a wide variety of market conditions. Our M&A backlog is up substantially over the last year. We have already booked $3 million in fees and have announced six additional transactions representing $13 million of fees.

Our public equity backlog remains strong with 13 file transactions of which 4 are lead managed. Market conditions have remained difficult for the first part of 2008 with only four IPOs pricing across our sectors in January and six pricing into February thus far. However, our filed end on filed backlog is as high as it was at any point last year. Many of our clients continue to need capital in order to execute their business plans and we will be ready to act on their behalf when the market is more receptive.

Finally we have repurchased approximately 1.9 million shares, nearly completing the share repurchases authorized by the Board in early November. After executing the repurchase program, I believe we will remain very well capitalized with a strong liquid balance sheet.

We have avoided forecasting revenues in the past and will not change that posture now. But it is clear that our M&A business is strong and our secondary equity business continues to perform well. The remaining question is when the markets will open, and I have no sense of that. What I can say is that when they do, we have a strong and building backlog and we will be ready.

I'll now turn the call over to Tom to review the financial results in more detail before we take your questions.

Tom Conner

Thank you, Kim.

For the quarter December 31, 2007, total revenue was $59.3 million, representing a decrease of 39% from $97.4 million during the same quarter of 2006. Revenues for the full year decreased 24% to $261.6 million as compared to $345 million in 2006. Investment banking revenue for the fourth quarter was $20.6 million, a decrease of $32.5 million compared to the same period in 2006. The decrease primarily reflects lower transaction volumes in our public and private capital raising activities partially offset by an increase in our strategic advisory fees.

Before I discuss sales and trading-related revenues, I would like to mention a role-up change. We have combined commissions and principal transactions as well as fees paid to us towards our equity research, which was previously recorded in other revenue into a new revenue line called brokerage. We believe these revenues should all be reviewed on a combined basis as the majority of these revenues are derived from the same group of clients.

Brokerage revenue for the fourth quarter of 2007 was $35.1 million, a decrease of $4.9 million compared to $40 million in the same quarter of 2006. The decrease resulted primarily from a reduction in the value of warrant positions that were previously received in connection with investment banking transactions and a decrease in revenues related to our convertible trading activities compared to the fourth quarter of 2006.

In addition, the fourth quarter of 2006 included $1.5 million of gains on restricted stock related to our exchange fees. Excluding these items, our core brokerage business increased $0.2 million to $36.1 million for the fourth quarter of 2007, compared to the fourth quarter of 2006.

Revenue from interest and dividend income for the fourth quarter of 2007 was $2.3 million compared to $3.2 million in the same period last year. The decrease of $0.9 million resulted from a combination of lower average interest bearing assets and lower average interest rates during the fourth quarter of 2007 compared to the fourth quarter 2006.

Turning to expenses, our employee compensation and benefits expense was $51.1 million for the fourth quarter of 2007, a decrease of $8 million compared to $59.1 million for the same quarter last year. The decrease was primarily attributable to the application of the compensation to revenue ratio to lower revenue in 2007, partially offset by the increase in the compensation to revenue ratio to 65% for the full year of 2007.

Employee compensation and benefits expense for the fourth quarter of 2007 included $2.4 million of expense associated with the initial grant of equity to our employees in connection with its IPO compared to $2.6 million in the same quarter last year.

Excluding the expense associated with the initial grant of equity and the cumulative expense adjustment related to the increase in the compensation ratio, employee compensation and benefits expense as a percentage of total revenue was 65% and 58% for the fourth quarters of 2007 and 2006 respectively.

Non-compensation expenses were was $25 million for the fourth quarter of 2007, a decrease of $3.9 million or 13% compared to $28.9 million in the same quarter last year. The decrease was primarily attributable to reductions and communications and floor brokerage and trade execution related expenses as a result of our new clearing agreement.

We recorded a tax benefit of $6.1 million for the fourth quarter of 2007 compared to a provision for taxes of $3.1 million for the fourth quarter 2006. For the fourth quarter of 2007, we recorded a GAAP net loss of $10.7 million compared to GAAP net income of $7.2 million in the fourth quarter of 2006.

