Michael Lacovara - Chief Executive Officer
Dave Horin - Chief Financial Officer
Julie Prozeller - Financial Dynamics
Devin Ryan - Sandler O’Neill
Maxi Breezy - Geneva Capital Group
Rodman & Renshaw Capital Group Inc. (RODM) Q3 2008 Earnings Call November 13, 2008 10:00 AM ET
Good morning and welcome to the Rodman & Renshaw third quarter 2008 earnings conference call. At this time all parties have been placed on a listen only mode. Following today’s presentation, the floor will be open for questions. (Operator Instructions) It is now my pleasure to introduce your host Mrs. Julie Prozeller of Financial Dynamics. Ma’am, the floor is yours.
Thank you operator. By now you should have received a copy of the company’s third quarter 2008 earnings release. If you haven’t, please call Financial Dynamics at 212-850-5600. On the call today we have Michael Lacovara, Chief Executive Officer; and Dave Horin, Chief Financial Officer of Rodman & Renshaw.
Before we begin I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties described in the company’s earnings release and other filings with the SEC. Rodman & Renshaw has no obligation to update the information presented on the call.
Also on today’s call our speakers will reference certain non-GAAP financial measures which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.rodm.com.
With that I’d like to turn the call over to Rodman & Renshaw’s CEO, Michael Lacovara.
Thank you Julie and good morning everyone. I want to thank you again for joining us for the third quarter 2008 earnings call. As usual, I’ll give a brief overview of the quarter and then we’ll pass the call over to Dave who will speak in more detail about the financial results for the quarter before he turns it back to me for a brief comment on our outlook for the remainder of this year. We’ll then open up the call to your questions.
I think there are really two stories to the third quarter at Rodman. Until the last 10 days of the quarter I felt our revenue was solid, our expenses were under control, absent some unusual items that Dave will discuss, and the valuations in the as yet un-hedged portion of our warrant portfolio had held up nicely.
Then, as we all know, the financial world went haywire and we saw immediate and dramatic reversals in the warrant portfolio and a number of transactions get delayed or shelled entirely. Even so we were profitable on a cash operating basis for this quarter.
More specifically in what is historically the lightest quarter for corporate finance revenue and in the most distressed financial markets in many decades, our third quarter banking fees were up significantly on a year-over-year basis. We reported $11.9 million in banking fees compared to $8.8 million in the prior year period. Furthermore, excluding principle transactions in which we recorded a loss of $4.9 million due to the severe reversals on our warrant portfolio.
In the second half of September, the company reported revenue of $13.5 million as compared to $10.1 million in the third quarter of last year. Included in that revenue was a significant cross border strategic advisory assignment and I think we will see continued growth in our M&A and advisory revenue in the coming quarters.
Over the past six months, despite the high market turbulence, we are cash flow positive on an operating basis, that is excluding acquisitions and on a year-to-date basis we have achieved positive earnings per share of $0.12. Although our compensation ratio, excluding pre-offering stock compensation expense was higher than we would like as a percentage of net revenue, for the year we remain at 45% of net revenue, well below our target ratio of 55%.
For the year our compensation ratio, excluding pre-offering stock compensation expense, as a percentage of what we call transaction related revenue, which we defined as revenue excluding principle transactions, stands at 49%. I believe that is an achievement unique in our industry and a testament to both the platform and the model we are building at Rodman.
I would now like to turn the call over to Dave to review our financial results in more detail.
Thank you, Michael. I would like to organize my remarks by first discussing our operating cash flow for the quarter, then our liquidity position as of September 30, 2008 and finally our financial performance for the quarter.
As Michael stated previously, our third quarter is typically the slowest quarter of the year and our goal as of the beginning of the period was to breakeven from the operating cash perspective. We were able to achieve this objective despite the sudden and severe market reversals and the unprecedented market wide declines in financing activity.
Cash and cash equivalents were $23.5 million as of September 30, 2008 and $30.3 million as of June 30, 2008. Unrestricted cash amounted to $17.5 million as of September 30, 2008 and restricted cash amounted to $6 million as of September 30, 2008. These numbers were transposed in a version that was sent out early this morning, but have since been corrected.
