Hannah Sloan – Financial Dynamics
Michael Lacovara – CEO
David Horin – CFO
Devin Ryan – Sandler O'Neill
Rodman & Renshaw Capital Group, Inc. (RODM) Q2 2008 Earnings Call Transcript August 12, 2008 10:00 AM ET
Good morning and welcome to the Rodman & Renshaw Second 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 your questions. (Operator instructions)
It is now my pleasure to introduce your host, Ms. Hannah Sloan of Financial Dynamics. Ma'am, the floor is yours.
Thank you, operator. By now, you should have received a copy of the Company's second quarter 2008 earnings release. If you haven't, please call Financial Dynamics at 212-850-5600.
On the call today are Michael Lacovara, Chief Executive Officer, and David 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 the uncertainties described in the company's earnings release and other filings with the SEC. Rodman & Renshaw has no obligation to update 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. Reconciliations of those measures to GAAP will be posted on the Investor Relations Web site at www.rodmanandrenshaw.com.
With that, I'd like to turn the call over to Rodman & Renshaw's CEO, Michael Lacovara.
Thank you, Hannah. Good morning, everyone. I'd like to thank you all for joining us for the second quarter 2008 earnings call, and let me review briefly how Dave Horin and I will proceed this morning.
First, I shall review some of the financial highlights for the quarter and touch on some of the strategic initiatives that we executed during the first half of the year. Then I shall pass the call to our CFO, Dave Horin, 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 the current market environment and our outlook for the remainder of this year. We shall then open up the call to your questions.
Turning now to the second quarter of 2008, I'm very pleased to report that despite the challenging economic environment, we achieved revenues for the quarter of $29.5 million, an increase of 95% from the first quarter of this year, driven by particular strength within our core healthcare sector and once again our market leadership and PIPE financings.
We were solidly profitable during the quarter with net income increasing from $1.1 million or $0.03 a share in the first quarter of the year to $6 million or $0.18 per share for the second quarter.
As important, as I look at our maturing platform, we achieved record operating margin of 34% and maintained a compensation ratio under 40% of revenue, and that's well below our targeted 55% level. I believe that these results represent the beginning of the validation of our strategy, which diverges from that of some of our competitors.
Rodman remains very much a work in progress. We are a young but growing organization, and we are expanding a platform around higher margin businesses with relatively low fixed costs and expenses that vary highly with our revenue.
We have shunned a hunkered down approach, living on our cash until conditions improve, and have decided not to pay out-sized guarantees to retain or attract bankers in the hope that big upfront bets today may pay off if and when the market turns.
Instead, we have focused on executing our growth plan through acquisitions and new hires without guarantees, and at the same time working to move the firm to a culture and a payout approach that is performance-based and keeps the compensation going out in line with the cash coming in.
In addition, while results in the second quarter were driven significantly by our traditional core practices in healthcare and PIPEs, we are beginning to see the benefits of our more diversified product mix and deeper and broader sector coverage.
And I am pleased with the progress of our new energy group, our Miller Mathis subsidiary focusing on metals and mining, and our new global capital markets team.
Rodman now has offices in Houston and Calgary and proximity to both those in need of capital and those who provide that capital in energy, metals and natural resources.
We have deepened our ability to offer a broader range of capital market services, and we have begun to secure mandates for lead managed IPOs and secondary offerings.
In the quarter we also further strengthened our research capabilities by adding talented analysts in our new targeted verticals, which will enhance our ability to serve our corporate, institutional and now our high network clients.
Finally, during the quarter we continue to diversify our sources of revenue by announcing our first substantial merchant banking endeavor, the creation of the Aceras BioMedical joint venture. That venture joins Rodman's deep industry knowledge and financing capabilities with an established life science investment team with a proven and an enviable track record. Although we are still in the early days of this venture, I am confident in the deeply talented team with whom we have partnered.
These added capabilities and businesses and the solid folks we have brought on board should give us greater stability, greater breadth and greater reach, and should lead to enhanced revenue and profits particularly as the markets normalize.
