Bgc Group Inc

NASDAQ:BGC

Earnings Call Transcript 2018-Q1

[Operator]

Welcome to the BGC Partners, Inc. First Quarter 2018 Earnings Conference Call. My name is Candace, and I will be your operator for today's call.

[Operator Instructions] Please note that this conference is being recorded.

I would now like to turn the conference over to Ujjal Basu Roy. Mr. Roy, you may begin.

[Ujjal Basu Roy, executive]

Good morning. We issued BGC's first quarter 2018 financial results press release and the presentation summarizing these this morning. You can find these at ir.bgc.partners.com. You can also find details about Newmark Group Inc.'s separate conference call scheduled for today, right after BGC, as well as Newmark's financial press results -- press release -- Newmark's financial results, press release and presentation at ir.ngkf.com. Unless otherwise stated, the result provided on today's calls compare only the first quarter of 2018 with the year-earlier period. We will be referencing our consolidated results on this call only on adjusted-earnings basis unless otherwise stated. We may also refer to adjusted EBITDA.

Please see today's press release of full year financial results and for results under generally accepted accounting principles or GAAP. Please also see the section in the back of today's press release for the complete definition of any such non-GAAP terms, reconciliations of these items to the corresponding GAAP results and how, when and why management uses them.

For the purposes of today's call, all the company's fully electronic businesses are referred to as FENICS. These offerings include the Financial Services segment's fully electronic brokerage products as well as the offerings of market data, software solutions and post-trade services.

Also on today's call, Newmark is synonymous with our real estate services segment and specifically referred to as Newmark standalone, in which case it refers to the results of Newmark Group's Inc.

BGC's financial results have been recast to include the results of Berkeley Point for all periods discussed in today's call because these transactions involve the reorganization of entities under common control. As we had previously announced, beginning with this quarter, the consolidated [indiscernible] and we'll recognize the receipt of NASDAQ earn-out payments when earned in the third quarter of adjusted -- for adjusted earnings instead of prorating over the following 4 quarters and as consolidated results. This is consistent with Newmark's standalone methodology. BGC's consolidated results for adjusted earnings have been recast to incorporate this change in NASDAQ earn-out methodology from 2017 onwards. We would like to remind you that with respect to our plans for the proposed tax-free spin-off of Newmark, we cannot provide any assurance with that in if, when, how and whether the spin-off will take place.

I'll also remind you that the information regarding our business on today's call that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1974 as amended. Such statements involve risks and uncertainties. Except as required by law, BGC undertakes no obligation to update any forward-looking statements.

For a discussion of additional risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see BGC's Securities and Exchange Commission filings, including but not limited to the risk factors set forth in our most recent Form 10-K and any updates to such factors contained in the subsequent Form 10-Q or Form 10-K filings.

I am now happy to turn the call over to Howard Lutnick, Chairman and CEO of BGC Partners.

[Howard W. Lutnick, executive]

Thank you, Ujjal.

Good morning, and thank you for joining us for our first quarter 2018 conference call. With me today are BGC's President, Shaun Lynn; our Chief Operating Officer, Sean Windeatt; and Steve McMurray, our Chief Financial Officer.

Revenues from our Financial Services business were up by more than 17%. Newmark's revenues grew by more than 29%. BGC's consolidated revenues grew by 22% to a quarterly record of $957 million while post-tax earnings per share were up by 39% to $0.32. I'm also pleased to report that our board declared an $0.18 qualified dividend for the first quarter, which is consistent with our quarterly dividend last year.

At yesterday's closing stock price, this translates into a 5.4% annualized yield. The board expects to maintain its quarterly dividend for the remainder of the year.

And with that, I will now turn the call over to Shaun.

[Shaun Lynn, executive]

Thank you, Howard, and good morning, everyone. Our overall revenues at Financial Services increased by 17.1% to $516.6 million to the quarter. Brokerage revenues increased across all of our Financial Services asset classes, led by 18% growth from our Rates business, and 24% improvement in foreign exchange brokerage and a 13% growth from net energy and commodities business.

More than half of the 29% growth generated from expertise insurance and other asset classes was organic, and the remainder due to the acquisition of Besso, which closed at the end of February last year. Virtually, all of their growth generated by Financial Services was organic. We benefited from a combination of better macroeconomic conditions, increased volatility in certain asset classes and gains in market share across our businesses. Over the past few years, we have grown our Financial Services earnings despite a low volatility and low-interest rate environment. As market shows signs of improvement, we believe that we are in a strong position to increase average use and profits.

