Bgc Group Inc

NASDAQ:BGC

Earnings Call Transcript 2018-Q3

[Operator]

Welcome to the BGC Partners Inc. Third Quarter 2018 Earnings Conference Call. My name is Nicole, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded.

I'd now like to turn the call over to Ujjal Basu Roy, Vice President of Investor Relations. You may begin.

[Ujjal Roy, executive]

Good morning. We issued BGC's third quarter 2018 financial results press release and the presentation summarizing these this morning. You can find these at ir.bgcpartners.com. BGC's results consolidate those of the company's publicly traded and majority-owned subsidiary Newmark Group, Inc. You can find details about Newmark Group Inc.'s separate conference call scheduled for today right after BGC's as well as Newmark's financial results press release and presentation at ir.ngkf.com. Both Newmark's and BGC's financial results have been recapped and include the results of Berkeley Point for all periods discussed in today's call because the transaction involved reorganization of entities under common control. Unless otherwise stated, the results provided on today's call compare only to the third quarter of 2018 with the year-earlier period. We will be referring to our results on this call only on an adjusted earnings basis unless otherwise stated.

We may also refer to adjusted EBITDA. You may refer to our liquidity, which we define as cash and cash equivalents plus marketable securities that have not been financed, reverse repurchase agreements, and securities owned, less securities loaned and repurchase agreements. We define total capital as redeemable partnership interest, total stockholder's equity and noncontrolling interest in subsidiaries. Please see today's press release for results in the Generally Accepted Accounting Principles, or GAAP. Please also see section in the back of today's press release for the complete definitions of any non-GAAP terms, reconciliation of these items to corresponding GAAP results and how, when and why management uses them.

All of the company's fully electronic businesses are referred to as Fenics. These offerings include the Financial Services segment, fully electronic brokerage products as well as the sale of market data, software solutions and post-trade services.

On today's call as well as in today's BGC's press release and investor presentation, we may refer to the financial results of postspin BGC. Postspin BGC represents the results of the company, excluding the results of Newmark Group and the NASDAQ earn-out or what BGC would look like had the spinoff of Newmark already occurred. Put another way, postspin BGC includes the results of BGC's Financial Services segment, excluding the NASDAQ payment for prior periods plus the appropriate pro-rata portion of corporate items. Please see the release and investor presentation for more information on postspin BGC.

I 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 1934 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 the most recent risk factors contained in subsequent Form 10-Q or Form 8-K filings.

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

[Howard W. Lutnick, executive]

Thank you, Ujjal. Good morning, everyone, and thank you for joining us for our third 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.

Newmark's revenues grew by more than 30%, while Financial Services top line was up by approximately 7%. BGC's consolidated revenues grew by 18% to a quarterly record of $977 million. Our results this quarter were impacted by a decline in NASDAQ's share price and our modestly higher annual tax rate as a result of our higher full year earnings. But for these factors, our adjusted earnings per share would have been approximately $0.03 higher.

Newmark today received on a stand-alone basis, a BBB- stable credit rating from Fitch and a BB+ stable rating from S&P. Newmark has a strong credit profile based on its earnings and adjusted EBITDA growth, it's net debt-to-adjusted-EBITDA ratio of 1x, the remaining $400 million of unencumbered available NASDAQ payments and the $405 million of MSR value carried on its balance sheet at amortized cost, which are worth an additional $40 million at fair value.

Newmark's credit metrics, together with its target net leverage ratio of 1.5x or less compares favorably to our full-service real estate peers. Although the spinoff is subject to certain conditions, we expect to announce the record date of distribution upon the successful completion of Newmark's debt offering, which was announced this morning. We expect to complete the spin-off in a reasonable time thereafter, but not later than the end of 2018.

I'm also pleased to announce that our Board of Directors declared an $0.18 dividend for the third quarter, which is consistent sequentially and year-on-year. At yesterday's closing stock price, this translates into a 7% annualized yield.

With that, I'll turn the call over to Shaun.

[Shaun Lynn, executive]

Thank you, Howard, and good morning, everyone. Our Financial Services business continued to gain market share in 2018 as we benefit from our investment in technology, improved front-office productivity and the successful integration of GFI, Sunrise and other recent acquisitions. Our year-on-year revenue growth was virtually entirely organic growth across all of our financial services asset classes. This was led by a 20% improvement in our energy and commodities business and an 8% growth in our foreign exchange business. Our quarterly revenues would have been at least $5 million higher but for the strengthening of the U.S. dollar.

Fenics businesses with notable performance during the quarter included rates, credit, equity and spot FX products. In addition, our FENICS U.S. Treasuries business has been growing rapidly, albeit from a small base, and we believe that FENICS UST is now the #3 central in the order book. Revenues from our high-margin data, software and post-trade business increased by 20% year-on-year. Overall Fenics revenues grew by almost 13% as we continue to invest in technology and to convert our voice/hybrid desks to more profitable fully electronic trading.