That said, I believe we can run this business profitably even in these tougher times. Only the naive would say that the capital markets are healthy, but we, at Rodman, think we can say not only that we are well-positioned for the future, which I believe we are, but that we are performing profitably in the here and now.
Let me now take a moment to turn the call over to Dave Horin who will review our financial results in more detail.
Thank you, Michael. Before I begin to discuss our financial performance, I would like to note that the following financial discussion will be a comparison of the current quarter to the prior quarter. We believe that year-over-year comparisons are less meaningful. This is because we were not a public company four quarters ago.
We have, however, included the second quarter 2007 metrics in our earnings release, and we will discuss current quarter comparisons to the corresponding prior period in the ND&A section of our Form 10-Q, which we intend to file this week.
Investment banking revenue was $22.3 million for the second quarter of 2008, which includes $8 million in revenue related to the receipt of warrants as compensation for activities as underwriter or placement agent using the Black-Scholes Option Pricing Model. This compares to investment banking revenue for the first quarter of 2008 of $8.9 million, comprised of $7.4 million of cash fees and $1.5 million related to warrants received.
Breaking down the $22.3 million of investment banking revenue during the second quarter, private placement and underwriting revenue excluding the $8 million of revenue related to warrants received during the quarter was $14.3 million.
During the quarter, we completed 14 financing transactions with an average transaction size of $22.6 million, compared to 13 financing transactions with an average transaction size of $10.8 million in the prior quarter.
Strategic advisory fees for the second quarter were $1.5 million compared to $700,000 in the first quarter of 2008.
Returning to our warrant portfolio, we are mindful that this is our most significant area of volatility. Accordingly, in late June, we entered into a relationship with a third-party fund manager that specializes in publicly-traded microcap financial instruments, through which the fund manager, Delta, hedges the securities underlying our warrant portfolio. The fund manager has sole discretion over investment decisions related to our warrant portfolio.
As of June 30, 2008, the fund's net asset value was approximately $1.5 million, consisting primarily of financial instruments sold. We expect the percentage of warrants hedged to grow as the manager fully implements its hedging strategy.
Now let me return to our revenue breakdown. Sales and trading commissions for the quarter were $1.7 million compared to $1.6 million in the prior quarter. Principal transaction revenue was $4.4 million compared to $4.3 million for the prior quarter.
The majority of the principal transaction revenue during the current quarter was attributed to an unrealized gain in a single financial instrument, which was obtained through an investment banking transaction during the second quarter.
Turning to our conference fees. During the quarter we recorded $800,000 in conference fees associated with our Monaco Global Healthcare Conference held in May. As you will recall, we typically incur conference fees only in the second and fourth quarters.
Employee compensation and benefits expense for the quarter, including pre-offering stock compensation expense, was $12.5 million compared to $8.3 million in the prior quarter. Excluding pre-offering stock compensation expense of $1 million, employee compensation and benefits expense for the quarter was $11.5 million compared to $7.2 million in the prior quarter.
Employee compensation and benefits expense for the quarter excluding pre-offering stock-based compensation represented 38.9% of total revenue compared to 47.6% in the prior quarter. Our total compensation and benefits expense ratio was 42.3% compared to 54% in the prior quarter.
Compensation and benefits expense decreased due to a migration from a fixed compensation structure to a variable compensation structure during the second quarter. Specifically, we modified senior bankers' employment packages, such that these bankers will be subject to a draw rather than a fixed salary.
We limited guarantee compensation payment to producers, and we reduced the payout on non-cash revenue. This 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.
During the first quarter of 2008, we accrued interim compensation and benefits expense based on annual target compensation ratios. During the second quarter, both Michael and I performed the bottoms-up analysis and implementation of discretionary compensation, whereby we sat down with essentially all front-office employees of the firm and assessed their performance in light of their revenue contribution, the current economic environment, and prevailing labor markets. This approach helped us finalize our mid-year bonuses which were paid in late July, and rationalized our compensation and benefit estimate for the first half of 2008.
Non-compensation expense was $6.9 million for the quarter or 22.7% of total revenue, compared to $4.8 million or 32% of total revenue in the prior quarter. Non-compensation expenses include $2.3 million of expenses related to our Monaco Global Healthcare Conference. We continue to manage the cost structure of the firm very aggressively, and believe our cost control measures are starting to take effect.