Our FENICS business also generated strong revenue growth as we continue to invest in technology and convert our voice and hybrid desks to more profitable, fully electronic trading. FENICS revenues from rates and credit improved by double-digit percentage year-on-year, while data, software and post-trade revenues were up by 15%. All else being equal, as FENICS revenues become a larger portion of our Financial Services results, we expect overall profitability to improve. While we analyze how to optimally configure our voice hybrid and fully electronic businesses, BGC will continue to provide total FENICS revenues. Over time, the company expects FENICS to achieve adjusted earnings margins of 50% before corporate items, and intends to provide more detailed information next year.

FENICS is not a separate company. It is not a segment, it is not even a separate broker-dealer. But all of this is [indiscernible]. We are being thoughtful in examining exactly how -- exactly this and how best to present our business, how best to internally structure and configure a high-margin FENICS business.

Moving on to segment profitability. Our overall Financial Services pretax earnings were up by 31% to $130 million. And margin expansion was due largely to the 19% year-on-year increase in revenue per producer for the first quarter of 2018 in Financial Services.

And finally [ph], our productivity has improved year-on-year for 5 quarters in a row. With respect to our results from real estate services, revenues for Newmark as a standalone company increased by 29% year-on-year in the quarter to $430 million, while pretax adjusted earnings increased by 83% to $64 million. Please see Newmark's press release from earlier today for more details.

With that, I'm now happy to turn the call over to Steve.

[Steve McMurray, executive]

Thank you, Shaun, and hello, everyone.

BGC generated consolidated quarterly revenues of $956.6 million, up 22.1%, while revenues from the Americas were up by 23.4%; revenues from Europe, Middle East and Africa were up by 32%; while Asia Pacific revenues increased by 13%.

With respect to expenses, compensation increased by 16.1%. Our compensation ratio improved by 290 basis points to 55.8% due to the mix of revenues by geography and products.

BGC's consolidated noncompensation expenses increased by 29.6% to $234.7 million, with more than 1/3 of the increase relates to transfer expenses from the implementation of ASC 606. As a percentage of our revenue, our noncompensation expenses were 24.5% versus 23.1% in the year-ago period.

Our overall expenses were $768.2 million compared to $640.6 million. Our pretax earnings before noncontrolling interest in subsidiaries and taxes grew by 54.8% to $184.7 million. Our tax rate adjusted earnings was 11.6%, which reflects our estimated full year 2018 rate. In the first quarter of last year, our non-GAAP tax rate is 13.8%. Our tax rate declined due to the recently enacted U.S. tax cut, although this is partially offset by higher pretax earnings and the geographical mix of our income. Until the proposed spin-off of Newmark, noncontrolling interest will reflect the allocation of income to Newmark's public shareholders and pro-rata ownership of certain shares and/or units of BGC and Newmark.

BGC's post-tax earnings grew by 49.7% to $154.3 million. Our post-tax earnings per share grew by 39.1% to $0.32. BGC's fully diluted weighted average share count was 478.9 million without adjusted earnings in GAAP.

As previously reported, in December 19, 2017, through March 6, 2018, BGC sold 19.4 million newly issued Class A common shares net proceeds of $270.9 million. $242 million of these gross proceeds were used to purchase 16.6 million newly issued exchangeable limited partnership units of Newmark during the first quarter of 2018. Our share count also increased year-on-year due to equity-based compensation, front-office hires and acquisitions.

As of March 31, 2018, our spot fully diluted share count was 482 million. With respect to the balance sheet, as of quarter-end, our liquidity, which we define as cash and cash equivalents plus multiple securities that have not been financed, reverse repurchase agreements and securities owned, less securities loaned and repurchase agreements, was $454.5 million. Long-term debt and characterized borrowings were $1,375,900,000 compared to $1,650,500,000 at year-end 2017. Book value per common share was $2.79 as compared to $2.17, and total capital, which we define as redeemable partnership interest, total stockholder's equity and noncontrolling interest in subsidiaries, was $1,486,700,000 as compared to $1,186,200,000.

Total capital increased and long-term debt decreased, primarily due to the net impact of the previously mentioned share issuance and the subsequent use of funds by Newmark to repay the remaining balance of the $575 million unsecured senior term loan in full.

The change in BGC's cash and liquidities since year-end 2017 was impacted by ordinary movements of working capital and cash paid with respect to investments, new hires and annual employee bonuses.