We expect to have $1.6 billion of voice/hybrid brokerage revenues to provide substantial opportunity for additional conversion into more profitable, fully electronic trading. Our overall revenues for Financial Services as a segment increased by 7% to $447 million for the quarter, while pretax adjusted earnings were up by 6% to $102 million. Our continued growth in profits was led by the 8% year-on-year increase in revenue per producer for the third quarter in 2018. Our Financial Services front-office productivity has improved year-on-year for 7 quarters in a row.

As we roll out new products and services across Fenics, and our brokers and salespeople increase their productivity, we expect to continue to have strong performance and organically increase our revenues, market share and profits.

With respect to our results for Real Estate Services, revenues for Newmark as a stand-alone company increased by 30% year-on-year in the quarter to $519 million or pretax adjusted earnings increased by 23% to $178 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 $977.3 million or 18.2%. Our revenues from the Americas grew by 23%. Revenues from Europe, Middle East and Africa were up by 10%, while Asia Pacific revenues increased by 12%.

With respect to expenses, compensation increased by 9.3%, which is primarily driven by higher revenues. Our compensation ratio improved by more than 425 basis points to 52.9%. BGC's consolidated noncompensation expenses increased by 28.4% to $249.4 million. Noncompensation expenses would have increased by approximately 18%, excluding the $21.1 million of Newmark pass-through expenses, which are reported as a gross of revenues and expenses in the ASC 606.

As a percentage of revenue, our noncompensation expenses were 25.5% versus 23.5% in the year ago period. Our noncompensation ratio would have stayed around the same level year-on-year but for the impact of ASC 606. Our overall expenses were $766.3 million compared to $667.2 million in the third quarter 2017.

As a result of the NASDAQ monetization transactions, our total equity increased by approximately $325 million, including the receipt of $206 million of cash and the value of the forwards. The transactions established downside redemption value with the NASDAQ shares for 2019 through 2022 earn-outs, while maintaining all the potential appreciation of both the applicable strike prices.

In addition to these monetized NASDAQ shares, Newmark expects to receive an additional approximately 5 million NASDAQ shares, which will be worth more than $400 million based on yesterday's closing price. The consolidated balance sheet does not yet reflect these shares because the payments are contingent upon NASDAQ generating at least $25 million in gross revenues annually. NASDAQ generated gross revenues of approximately $4 billion in 2017 and net revenues of $2.4 billion.

Moving on to our earnings. Our pretax earnings before noncontrolling interest in subsidiaries and taxes were up by 17.9% to $264 million. As a result of high consolidated earnings, we see non-GAAP tax rate for the full year 2018 is now expected to be between 12% and 12.4%. Therefore, BGC's quarterly effective tax rate under adjusted earnings is 12.7% for the third quarter 2018. For the full year 2017, our non-GAAP tax rate was 11%. BGC's posttax earnings were up by 9.4% to $205.8 million. Our posttax earnings per share were up by 2.4% to $0.42.

BGC's fully diluted weighted average share count was 487.6 million for both adjusted earnings and GAAP. Our share count increased year-on-year largely due to the sale of 19.4 million BGC Class A common shares from December 19, 2017, through March 6, 2018, for net proceeds of $270.9 million. $242 million of the gross proceeds were used to purchase 16.6 million newly exchange -- newly issued exchangeable limited partnership units of Newmark during the first quarter 2018, which Newmark used to repay $242 million of its long-term debt. This substantially improved the consolidated company's balance sheet. As of September 30, 2018, our spot fully diluted share count was 487.8 million.

With respect to the specifics of our balance sheet, as of quarter-end, our liquidity was $526.3 million. Notes payable under the borrowings were $1,323,000,000 compared to $1,650,500,000 at year-end 2017. Book value per common share was $3.11 as compared to $2.17. And total capital was $1,940,400,000 as compared to $1,186,200,000. The change in cash and cash equivalents since year-end 2017 was due in part the company using the proceeds received from the first quarter of 2018 share issuance and from the monetization of approximately 4 million NASDAQ shares as well as cash in hand to reduce debt by net total of approximately $227 million.

Restricted cash includes cash pledged by Newmark for the benefit of Fannie Mae. Subsequent to the end of the third quarter, Newmark voluntarily withdrew an elective excess of approximately $252 million of restricted cash from Fannie Mae.

Total capital increased largely due to the NASDAQ monetization, the positive effect of GAAP net income on retained earnings and the previously mentioned share issuance.

