TMCnet News
RODMAN & RENSHAW CAPITAL GROUP, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes included elsewhere in this report. Overview We are a full-service investment bank dedicated to providing corporate finance, strategic advisory and related services to public and private companies across multiple sectors and regions. We also provide research and sales and trading services primarily to institutional investors. We are the leader in the PIPE (private investment in public equity) and RD (registered direct offering) transaction markets. We have been ranked the #1 Placement Agent by deal volume of PIPE and RD financing transactions completed every year since 2005. The sectors that we currently serve include life science/healthcare, industrials, airlines and technology. Our primary product and service offerings include financing transactions, including private placements and public offerings. We also provide research and sales and trading services to institutional investors. This year we introduced our DirectMarkets platform, the first-ever 24/7 automated electronic transaction platform to link issuers with investors for primary offerings of securities by existing publicly-traded companies. The DirectMarkets platform was developed by us over the past several years, building on the expertise that we have obtained in completing more than 580 financing transactions for public companies since 2002. During the last decade, capital-raising options and alternatives for public companies have evolved from traditional follow-on offerings to registered directs, at the market and confidentially marketed public offerings. Through this evolution, the issuer has gained more influence over the capital-raising process by acting on shorter notice and reducing its exposure to market volatility during the life of a deal. The DirectMarkets platform is the next and logical evolutionary step in empowering the issuer and bringing access to the capital markets directly into the C-Suite of public companies through an electronic interface linking public company issuers with investors. Business Segments We operate in three business segments, Capital Markets, DirectMarkets and Merchant Banking. The Capital Markets reportable segment includes our investment banking, sales and trading activities and research. The Capital Markets reportable segment is managed as a single operating segment that provides the following principal sources of revenue: • investment banking fees, which are derived from corporate finance activities and strategic advisory services; • realized and unrealized gains with respect to securities held for our own account; • commissions on sales and trading activities; • conference fees; and • other miscellaneous sources of revenues, such as interest. Although we have multiple sources of revenue derived within Capital Markets, most of its revenue is derived from (a) investment banking services and consists of private placement, underwriting and strategic advisory fees earned upon the successful completion of financing or other types of corporate transactions, such as mergers, acquisitions and dispositions and (b) sales and trading activities. The DirectMarkets segment is comprised of operating activities related to the DirectMarket platform. This year we introduced our DirectMarkets platform, the first-ever 24/7 automated electronic transaction platform to link issuers with investors for primary offerings of securities by existing publicly-traded companies. The DirectMarkets platform was developed by us over the past several years, building on the expertise that we have obtained in completing more than 580 financing transactions for public companies since 2002. During the last decade, capital-raising options and alternatives for public companies have evolved from traditional follow-on offerings to registered directs, at the market and confidentially marketed public offerings. Through this evolution, the issuer has gained more influence over the capital-raising process by acting on shorter notice and reducing its exposure to market volatility during the life of a deal. The DirectMarkets platform is the next and logical evolutionary step in empowering the issuer and bringing access to the capital markets directly into the C-Suite of public companies through an electronic interface linking public company issuers with investors. The Merchant Banking segment is primarily comprised of operating activities related to Aceras BioMedical. On May 12, 2008, we formed Aceras BioMedical, a joint venture through which we, in partnership with Aceras Partners, make principal investments in early-stage biotechnology and life sciences companies. In conjunction with the establishment of the joint venture, we formed a new wholly-owned subsidiary which holds a 50% stake in Aceras BioMedical and serves as the holding vehicle for all of our principal-related businesses. At March 31, 2012, our outstanding investment commitment to Aceras BioMedical to fund operations and the joint venture's principal investments in life science companies was $10.3 million. We receive 50% of Aceras BioMedical's economic interest in all investments made. 23 -------------------------------------------------------------------------------- Business Environment 2011 was a very difficult period in our industry and the trend has continued to date. With the many geopolitical and economic