The $6.8 million change in cash and cash equivalents is primarily due to the following five items: (1) midyear bonus payouts of $5.1 million; although paid in July, these bonuses were fully accrued as of June 30, 2008 and relate to the first half of production. As previously announced to our employees, 2008 represents the last year in which Rodman will pay midyear bonuses.
(2) Cash used in investing and financing activities of $900,000, including additional earn-out payments related to acquisitions consummated earlier this year. (3) Cash outflows of $400,000 related to Aceras Biomedical startup activities. (4) Nonstandard professional and consulting fees of $800,000 due to a change in accounting firms and an upcoming arbitration proceeding offset by; (5) $400,000 of cash provided by recurring operations.
Based on our operating cash flows we believe that our liquidity position is sustainable if current market conditions persist for an extended period of time. As of September 30, 2008 we had liquid assets of $31.9 million consisting of cash and cash equivalents, level one assets and current receivables.
Now let me discuss this quarter’s financial performance. Earnings before income taxes, depreciation and amortization, excluding unrealized losses on our non-operating financial instruments, for the third quarter of 2008 were $1.4 million which compares to $900,000 for the third quarter of 2007. We consider this metric a meaningful measurement of our operating and financial performance and utilize this performance indicator as we make decisions about resource allocation, compensation and personnel evaluation.
Investment banking revenue was $11.9 million for the third quarter of 2008 which compares to $8.8 million for the third quarter of 2007. Breaking down the $11.9 million of investment banking revenue during the third quarter, private placement and underwriting revenue was $8.4 million.
During the quarter we completed 13 financing transactions with an average transaction size of $11.4 million which compares to nine financing transactions with an average transaction size of $16.2 million in the third quarter of 2007. These results are noteworthy given the unprecedented lack of capital markets activity and lack of general industry wide completed deal volume during the current quarter.
Strategic advisory fees for the second quarter were $3.5 million compared to $2.3 million in the third quarter of 2007. The increase in advisory fees reflects our continued expansion beyond our core PIPE practice into different verticals and product offerings and we expect both the number of advisory engagements and revenue from such engagements to increase in the coming quarters.
Sales and trading commissions for the quarter were $1.4 million compared to $1.3 million in the prior year quarter. Principle transaction losses for the quarter were $4.9 million compared to losses of $500,000 for the prior year quarter.
The decrease was a result of unusual volatility during the latter half of September, in a few concentrated small capitalization warrant positions acquired in connection with our investment banking activities. The losses from our warrant portfolio have no effect on our cash position and we continue to take steps to hedge, sell or otherwise reduce the volatility in this non-operating area.
Employee compensation and benefits expense for the quarter, including pre-offering stock compensation expense, was $5.9 million compared to $4.9 million in the prior year quarter. Excluding pre-offering stock compensation expense of $600,000, employee compensation benefits expense for the quarter was $5.3 million compared to $4.5 million in the prior year quarter.
Employee compensation and benefits expense for the quarter, excluding IPO stock-based compensation represented 40% of transaction-related revenue, defined as revenue excluding principle transactions compared to 45% in the prior quarter.
Our low transaction based compensation ratio in the current quarter is a result of a migration from a fixed compensation structure to a variable compensation structure based on transaction related revenue that is in line with our strategic goal to create a platform around higher margin endeavors, with relatively low fixed costs and expenses that vary highly with revenue.
Non-compensation expenses were $6.9 million for the quarter compared to $4.5 million in the prior year period and represent 51% of transaction related revenue this quarter as compared to 44% in the prior year quarter. Non-compensation expenses during the current quarter include approximately $800,000 of atypical and consulting fees due to a change in accounting firm and an upcoming arbitration proceeding which I highlighted earlier in this call, as well as increased rental expenses due to the expansion of our platform and the headcount.
Income tax benefit was $1.4 million for the quarter which equates to an effective tax rate of 33% compared to a $900,000 tax expense for the three months ended September 30, 2007.
The current quarter effective tax rate was affected by a $350,000 return to provision adjustment and change in income tax estimates as a result of our state and local tax review. Absent this adjustment the effective tax rate would have been 42%.