We believe that the combination of lower long-term debt, increased total equity and improving adjusted EBITDA will strengthen the consolidated company's balance sheet and improve BGC's credit ratios, including debt-to-equity, interest coverage and debt-to-adjusted EBITDA.

I'd like to take a moment to remind you of the key steps in Newmark funds to take to -- a tax-free spin-off with Newmark. First, Newmark intends to maintain its own credit rating; second, Newmark expects to repay or refinance its $812.5 million of long-term debt owed to or guaranteed by BGC. This is necessary for the spin-off to be tax-free. Newmark management is planning to begin the process of issuing its own credit rating after BGC's credit watch has been resolved. Please remember that our consolidated balance sheet does not reflect the expected receipt of more than $870 million of additional NASDAQ stock over the next 10 years, but these shares are contingent upon NASDAQ generating at least $25 million in gross revenues annually. If NASDAQ undergoes a change in control, we will get paid all at once. Let's look at $75 million contingency in context, NASDAQ generated gross revenues of approximately $4 billion in 2017.

With that, I am happy to turn the call back over to Howard.

[Howard W. Lutnick, executive]

Thank you, Steve. Our outlook for the second quarter of 2018 compared with the second quarter of last year is as follows: we expect to generate revenues of between $890 million and $940 million, which is up between 5% and 11% compared with $849 million; we anticipate pretax earnings to be in the range of $145 million to $165 million, up 7% to 22% as compared with $135 million last year; we anticipate our consolidated adjusted earnings tax rate to be in the range of approximately 11% to 12% for the second quarter and full year 2018; and Newmark's standalone tax rate is expected to be between 12% and 14%. Additionally, we expect to update our guidance by the end of the quarter.

Barry and I will be hosting Newmark's earnings call at 11:00 a.m., so please hold your detailed real estate services questions until then.

With that, operator, we would now like to open the call for questions.

[Operator]

[Operator Instructions] Our first question comes from Rich Repetto from Sandler O'Neill.

[Richard Repetto, analyst]

Howard, I guess the first question is on FENICS. I guess, putting out the margins as you have prior. And I guess, you said that you were evaluating how you want to present it, like, I'm trying to understand why the presentation from prior -- why wasn't that adequate to continue? Or are you investing more or trying to understand not having the expenses from FENICS?

[Howard W. Lutnick, executive]

Well, I think, Shaun is sort of trying to save best, which is FENICS is not a separate company. It's not a segment. It's not even a separate broker-dealer. But that's just the way it is now. So as we examine how best to present the business, right, we're going to consider how best until we structure it and configure it. And that might change things. So we'd rather be thoughtful and examine it. We're going to continue to put out the revenues. We've told you, we still expect the 50% margin before corporate items. And nothing other than that. I mean, this is just us being thoughtful to make sure we're maximizing the value of our high-margin business.

[Richard Repetto, analyst]

So it's fair to say that the level of investment hasn't accelerated or decelerated materially from last few quarters relative to the revenue side, so I guess?

[Howard W. Lutnick, executive]

That would be right. That is correct, with respect to the first quarter for sure.

[Richard Repetto, analyst]

Okay. And then, I think we've asked this and maybe we'll get more on the Analyst Day. But understanding whether there's a certain platform that have been performing better than others and the -- I think everybody as well as you look and seen what you've done with other platforms like eSpeed, et cetera, Trayport. Other -- when you say it is part of BGCP, are there specific platforms that are doing exceptionally well? I know you called out certain asset classes in FENICS.

[Shaun Lynn, executive]

Rich, it's Shaun. Yes, there are certain platforms within the group that has been exceptionally well this quarter, which as you say, which we highlighted in some areas. And platforms -- the actual platform across the board is doing well. We've had new functionality. And -- but I don't want to call that any certain specific area apart from the [ broad worry ] that we've actually represented in the remarks.

[Richard Repetto, analyst]

Okay. And I guess one other question. When a new share is issued by BGCP to -- for employees or for whatever reason now, they continue to get the same rights to Newmark shares. And I guess, like you said in the release, it would've been -- the conversion would be 0.4702 at the end of the quarter. But if a share was issued to an employer or a unit was issued to an employee, say today, he would still get that same ownership of Newmark?