Our results for the fourth quarter 2007 included a $10.1 million cumulative adjustment to compensation expense to increase our compensation revenue ratio to 65% for the full year. Excluding the compensation expense associated with initial grant of equity, our adjusted net operating loss for the fourth quarter was $9.2 million compared to adjusted net operating income of $8.3 million in the same quarter last year.

Loss per share for the fourth quarter of 2007 was $0.86. For the full year, we recorded a GAAP net loss of $11.3 million compared to GAAP net income of $37.9 million in the prior year. As Kim mentioned, our 2006 full year results included $25.8 in one-time gains related to the sale of seats on foreign exchanges.

Excluding the compensation expenses associated with initial grant of equity, our adjusted net operating loss for 2007 was $7.4 million, within the range provide in our press release on December 10. Loss per share for 2007 was $0.88. Tangible book value per share at the end of 2007 based on common share of outstanding was $10.95.

This concludes our formal remarks. Kim and I will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Sir, your first question comes to you from the line of Jeff Harte of Sandler O'Neill. Please proceed.

Jeff Harte - Sandler O'Neill

Good morning, guys. On the brokerage, kind of commission side, the core being of 1% year-over-year, can you talk a little bit about maybe differences between client activities, volumes and loss rates, I mean did one or the other increased by more than 1%? Specifically, I guess I'm looking at trading volumes, seems to be a little stronger. I thought maybe brokerage revenues will be a little higher?

Kim Fennebresque

I think our loss ratio has remained fairly constant. So I think after that it's a calculation as to kind of revenue mix among the customer mix.

Jeff Harte - Sandler O'Neill

Okay. Agreeing with your comments that who knows when the markets are going to come back and how important that's going to be for investment banking revenues, how do you look at comp expense through 2008, given that the year is kind of off to a slow start in the equity underwriting? If we don't actually see a decent pickup in industry activity levels in equity origination, we potentially will be looking at another 65% compensation expense ratio here in 2008?

Kim Fennebresque

I certainly wouldn't deny the possibility of it, Jeff, having, even to my own surprise, decided to make this decision last fall, although obviously we were the first do that. Several others followed suit quickly there after. We are certainly not going to accrue 65%, and we do expect there will be improvement in activity. As to when and how much, I don't know. So I think my ability of forecast that may be no better than my ability to forecast market activity. So I obviously am probably the last person who should commit a comp to revenue ratio, but suffice it to say that when we went to 65%, we did it with great reluctance.

Jeff Harte - Sandler O'Neill

Okay. And finally, in the pipes business, a lot of kind of the biotech-type companies we look at just being customers of yours, we kind of make the assumption that they only have a limited amount of cash on hand and they're not generally generating revenues, yet eventually they're going to come back to the market. Do you have any kind of a concept, I know this is a 30,000 foot question of how long kind of some of the smaller biotech-type companies can actually hold up before coming back to the market, and actually maybe we see some even at the tough markets some countercyclical capital raises for you there?

Kim Fennebresque

That is beyond my specific knowledge. What I will say, one of the things about the pipe business is that it makes it hard to forecast as pipe transactions tend to come and go very quickly. So there really is never much of a pipe backlog. But I think the conclusion you reached that a lot of the early stage life sciences companies that are mostly spending money rather than generate money do need capital in order to stay in business. Certainly, your thesis makes sense. Whether that results in increased private equity activity or not and whether it results in private activity or not with us is obviously an open question.

Jeff Harte - Sandler O'Neill

Okay. Thank you.

Kim Fennebresque

You are welcome.

Operator

Thank you, sir. (Operator Instructions)

Gentlemen, there appears to be no further questions at this time. I am going to turn it back to you for your closing remarks. Thank you.

Kim Fennebresque

Thank you. Well, I certainly recognize that this has been a difficult period not just for Wall Street generally, but for us in that context. And I assure you that we do all we can everyday to make this all be successful and we will continue to do that on your behalf. Thank you very much. I appreciate your time.

Operator

Ladies and gentlemen, that concludes your conference for today. You may now disconnect. Have a great day.

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