Absent [ph] revenue and expenses associated with our Monaco Global Healthcare Conference, our non-compensation expense, the total revenue ratio for the quarter was only 16% and our operating margin was about 40%, well above our peers.
Income tax expense for the quarter was $4.2 million. During the quarter we commenced an evaluation of our past state and local tax practices. As a result of the state and local tax review, which we expect to complete during the current quarter, we have decreased our effective tax rate from 45% for the fourth quarter of 2007 to 41% for the second quarter of 2008.
Finally, cash and cash equivalents, including cash and cash equivalents segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations, were $30.3 million at June 30, 2008, as compared to $38.8 million at March 31, 2008.
The decline in cash and cash equivalents and segregated cash is primarily due to $6.1 million spent on the acquisition of COSCO Capital Management, $8.1 million related to the issuance of forgivable loans, and the purchase of a customer list, and $400,000 used in our stock buyback program, offset by $6 million of cash generated from operations.
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 his outlook for the remainder of the year.
Thank you, Dave. Before I turn to the current environment, let me make sure that everyone is aware that in addition to announcing our earnings for the second quarter this morning, we also announced that Rodman has decided to terminate its share repurchase program.
We have prudently used the capital, our capital to purchase approximately 530,000 shares, and at this point we believe that the better course is to keep our capital for other purposes and to permit insiders once again to buy our stock.
Turning to the markets overall, I think about all one wisely can say is that the markets remain challenging and difficult to predict. Going forward we will, therefore, continue to focus on our expenses and remain prudent with our capital, although we continue to be opportunistic about acquisitions of talent or franchises that will strengthen our business, and we continue to see a building pipeline. Meanwhile, we will focus on integrating the new businesses and people we have brought on board.
Overall, I am pleased with the progress we have made during the quarter and the first half of the year, and I believe that we are acceptably positioned for the remainder of 2008. We remain committed to our strategy, which I believe is beginning to produce benefits for us and for our shareholders. We will continue to build on our strong platform to ensure that we are poised for profitable performance both now and in the future.
And at this point, Dave and I are happy to take your questions. Operator?
(Operator instructions) And your first question comes from the line of Devin Ryan with Sandler O'Neill. Please proceed.
Devin Ryan – Sandler O'Neill
Hey, good morning, guys.
Devin Ryan – Sandler O'Neill
Congrats on the quarter. The second quarter look like your strongest second – or your second strongest investment banking quarter on record. Can you give any color on the deals that were executed? And we can track most of that, but what the contribution was from the newer groups within Rodman, if at all?
Let me answer at a higher level about what our practice is going to be. We do not break out by a separate group or by vertical, in essence, how the groups performed. Most of the revenue for the quarter was driven by the traditional healthcare team. And as you know, we acquired COSCO I think only on the 2nd of June, that transaction closed. So you only saw about 28 days of their performance in the quarter. What we do is track how they are performing, the new groups, as we ramp them up, and we expect to see significant contributions in the second half of the year from all of the new groups; both the capital markets team we brought in as well as both COSCO and the Miller Mathis teams. Dave, do you want to go into further detail?
Yes. And just real quick just for the quarter, healthcare accounted for about 72% of the total revenue; investment banking revenue for the current quarter, correct.
Devin Ryan – Sandler O'Neill
Okay, that's helpful. Also just life science stocks has it done extremely well since the beginning of July. I recognize that August can be a slow month, and then obviously we don't know about how tough the environment is. But are you seeing any change in the level of activity on maybe the client then or number of potential deals in the pipeline, just as a result of kind of the pop in a lot of these life science stocks?
Yes, for the pipeline we track that consistently. We track it actually weekly. And it looks like for the second half we do see – we do think we have a robust pipeline. That could change on a dime, obviously, as the market conditions do change. But we are very happy not only with our healthcare pipeline, but with our non-healthcare pipeline and our new acquisition pipeline as well.