This concludes the review of our financial performance. I will now turn the call back to Michael who will talk about the current operating environment and our outlook for the remainder of the year.
Thanks, Dave. I’ll keep my remarks brief. Overall I don’t think anyone feels that we can credibly predict when the markets will normalize sufficiently, nor can we be assured of a time horizon over which we’re likely to realize all or even the preponderant majority of the significant number of transactions in our pipeline.
That said, I should say that I’m excited about the four trends. First, even in these times PIPEs have tended to hold up substantially better on a product basis than almost every other financing vehicle and nobody does more PIPEs or in our view has greater expertise in that product than Rodman. Because of that we are seeing opportunities and receiving mandates from a wider range of companies across sectors, geographies and market caps than we have traditionally.
Second, because our team is broader and deeper than it has ever been, we believe we can turn those mandates into long-term relationships for both the broader range of financing products and for high value advisory assignments. I’m extremely heartened by the enthusiasm and activity at our Global Investor Conference which concluded yesterday at which more than 550 companies presented to well over 1,000 institutional investors.
I strongly believe that our decision to push forward, indeed expand events like our conference and our overall client development efforts will help us continue to steel a march on our competitors.
Third, we are almost overwhelmed at the quality and number of extremely talented folks who have expressed an interest in coming to work at Rodman and to contribute to the platform we have built in our first year as a public company. We expect to continue to hire producers who will continue to add to our depth and our reach.
Finally, I think Rodman has built what competitors have begun to talk about building, that is an investment bank driven by high margin revenue with relatively low fixed costs, an aversion to old-style Wall Street guarantees and a strong tilt towards performance based compensation at all levels of the organization.
Let me finally say a word about the price of our stock. As I said this morning in our earnings release, I believe that the price of Rodman’s stock has become wholly divorced from the fundamentals of our business, much less the prospects of that business. Our franchise is broader and deeper than it has ever been and we have been profitable on a cash operating basis in every quarter this year.
As soon as our policies permit I plan to be in the market buying our stock and, based on a number of inquiries and conversations I’ve had in the last few days, I expect that other members of management and our Board of Directors may do so as well.
None of us can predict the future direction of the markets; however, we remain confident in the resiliency of our long-term business model, in the commitment of our outstanding people and believe we are well positioned not just to weather this storm, but to continue to become a stronger and more successful player now and when the markets return to health.
On that note I’d like to open it up to questions; Dave and I are happy to take them.
(Operator Instructions) Your first question comes from Devin Ryan - Sandler O’Neill.
Devin Ryan - Sandler O’Neill
Michael, you mentioned the blackout period with your shares; when does that blackout period end and then when would you be able to get back into the market?
It’s two business days after today, after the date of the earnings release and I plan to have an order in as soon as my general counsel, who’s sitting about 12 inches from me, will permit.
Devin Ryan - Sandler O’Neill
You mentioned the annual investment conference in New York and I guess that just ended yesterday; can you just give us some insight into what investors and companies are saying today and how they’re planning in terms of capital raising schedules as we approach the end of the year and maybe into the beginning of next year and even touch on investor appetites as well.
Of course, I can’t comment on specific conversations we had of which there were many, but I think it’s fair to say that there were no surprises. There were companies within healthcare and outside of healthcare; and I’ll touch on the non-healthcare companies in a moment; that have significant needs for capital and have become, shall we say more flexible or more realistic in their understanding of what that capital is going to cost.
At a high level I think that the contraction or maybe temporary disappearance of the debt markets has made more people interested in doing equity, understanding there may have to be some structure around that equity which means things like PIPEs or converts where we think we are extraordinarily skilled and able.
I was personally surprised at the number of investors who came, at the number of investors who shook the hands of me and Dave and our partners to say thank you for having a conference when nobody else is because we do have money to put to work. That said, everybody is being extremely cautious and extremely careful. I do think we will see some transactions come out of a conference between now and year end, but I’m no longer in the predicting business, I’m just telling you that I have very good people who are working very hard.
The one really highlight of the conference is the extent to which we were able to attract companies from outside of healthcare. We had I think 80 companies from China presenting at our conference and we had several dozen companies in both the metals and mining space and in the energy space and there were high levels of investor interest around all of those companies.