[Howard W. Lutnick, executive]

No. So the way it works now is for a Financial Service employee, they participate in the business -- the portion of the business that is Financial Services and the Newmark employees participate in the financial outcomes of the business of Newmark. So they are literally the employees of both since the spin-off of Newmark are separated, vis-à-vis the employees. And then with respect to our share count, if you issued -- the math of one and the other, you put them together and it equals a share for the public. That's basically how it works. So that way, the Newmark employees are really receiving Newmark and the BGC Financial Service people are receiving Financial Services. But when you add them together, of course, it adds up to BGC and the public Newmark.

[Operator]

Patrick O'Shaughnessy from Raymond James has a question on line.

[Patrick O'Shaughnessy, analyst]

So first, the question on essential services business. Obviously, pretty strong results for you guys in the quarter, pretty strong results from the big banks reported sales and trading revenues. I think we have typical seasonality trends so far in April. But how sustainable -- do you feel like something has kind of structurally changed the entire volatility that this business is finally looking up on a sustainable basis?

[Shaun Lynn, executive]

Patrick, it's Shaun. We feel much happier there's a bounce and respect. We are -- and we've had a reasonable fourth quarter, good first quarter. And as we've said in the described remarks where we are currently, there is a better feeling in the marketplace. Volatility is better. There is much more activity. We are hopeful that this is going to be continuing through the year, of course, and going forward and then we turn the corner. And we -- that feels good and that is the case.

[Patrick O'Shaughnessy, analyst]

Great. And then you've guys touched on the credit watch that's on BGC Partners right now. And also there's one on the Cantor parent. Can you provide an update on where you think you stand in terms of resolving the credit watch at both levels?

[Howard W. Lutnick, executive]

We remain optimistic. As we discussed, the credit metrics for BGC have all improved. And we are optimistic that this will be resolved in a positive way within this quarter.

[Patrick O'Shaughnessy, analyst]

And you feel the same at the Cantor level as well?

[Howard W. Lutnick, executive]

We do.

[Patrick O'Shaughnessy, analyst]

Great. And then a question I -- it's been a few quarters since you kind of entered the insurance brokerage space. So what are your current thoughts on that landscape? And might there be more deals in the pipeline for you in that vertical?

[Shaun Lynn, executive]

Well, we've been, as it's been over a year now since we -- we've had some great organic growth. I think there's some good opportunities to hire a very good -- high-quality staff. But there are also acquisition opportunities, too, which we've been consistently looking at. So it's a good marketplace. So do I think it's better than last year. I think it is. I think our name is out there now. We're a very different offering, I think, compared to the traditional insurance landscape and a very good company, the way we look at things. As we've always said, we see it as pure brokerage. And we think we're very good at severing a brokerage company.

[Patrick O'Shaughnessy, analyst]

Okay. And then last one for me. Obviously, with the CME-NEX deal that was talked about during the quarter. I think maybe a couple of potential ramifications for you guys. So one is with Brokertec, certainly it's a dominant venue for [ honoring ] the U.S. Treasuries right now. Do you think that there could potentially be some disruption here that lets you guys get your foot back in the door on that front with the FENICS UST product. And then I guess the second part is, I think that deal also highlighted the value of Nexus post-trade processing abilities. And kind of where do you guys you think currently stand with post-trade reprocessing?

[Howard W. Lutnick, executive]

So I'll answer the first part and I'll have Shaun answer the second. The macroeconomic environment for us was the NEX deal going to CME definitely puts more focus on our business and the feeling of the big market participants and the big banks and how comfortable they are with having the monopolists in future own a -- such a huge position in cash. They may feel that they'd like some alternatives. And so I think that does put us in a better light and thus give us opportunity to grow going forward. So I like the model. I think it's a smart transaction for the CME. But I think it also improves the -- let's call it the base economic framework for us on which to operate. People are much more happy to see us, much more happy to talk to us. And I think the opportunity for us is better. And then, with respect to post-trade, I'll hand it over to Shaun.

[Shaun Lynn, executive]

So with regards to post-trade, yes, of course, it's a very, very exciting landscape. Basel III has helped us enormously in that respect. And with the constraints that are put on the major [indiscernible] record banks. They are looking for solutions that are going to help them with regards to their collateral. We have -- we are the new entrants on the landscape. We are growing our market share and coming out with new innovations all the time. And we're very excited and confident that we're going to build a new [indiscernible] business in that silo.

[Operator]

[Operator Instructions] I'm showing a follow-up from Richard Repetto.

[Richard Repetto, analyst]

Yes. Can you hear me?

[Operator]

Yes.