uncertainties, it is difficult to time a market recovery or predict its sustainability. Market conditions and valuations for companies in the sectors in which we are active, as well as general market conditions, can materially affect our financial performance. Declining valuations in various sectors in which we are active, unprecedented volatility and lack of liquidity in certain sectors of the capital markets, as well as a slowing of economic growth generally has led to declines in financing activity, smaller financing transactions, and declining trading activity and a resulting decline in revenue from prior periods. It is not possible to predict whether, and to what degree, these conditions will continue, abate, or reverse, and the level of capital markets and trading activity is expected to remain uncertain for the foreseeable future. In addition, the nature of our revenue generation, including the size of transactions, the timing of transaction closings and the sectors in which those transactions occur, make future performance difficult to predict and potentially highly variable. Revenues for many of the services we provide are earned only upon the successful completion of a transaction. Accordingly, revenues and net income in any period may not be indicative of full-year results or the results of any other period and may vary significantly from period to period. Critical Accounting Policies Our Consolidated Financial Statements are prepared in conformity with GAAP, which require management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and related notes. Actual results can and will differ from estimates. These differences could be material to the financial statements. We believe our application of accounting policies and the estimates required therein are reasonable. These accounting policies and estimates are constantly re-evaluated, and adjustments are made when facts and circumstances dictate a change. Historically, actual results have not differed materially from those determined using necessary estimates. Our management believes that our critical accounting policies (policies that are both material to the financial condition and results of operations and require management's most difficult subjective or complex judgments) are our valuation of financial instruments, valuation of goodwill and other intangible assets, income taxes and our use of estimates related to compensation and benefits during the year. Valuation of Financial Instruments As defined in ASC Topic 820, fair value generally is based on quoted market prices. If quoted market prices are not available, fair value is determined based on other relevant factors, including dealer price quotations, price activity for equivalent instruments and valuation pricing models. Among the factors considered in determining the fair value of financial instruments are discount margins, weighted average spreads, discounted anticipated cash flows, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, as well as other measurements. Certain financial instruments have bid and ask prices that can be observed in the marketplace. For financial instruments whose inputs are based on bid-ask prices, such financial instruments are adjusted to the point within the bid-ask range that meets the Company's best estimate of fair value. For offsetting positions in the same financial instrument, the same price within the bid-ask spread is used to measure both the long and short positions. The valuation process for financial instruments may include the use of valuation models and other techniques. Adjustments to valuations derived from valuation models may be made when, in management's judgment, either features of the financial instrument such as its complexity, or the market in which the financial instrument is traded require that an adjustment be made to the value derived from the models. An adjustment may be made if a financial instrument is subject to sales restrictions that would result in a price less than the quoted market price. Adjustments from the price derived from a valuation model reflect management's judgment that other participants in the market for the financial instrument being measured at fair value would also consider in valuing that same financial instrument and are adjusted for assumptions about risk uncertainties and market conditions. Results from valuation models and valuation techniques in one period may not be indicative of future period fair value measurements. 24 -------------------------------------------------------------------------------- Financial instruments owned and financial instruments sold, not yet purchased are stated at fair value, with related changes in unrealized appreciation or depreciation reflected in principal transactions, net in the accompanying Consolidated Statements of Operations. Equity interests in certain private equity securities and limited partnership interests are reflected in the Consolidated Financial Statements at fair value, which is often represented at initial cost until significant transactions or developments indicate that a change in the carrying value of the securities is appropriate. This represents the Company's best estimate of exit price. Generally, the carrying values of these securities will be increased or decreased based on company performance in those instances where market values are readily ascertainable by reference to substantial transactions occurring in the marketplace or quoted market prices. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company utilizes assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable firm inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial instrument assets and liabilities carried at fair value have been classified and disclosed in one of the following three categories: Level 1 includes those financial instruments whose valuations are based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment. Level 2 includes those financial instruments that are valued using models or other valuation methodologies calibrated to observable market inputs. These models are primarily industry-standard models that consider various assumptions, including discount margins, credit spreads, discounted anticipated cash flows, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, default rates, as well as other measurements. In order to be classified as Level 2, substantially all of these assumptions would need to be observable in the marketplace or able to be derived from observable data or supported by observable levels at which transactions are executed in the marketplace. Level 3 is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are unobservable from objective sources. Included in this category are warrants, private securities, restricted securities and limited partnership interests. Compensation and Benefits The use of estimates is important in determining compensation and benefits expenses for interim and year end periods. A substantial portion of our compensation and benefits represents discretionary bonuses. In addition to the level of net revenues and pre-tax income, our overall compensation expense in any given year is influenced by prevailing labor markets, revenue mix and our use of equity-based compensation programs. We believe the most appropriate way to allocate estimated annual discretionary bonuses among interim periods is in proportion to net revenues and pre-tax income earned or reasonably expected. Consequently, we generally accrue interim compensation and benefits based on annual targeted compensation amounts and interim revenues received. Goodwill At least annually, and more frequently if warranted, we assess whether goodwill has been impaired by comparing the estimated fair value of each reporting unit with its carrying value. The fair value of reporting units are based on valuations techniques that we believe market participants would use, although the valuation process requires significant judgment and often involves the use of significant estimates and assumptions. The estimates and assumptions used in determining fair value could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. Adverse market or economic events could result in impairment charges in future periods. (Refer to Note 5, Goodwill and Other Intangible Assets, in our Consolidated Financial Statements for further detail on our assessment of goodwill.) 25 -------------------------------------------------------------------------------- Income Taxes Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Management on an ongoing basis, at least quarterly, evaluates our tax positions and ascertains whether those tax positions that may be uncertain require de-recognition or re-measurement. We do not believe that there are any material uncertain tax position requiring de-recognition or measurement. First quarter of 2012 compared to first quarter of 2011 Results of Operations The following table sets forth our results of operations for the three months ended March 31, 2012 and 2011 (in thousands of dollars): --------------------- --------------------- March 31, 2012 March 31, 2011 --------------------- --------------------- % of Net % of Net Revenue Revenue -------- -------- Revenues: Investment banking $ 23,476 27,471 Merchant banking (5,037 ) 566 Brokerage 6,510 1,162 Conference fees - 446 Principal transactions 204 (2,315 ) Interest and other income 291 15 - ------ - ------ Total revenues 25,444 27,345 - ------ - ------ Operating expenses: Compensation and benefits 13,882 54.6 % 17,863 65.3 % Conference expense - 0.0 % 2,907 10.6 % Professional and consulting 2,688 10.6 % 1,574 5.8 % Occupancy and equipment rentals 823 3.2 % 773 2.8 % Advertising and marketing 187 0.7 % 307 1.1 % Communication and market research 1,883 7.4 % 914 3.3 % Execution and clearing 1,010 4.0 % 78 0.3 % Depreciation and amortization 403 1.6 % 397 1.5 % Business development 1,006 4.0 % 1,299 4.8 % Interest expense 114 0.4 % 205 0.7 % Bad debt expense - 0.0 % 37 0.1 % Hudson acquisition related expense - 0.0 % 418 1.5 % Other 1,470 5.8 % 862 3.2 % - ------ - ------ Total operating expenses 23,466 92.2 % 27,634 101.1 % - ------ - ------ Income (loss) before income taxes 1,978 7.8 % (289 ) -1.1 % Income tax expense (benefit) - (103 ) - ------ - ------ Net income (loss) $ 1,978 (186 ) - ------ - ------ 26 -------------------------------------------------------------------------------- Our operating income for the three months ended March 31, 2012 and 2011 included the following non-cash expenses (in thousands of dollars): Three Months Ended ----------------------------------- March 31, 2012 March 31, 2011 ---------------- --------------- Stock-based compensation $ 601 851 Amortization of forgivable loans 117 546 Depreciation and amortization 403 397 ---- ----------- ---- ---------- Total $ 1,121 1,794 ---- ----------- ---- ---------- Revenues Merchant Banking Segment Merchant banking revenue consists of gains and losses on investments by our Aceras BioMedical joint venture and other principal investments activity. During the three months ended March 31, 2012, BioMarin Pharmaceutical Inc. ("BioMarin"), the purchaser of Huxley Pharmaceuticals from Aceras ("Huxley"), recorded an impairment charge of $6.7 million related to certain assets acquired. These assets were IPR&D assets associated with U.S. marketing rights of a product candidate for the treatment of Lambert-Eaton Myasthenic Syndrome that is in Phase 3 clinical trials in the U.S. BioMarin had previously disclosed that it was exploring strategic options for this product candidate in the U.S., including potential out licensing arrangements. In March 2012, BioMarin disclosed that it had determined to suspend these initiatives. Based on this triggering event and lower than expected reported European sales revenue, we revised the carrying value of the contingent payments related to the sale of Huxley and recognized a non-cash charge of $5.0 million in merchant banking revenues for the three months ended March 31, 2012. The value of Aceras BioMedical's assets as of March 31, 2012 and December 31, 2011 was determined based on an independent valuation performed by a third party valuation firm, which took into consideration, where applicable, cash received, cost of the investment, market participant inputs, estimated cash flows based on entity specific criteria, purchase multiples paid in other comparable third-party transactions, market conditions, liquidity, operating results and other qualitative and quantitative factors. The values at which our investments are carried on our books are adjusted to estimated fair value at the end of each quarter taking into account, factors including, general economic and stock market conditions. DirectMarkets Segment Total revenue for the three months ended March 31, 2012 was $0.3 million, which came from non-investment banking advisory fees related to the Investment Relations Group assets recently acquired. Capital Market Segment Within our Capital Markets segment we derive revenues from two primary sources - investment banking and sales and trading. Total revenue for the three months ended March 31, 2012 was $30.2 million, representing an increase of 13% from $26.8 million in the comparable period of 2011. The increase was primarily due to a $5.3 million increase in brokerage revenues related to the Hudson Holding Corporation ("Hudson") business acquired in the second quarter of 2011. Investment Banking Revenue Our investment banking revenue is derived from private placement and underwriting activities and strategic advisory services. The following table sets forth our revenue from our investment banking activities for the three months ended March 31, 2012 and 2011 (in thousands of dollars): Three Months Ended ---------------------------------- March 31, 2012 March 31, 2011 ---------------- --------------- Revenue: Private placement and underwriting $ 15,731 25,678 Strategic advisory 7,745 1,793 --- ------------ -- ------------ Total investment banking revenue $ 23,476 27,471 --- ------------ -- ------------ 27 -------------------------------------------------------------------------------- Investment banking revenue was $23.5 million for the three months ended March 31, 2012, which included $1.0 million related to warrants received as compensation for activities as underwriter or placement agent valued using Black-Scholes, as compared to revenue of $27.5 million, which included $4.3 million related to warrants received as compensation for activities as underwriter or placement agent valued using Black-Scholes, in the comparable period of 2011: • Private placement and underwriting revenue for the quarter was $15.7 million, including $1.0 million of fair value related to warrants received, compared to $25.7 million, including $4.3 million of fair value related to warrants received, in the comparable period of 2011. • Strategic advisory fees for the three months ended March 31, 2012 were $7.7 million, compared to $1.8 million for the comparable period of 2011. The increase in investment banking revenue was due in part to one significant advisory fee of $7.2 million (part of a total $11.7 million investment banking fee from ZaZa Energy LLC). • During the first quarter of 2012, we earned approximately $16.8 million in metals & mining and oil and gas transactions. We no longer focus on the metals & mining and oil and gas sectors and the employees who focused on these sectors are no longer employed with us. Sales and Trading Brokerage revenue was $6.5 million, net of $0.5 million of soft dollar expense for the three months ended March 31, 2012, compared with $1.2 million for the three months ended March 31, 2011. The increase in brokerage revenues was primarily due to the Hudson business acquired in the second quarter of 2011. Principal Transactions Principal transactions revenue was $0.2 million for the three months ended March 31, 2012, compared with a $2.3 million loss for the three months ended March 31, 2011. The increase in principal transactions is related to the increase in certain biotechnology warrants, partially offset by a loss in our Class B warrants issued in connection with our convertible