So I think over time, and again I’m not going to predict a time horizon; you will see the fruits of the acquisitions we’ve done and the expansion we’ve done and the overall strategy to marry our finance prowess with some sectors outside of biotech.
Devin Ryan - Sandler O’Neill
In terms of the warrant portfolio, how much of the warrant portfolio was hedged at the end of the quarter and did this strategy help offset any declines in the quarter; and then also, you had mentioned in previous quarters potentially paying a percentage of banker’s compensation with warrants, is that still an option?
Yes, two things. First of all, as far as what was hedged, you can see in our balance sheet we have a capital called financial instruments sold; about $2.1 million, was hedged. Kind of what the plan is what I call a long term when I talk to our partners or our third party managed firm on this, is sometime in 2009 we get to a point where we’re 40% or 50% hedged and we think that should mitigate some risk.
As far as our warrant portfolio, where it’s coming to, I think basically the level of volatility is increasing as we go and I think we have benefited maybe not now, but we will benefit as the stock market declines some of the short positions start to help us out.
The second part of your question was paying bankers and as far as paying bankers, we have started that process. Some large deals, what we’re trying to do is we’re paying the bankers right up front, right at the time of the transaction. So that in itself is kind of a hedge, it takes the financial instruments off our balance sheet and to us it’s a natural hedge.
Devin Ryan - Sandler O’Neill
And then in terms of the compensation this quarter, the comp ratio excluding the warrants as you noted was 40%. I know that the comp accrual is highly variable, but what you accrued for this quarter; what you actually expect to pay out or could we see a true up in the fourth quarter if revenues don’t recover from levels lets say this quarter?
Kind of the process that we went through similar to what we did last quarter is we had a list of names and we decided to accrue comp as if we were paying compensation as of the end of the third quarter. So although it’s really based on a target ratio it’s not for us. We went through a detailed list of names. As of the end of the quarter we have 141 people and we assumed once again that if we paid comps as of the end of September, this is the amount of cash that we’re paying out.
That’s the way we’re going to do it, because otherwise your comp ratio isn’t real and frankly it’s just an invitation for sloppy management. So we look at every quarter when we do an accrual, it’s done producer-by-producer, staff person-by-staff person, so that’s the number we would pay people if we were paying out at the end of every quarter.
Devin Ryan - Sandler O’Neill
That’s helpful and then finally for you Michael, Rodman has historically been known for its expertise and life sciences, but over the past few quarters, there have been a number of changes including entering new sectors like metals and mining and energy and now your new Director of Research has a background in industrial and commercial services. Just looking forward a couple years, what do you expect or what do you want Rodman to really be known for?
I certainly don’t want Rodman to be known as a firm that got out of a serious commitment to life science. I should note we made another senior level hire for life science analysts in the last two weeks, so we remain committed there.
I think what I want and what all of my senior colleagues and my Board want, is for people to think of Rodman kind of the way the conversation was going at the conference; as a group of people who can finance in good markets and in bad markets, who can be creative about it and are focused on a defined number of sectors and a defined number of situations, but are excellent across a broader range of products and PIPEs.
That’s why I was heartened that we have an increasing number of M&A mandates and we’ve hired some bankers with a broader level of expertise in the advisory and M&A world, so what I want people to think of is if you were a small or mid-cap firm in what will be I think a half dozen target sectors, you will come to us not as your banker of last resort, but as your relationship banker whose financing expertise is unparalleled and whose quality of advice is as good as our financing expertise is today. That’s what I want to be, I want to be the banker of choice in our sectors, in our market cap.
Devin Ryan - Sandler O’Neill
Okay and then just lastly, you mentioned in the prepared remarks and arbitration, can you just elaborate on what that is?
I thought you were going to end with a softball question. Yes, this was disclosed as long ago as the S1 for public offering. There was a research analyst who was terminated several years ago; he claimed he was terminated for violations of certain regulations, FINRA regulations; we terminated him for cause.