We announced that small healthcare deal this morning. We are actually moderately optimistic about August this year. I think because of what's happened in the life sciences sector over the last few months, it appears to us that at least at the margins, both companies or investors are frankly starting to wake up a little bit. So we think although July and August are typically our slowest months, we are going to be profitable over that period. And then September is usually a very good month for finance, particularly in healthcare. We are, I would say, moderately to slightly more than moderately optimistic about the healthcare side, in particular.
Devin Ryan – Sandler O'Neill
Does the upcoming election put any pressure on the client side or kind of is that influencing the level of activity as well? Just maybe your comments on that.
I think it would only be anecdotal. It depends – some people think it depends on which of the two celebrities wins the election in the fall. But there are some people who believe that there is pressure for healthcare firms to finance ahead of the election, just because of the political uncertainty that comes with a new administration, whether it's Republican or Democrat. I think you could just as plausibly argue the other side of that trade. So we are not seeing significant politically-driven pressure in terms of timing, because, let's face it, it's really where the stocks are and where the investors are that drive this market and drive most markets.
Devin Ryan – Sandler O'Neill
Right. Just moving on here. Excluding the principal transaction gains, I'm coming up with a comp ratio of about 46%. I know that's not a perfect way to look at it, but you gave some detail here and I just want to make sure we are thinking about things the right way and moving forward. In a similar revenue environment, would sub 50% comp ratio seem reasonable or sustainable?
It really depends on the mix of business. For example, like I said in our speech, our payout is less on the warrants and on principal transactions. It's also going to be greater on a typical healthcare cycle. So we do target to a 0.55% rate. We may be above that; we may be below it. But it is something – one of the things I do want to point out, we did take this bottoms-up approach. Both Mike and I, we sat down with all the bankers during the quarter, and from this approach we became very comfortable with our comp rate. It's less of an estimate this quarter than it is in most quarters, because we actually paid out cash in July.
I think for purposes of your model, Devin, I don't want to say that we are going to be below 50% perpetually. I think Dave said it exactly right, 55% is our target. We are very comfortable where we came out, and that the key metric that we look at is, are we getting ahead of ourselves on a cash or on a revenue basis; and we won't. And then are we on a person by person producer by producer basis? Are we paying them the right amount to give them an incentive to produce and to reward them for production and performance and growth? And we are still of a sufficient size or sufficiently small size that we can actually go through that exercise with all of the key producing people in the firm, which I think injects a certain level of rigor and also gets people's expectations kind of right-sized for the environment and their own performance.
Devin Ryan – Sandler O'Neill
Okay. And also you mentioned new hires, and you've made a handful of hires in recent months. Can you give any color on the sectors or businesses that you are looking at, or kind of where the people in the pipeline potentially are coming from?
Sure. If you go back to the S1 we filed when we did the offering last October, we are still very much in line with that strategy, which is we are continuing to invest in healthcare and we have a number of ongoing conversations with healthcare bankers at all levels. And that is people who are expert in kind of our traditional practice, but also people who would help us expand either by product or by for the sub-sector within healthcare. And then we have active conversations or intentions to pursue folks in the new verticals we've targeted, so continuing in energy, continuing in mining, metals and natural resources, also in clean tech. And when you look increasingly at agriculture and food, we did a couple of deals – financings in the last quarter for Chinese-based food companies. And we look at that as very much a growth sector for us and very consistent with the kind of finance and the kind of investors that we talk to.
Devin Ryan – Sandler O'Neill
Okay. All right, thanks guys.
I should say, add, Devin, we are very opportunistic about it. People come to us a lot who would not be in our target sectors, and we look at whether they can be accretive to the platform and whether they are a good fit. And if they are, we are going to hire them.
Devin Ryan – Sandler O'Neill
Okay, thank you.
(Operator instructions) At this time, there are no additional questions in queue. I would now like to turn the call back over to Mr. Michael Lacovara for the final remarks.
Let me do what I do every quarter, which is to say we have no final remarks, operator. I just want to thank everybody for participating, and we will talk to you in roughly 90 days. And we are hopeful for a solid third quarter as well. Thanks, everyone.
Thank you for joining today's conference. That concludes the presentation. You may now disconnect, and have a wonderful day.
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