We believe that the combination of lower long-term debt, increased total equity and improving adjusted EBITDA will strengthen our balance sheet and improve our credit ratios, including debt to equity, interest coverage and debt-to-adjusted EBITDA. Our balance sheet metrics have improved for the consolidated company as well as for both postspin BGC and Newmark stand-alone.

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

[Howard W. Lutnick, executive]

Thank you, Steve. As we announced earlier today, Steve will be stepping down from his role as CFO effective December 15. I'm pleased to report that the Board of Directors has appointed Sean Windeatt as Interim CFO, while continuing in his position of COO. The Board of Directors has also appointed Sean Galvin to the newly created role of Chief Accounting Officer. In addition, Kalyan Popuri has recently joined the company as our Global Treasurer. I'd like to take this opportunity to thank Steve for his contributions during his tenure and wish him well for the future.

Turning to our consolidated outlook for the fourth quarter. We expect to generate revenues between $1,015,000,000 and $1,075,000,000, which is between 14% and 20% higher compared with $894.2 million in the fourth quarter of last year. We anticipate pretax adjusted earnings to be in the range of $205 million to $230 million, which is between 44% and 62% higher compared with $142.3 million in the prior year period. We anticipate our consolidated adjusted earnings tax rate to be in the range of 12% to 12.4% for the full year 2018. This compares to 11% for 2017. For the full year 2018, we expect postspin BGC revenues to increase by between 9.5% and 11.5% year-on-year and pretax adjusted earnings to grow between 29.5% and 33.5%. We expect to update our guidance towards the end of December.

Barry Gosin and I will be hosting Newmark's earnings call at 11:00 a.m. So please hold your Newmark-related questions until then.

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

[Operator]

[Operator Instructions] Our first question comes from the line of Richard Repetto from Sandler O'Neill.

[Richard Repetto, analyst]

First, congrats on the Fitch credit rating for Newmark. And then also the commencement, I guess, of the marketing of the debt. So I guess, my question, Howard, is do we expect other credit ratings and when would we expect them?

[Howard W. Lutnick, executive]

Sure. So Standard -- so Fitch was BBB- stable. S&P will also be publishing today and they are BB+ stable. And that's what we have so far.

[Richard Repetto, analyst]

Got it. Very helpful. Then a question on the other income with NASDAQ. I'm trying to see -- we expected somewhere around $85 million. And can you tell us how that is accounted for? And it was just well below what we thought it would be and the stock was down a bit, 6% in the quarter, but not dramatically.

[Howard W. Lutnick, executive]

I don't think there's anything -- it was -- right the end of the quarter, it was 80...

[Steve McMurray, executive]

$85.8.

[Howard W. Lutnick, executive]

$85.8, and we multiplied by 992,000 shares.

[Steve McMurray, executive]

Yes.

[Howard W. Lutnick, executive]

And there's other things that the company owns that are also mark-to-market that are included in that number as well.

[Richard Repetto, analyst]

I guess, that's the question then. Can you walk us through some of the other things that brought that other income down as much?

[Howard W. Lutnick, executive]

The company owns some shares and other -- own shares in public companies, which I don't want to discuss. And we mark them to market along the way. I wouldn't expect them to be material after the end of the year.

[Richard Repetto, analyst]

Got it. So the -- I guess, the NASDAQ itself, I don't know, was not -- I mean, it was what you expected. It wasn't dramatically off, I guess. That's the point.

[Howard W. Lutnick, executive]

Yes, we're simply saying if you just -- just the NASDAQ movement and -- just the NASDAQ movement from our guidance moment, which was in -- when we first guided on August 2, just NASDAQ and the fact that our tax rate was a little higher because we made more money, that -- those 2 things were approximately $0.03.

[Richard Repetto, analyst]

Got it. Okay. And then, I guess, my last one, Howard, would be on the guidance going forward. It appears October is pretty volatile. And it seemed at least in our view, your guidance might be a little bit conservative. Can you just talk a little bit about how you're coming up with the numbers and the outlook for 4Q?

[Sean Windeatt, executive]

Yes, I think, we -- as you know, we guide what we see. You're correct to say that October has been -- it has been a good start to October. And that's why we've guided within the range. We gave additional information for Q4. It's easy to back into BGC postspin because we upped our full year estimate from up to 7% to 10% to up to 9.5% to 11.5%. So that growth is reflected in our guidance.

[Howard W. Lutnick, executive]

So we're -- and that was Sean -- by the way, that was Sean Windeatt. But we always guide what we see. We like the world the way it is going now. It is volatile. It is more volume. Volatility has always been as a friend of BGC Financial services and this change that you've all felt over the last month, you're going to see positive impact across the company going forward. We're looking forward to the improvement of volatility and add that piece to our business.

[Operator]

Our next question comes from the line of Patrick O'Shaughnessy of Raymond James.