There have been a variety of investigations conducted of Rodman and of him. I can tell you that no action was taken against Rodman. I can’t comment on the disposition of any investigation as to him and he had brought an arbitration proceeding against us and we brought claims against him and all of those claims are now scheduled to be arbitrated with a hearing beginning sometime in this quarter.
Being a former lawyer I have both, an unfortunate level of familiarity and a declining level of sympathy for lawyer fees, but the fees rose in the quarter as we got ready to try the case and having looked through the file with an old litigator’s eye, I’m very confident in our prospects. You can never predict any outcome, but I think we’ve done everything we can to position this right. I do think you may see some, again a high level of professional fees in the fourth quarter because there will be some hearing dates.
The other thing I should comment on is in the professional services, the professionals fees line of our income statement, one other thing that Dave mentioned was also the change of auditors bringing on KPMG.
The other thing that drove that number a little bit in the quarter is we pay a fairly significant amount of money to search consultants because we hired a number of senior people, some of whom came to us through consultants and we just look at that as an investment in our future. It does tend to raise the non-comp line in the quarter, but we think we are buying very, very good producers who are going to make the platform better on a long-term basis, but you get a mismatch between the expense and the revenue.
(Operator Instructions) Your next question comes from [Maxi Breezy] - Geneva Capital Group.
Maxi Breezy - Geneva Capital Group
Michael, I have a very difficult question for you. I’m looking at your cash flow statement for the Q2 which shows that net cash used in operation of $7.8 million. I’m asking your self if it’s justified to hand out $5 million in bonuses after operations burnt $7.8 million for the first two quarters of the year.
Let me comment Maxi on sort of a conceptual level and then I’ll ask Dave to exactly trace the cash flow for you, because there’s always something a little unusual about the way cash flow statements work for brokerages.
Do I think it was appropriate to pay people $5.1 million in the first half? The answer is, I do; and that is because we had committed to our people as we transitioned our entire compensation regime to pay midyear bonus. As you may recall, for all of Rodman’s history as a private company and up through last year it paid bonuses every quarter in fact. We are moving to the more standard approach for our peers of paying bonuses once a year after year end, but we agreed to really do the right thing by our employees to transition that and pay a half year bonus this year.
The second is the way that bonus was calculated. It was calculated after two quarters in which the firm was profitable, and it was calculated based on revenue produced by individual producers who contributed to the performance of the firm and based on the productivity of employees like research analysts who cannot get paid directly on production.
I think, particularly since it was within our previously announced targets, in fact below our announced ratios, below the ratios paid by our competitors and it’s what one needs to pay to keep the quality of people we have here. I actually do think that it was an appropriate use of the house’s money.
Now just on the actual question of the $7.8 million, I want to turn it over to Dave so he can trace the cash flow for you.
What’s basically driving that number; it’s a little misleading because as a broker dealer you have to include in your cash flow statement what I call the unrealized gains and losses for warrants which we’ve talked about as a non-operating expense what we consider it.
Now in our 10-Q that’s going to be released later today, you’ll be able to further see, you can back out what I call the warrant number, which is for that nine month period up $17 million; you’re going to see for the nine month period we are cash flow positive. So feel free; later on I think our 10-Q is going to be filed at the close of business today and if you have any further questions you’ll be able to see that number that we are slightly cash flow positive for the nine month period.
So the curiosity is, it says cash flow, but a lot of the cash flow isn’t cash; it’s actually a change in a mark in the warrant portfolio. I can tell you, my answer would have been different if I thought the firm had actually burned through $7.8 million six months. Then I would have husbanded our cash much more carefully.
Maxi Breezy - Geneva Capital Group
By the way, don’t get me wrong. I’ve got a lot of friends at Rodman, but I’m also a shareholder of the company and I’d like to think that also all of you are shareholders and to have our interest a little bit more aligned.
Maxi, you’re a friend of the firm and it was a hard question but an absolutely fair one.
And at this time I see no further questions in queue and I’d like to turn the call back over to Mr. Madison for closing remarks.
Mr. Lacovara will do the closing remarks. I’d just want to thank everybody for listening to us today and we’re hoping for some stability and some good things to come in the fourth quarter. Thank you all very much. Bye, bye.
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
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