debt. The following discussion combines Capital Markets, DirectMarkets and Merchant Banking expenses. Expenses Compensation Employee compensation and benefits expense for the first quarter of 2012 was $13.9 million, compared to $17.9 million for the first quarter of 2011. Employee compensation and benefits expense for the three months ended March 31, 2012, excluding the $0.2 million principal transactions gain from revenue, represented 55% of transaction related revenue (revenue excluding principal transactions), compared to 60% in the comparable 2011 period. We target a compensation ratio of 55% to 60% of transaction related revenue on an annualized basis. Non-Compensation Expenses Non-compensation expense was $9.6 million for the three months ended March 31, 2012, comparable to the $9.8 million for the same prior year period. The slight decrease from the prior year's quarter in non-compensation expense was substantially due to: • Additional fixed and variable expenses related to the acquisition of Hudson, including, a $1.0 million increase in communication and market research and a $0.9 million increase in execution and clearing; • An increase in professional and consulting fees of $1.1 million primarily related to certain regulatory inquiries and the expansion of DirectMarkets. As compared to prior periods, during the three-months ended March 31, 2012, we experienced an increase in the scope and amount of information requested by FINRA related to various aspects of our broker-dealer business; offset by, • A decrease of $2.9 million related to the discontinuation of the China conference in 2011. Income Taxes Due to the uncertainty in the current operating environment and the resulting impact on the realizability of our deferred tax assets we continue to record a full valuation allowance on such assets at March 31, 2012. 28 -------------------------------------------------------------------------------- Liquidity and Capital Resources We have historically satisfied our capital and liquidity requirements through cash generated internally from operations; however, on October 31, 2011 we raised $6.65 million of 10% Convertible Secured Debentures due 2013 with a net settlement feature, and warrants in a private placement financing. At December 31, 2011, we had liquid assets, consisting of unrestricted cash, restricted cash, "Level 1" assets less "Level 1" liabilities, "Level 2" assets (consisting of municipal securities) less "Level 2" liabilities (also consisting of municipal securities), net current receivables, and due to / due from clearing brokers of $15.5 million. As of March 31, 2012, we had liquid assets of $19.9 million. The increase in liquid assets primarily relates to an $11.7 million investment banking fee from ZaZa Energy LLC, partially offset by year-end bonus and severance payments of approximately $5.2 million paid during the first quarter of 2012 and treasury stock purchases of $0.5 million. The following table sets forth the calculation of liquid assets (non-GAAP) as of March 31, 2012 and December 31, 2011 (in millions of dollars): March 31, 2012 December 31, 2011 ---------------- ------------------- Total cash and cash equivalents 8.3 7.4 Financial instruments owned, at fair value (Level 1 and Level 2) 8.0 6.1 Private placement and other fees receivable 3.1 1.8 Receivable from brokers, dealers & clearing agencies 3.4 1.8 Financial instruments sold, not yet purchased, at fair value (Level 1) (2.9 ) (1.6 ) --- ------------ ---- -------------- Liquid Assets (non-GAAP) 19.9 15.5 --- ------------ ---- -------------- The timing of bonus and retention compensation payments to our employees may significantly affect our cash position and liquidity from period-to-period. While our employees are generally paid salaries and draws on a semi-monthly basis during the year, bonus payments, which make up a significant portion of total compensation, are generally paid semi-annually or annually. As a registered securities broker-dealer, we are subject to the net capital requirements of the uniform net capital requirement set forth in Rule 15c3-1 promulgated by the SEC pursuant to the Exchange Act. SEC regulations also provide that equity capital may not be withdrawn or cash dividends paid if certain minimum net capital requirements are not met. At March 31, 2012, we had excess net capital of $8.0 million. Regulatory net capital requirements may change based on investment and underwriting activities. Because of the nature of settlement transactions in our investment banking and brokerage business, we regularly monitor our liquidity position, including our cash and net capital positions. In light of the uncertainty with respect to the timing of a market recovery and its potential impact on the timing of our receipt of anticipated funds from operating activities, we regularly explore capital raising alternatives. Cash Flows Unrestricted cash and cash equivalents were $6.5 million at March 31, 2012, an increase of $0.7 million from $5.8 million at December 31, 2011. Operating activities provided $2.2 million of cash and cash equivalents during the three months ended March 31, 2012. The primary components of cash used for the three months ended March 31, 2012 were: (a) $0.5 million in treasury stock purchases and (b) $0.3 million in capitalization of software development costs and $0.1 in property, equipment and leasehold purchases. |