[Richard Repetto, analyst]

So Howard, a follow-up while I could. When -- with the trading of U.S. Treasuries on a platform, and I don't know how well -- or they're going to connect them to the treasury futures. But do you see this as any -- that part of it as any threat to the business? Or a trend where some of the spot products will trade along with the futures? Or is there anything in the past that would point you to that? That, that could be an effective way of sort of bringing together platforms or anything like that?

[Howard W. Lutnick, executive]

The CME has a tremendous market share in futures -- total market share in futures. And they can tie that and leverage that together. That is -- it is very strong competitor. So they have a very strong position and very strong competitor. So I think they will be able to do interesting things, front office, back office, connectivity, all sorts of very positive things to their marketplace. I think that will also open an area of concern for the banks who consider that and don't appreciate the level of advise they will have around themselves. Therefore, I think that will open up an opportunity for us and maybe have them listen more closely, pay closer attention to our offering, and hopefully, support our business, which is really about to launch in the coming months. So we really are -- that business is in the testing phase now broadly, and we hope in the coming months that we will go live and -- fully live. And we're excited about the opportunity that the CME and Brokertec together are an extraordinary competitor.

[Richard Repetto, analyst]

And I guess one last thing, the -- back to FENICS. As you invest there, can you talk about the areas of growth that -- where you're investing and what we could expect to see, how you're trying to grow FENICS to -- by funding certain areas, by putting more capital in certain areas?

[Shaun Lynn, executive]

Rich, we're investing across the board, from pre-trade, post-trade, market beta analytics, fully electronic, hybrid. We've continued to invest -- we've said consistently, we'd invest $150 million on average a year. So from that perspective, we're just continuing to invest.

[Operator]

I have a question from Michael Eisenberg with RPIA.

[Unknown Analyst]

Just circling back on the rating question that was asked earlier by Patrick. What gives you confidence that, that will be resolved this quarter? Obviously, it's an important statistic to have that IG rating for both Cantor and BGC, noting that the rating agencies are linking BGC to Cantor and the Cantor's rating. What gives you that confidence? Is it the equity raise that you've done? Is that enough? The rating agencies are pointing to specific targets in terms of equity to assets at Cantor as well as the cash flow leverage metrics at BGC. Can you give a little bit more specifics on that to give comfort?

[Howard W. Lutnick, executive]

Sure. So I said, we are optimistic. But I think we deserve to be investment-grade based on the existing standards that are out there. We know the standards of the rating agencies, and we have sought to meet them. I've seen our debt go down. I've seen all of our metrics go up across the board. So I think we have shown improved credit profile and improved credit metrics. And we are optimistic that those will resolve the credit watch positively for both BGC and Cantor.

[Unknown Analyst]

And you're in -- I mean, presumably, you're in dialogue with them. And the reason I ask is that there was a presumption that certain amount of capital will be raised around the IPO to delever and there was less capital raised as part of the IPO. They've then subsequently reiterated that they want more capital, whether it be through asset sales or equity being raised. Presumably, you're in contact with them to ensure that your confidence in your meeting the rating profile and the metrics are up to speed with what they would like. Is the rating agencies making fairly dogmatic and academic in how they look at things as opposed to commercial, which acknowledge what you're saying? I'm not diminishing what you're saying, vis-à-vis the improved capital and the way that you run your businesses in terms of conservative perspective. But the rating agencies, obviously can be quite academic and dogmatic in how they look at metrics. So I'm just -- that is why am asking.

[Howard W. Lutnick, executive]

So we are, of course, in dialogue with them. I would point out that Newmark did issue $16.6 million more units and did raise effectively the amount of money they had set out in their IPO. They just did it in a different fashion, which is BGC raised the money through its equity issuance and then that's -- it's owned -- 90% owned subsidiary and bought the shares. So the fact is from an overall perspective, from an overall credit perspective, Newmark was able to raise the capital and execute the plan just out there a couple of months later. But the same plan was executed. So I think -- we are in dialogue to them. And as I said, we deserve to be investment-grade based on the existing standards. We know those standards and we leave to S&P and Fitch their own determination, but I think we have done everything that we told them we would do and they expected us to do. And therefore, we are optimistic that this will be resolved in a positive way sometime this quarter.

[Operator]

We have no further questions at this time.

[Howard W. Lutnick, executive]

Well, thank you all for joining us today, and we look forward to updating you towards the end of the quarter and speaking to you again next quarter. Have an excellent day, everyone.

[Operator]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.