[Patrick O'Shaughnessy, analyst]

Starting with a question on the tax rate, I think you noted that it was a little bit higher due to stronger earnings and perhaps more earnings mix from Newmark. At this point, how should we be thinking about the tax rate for stand-alone BGC Partners in 2019?

[Howard W. Lutnick, executive]

I don't think we've put that out as of yet. I will take that under advisement. And if we can give you more guidance on it, we will do so.

[Patrick O'Shaughnessy, analyst]

Okay. Any thoughts on or updated thoughts on Brexit. It looks like the odds of a hard Brexit are probably increasing. Any expected impact on your business operations?

[Howard W. Lutnick, executive]

I don't know that I could credibly answer any better than you'd see with almost every company that has material business in the U.K. I think we have -- we think we have a plan in place, but I don't know that we know the outcome. So I think there are lots of people who've been on all sorts of different things with it. I just don't know the answer. So I think, we think we are adequately prepared. Shaun, do you want to add any?

[Shaun Lynn, executive]

Yes, Patrick, I think just taking one step further than what Howard said, I think we are adequately prepared for, hopefully, pretty much any outcome with regards to, be it hard Brexit or a negotiated exit. We have already invested heavily in Europe with regards to growth in Europe with lots of tranche has been one of the major centers. So we feel that we're positioned in a reasonable way going forward.

[Howard W. Lutnick, executive]

Yes, but I think the way -- the best way to say is a hard Brexit would absolutely be challenging for us and every company, and I don't think any company out there can credibly say they can understand how it will all work. The rules aren't written. It's just not possible. So all we can do is take a look at our business and try to plan as best we reasonably can for all variety of circumstances and hope that covers everything. But I don't think there's any company that can give you a more clear answer other than they know their business, they're studying their business and trying to manage for all different outcomes, reading the paper, listening to what politicians say. I, unfortunately, Patrick, can't give you any more insights than reading the newspaper and listening to the ground and trying to figure out what's best. But it will be a challenge, it could be pushed off. But the right answer is, I don't know.

[Patrick O'Shaughnessy, analyst]

Okay. Fair enough. Within Financial Services, we saw your headcount grow by, I think, 21 front-office personnel in the third quarter. Can you speak to the key drivers behind that headcount growth?

[Shaun Lynn, executive]

Obviously -- I mean, the headcount growth. Headcount growth -- day-to-day management of our business is to make sure that we're hiring the -- continue to hire the best talent across locations we have. We've seen some good growth in our Asia and European business, which has actually driven those hires for this particular quarter. But there's nothing special about this quarter in our hiring as opposed to any other quarter.

[Howard W. Lutnick, executive]

We continue to attract good staff this quarter, and as you've seen, our revenue has continued to increase.

[Patrick O'Shaughnessy, analyst]

Yes, I think it's just notable just from we've seen the relatively consistent decline in your front-office headcount ex any acquisitions. So does this imply that the fact that you're doing that hiring you're feeling probably better about the environment than you may have for most of the last several years?

[Shaun Lynn, executive]

No, we definitely feel confident. And we feel better about the environment. We're still converting more of that business to electronic. And it's always that balance, where we continue to hire great producers, convert the markets that we have to electronic and it's continuing that circle where you take more markets in electronic, you're giving them more tools to do their job, a better platform and that's attracting good stuff, and you continue to bring that into the platform. And therefore, more revenue produces while continuing to stay aggressive. You look at your staff and make sure that their performance is the best to their ability.

[Patrick O'Shaughnessy, analyst]

All right. Energy and commodities, I think, had a pretty good quarter, up sequentially over the second quarter when you look at some of the comps. The futures exchanges have energy volumes. Those are relatively soft in the third quarter. What were some of the key drivers of your outperformance?

[Shaun Lynn, executive]

We continue to invest in energy commodities. We've always been what we would consider a sub -- where we'd like to be subscale, but we've continued to invest. So it's not just the performing market, we need to continue to grow the business. And growth in each different product line. So -- and you see -- expect to see us do that going forward.

[Patrick O'Shaughnessy, analyst]

Great and then maybe last one from me. You spoke about your U.S. Treasuries operation within Fenics, and you now have phase #3, which, I think, implies bigger than the Tradeweb solution. Are there any other areas within Fenics that you would call out as being particular highlights right now?

[Sean Windeatt, executive]

Sure. The -- our foreign exchange platform is performing very well. Across a variety of transactions mid FX as well as our FX ECN. They're both performing well. And as you know, our credit businesses in Fenics have been continuing to grow. And Bill, anything you want to add?

[Shaun Lynn, executive]

No, actually -- there's many other products coming online, Patrick, as we continue to build at Fenics. We're using this platform that we have that we've built with U.S. Treasuries. The superfast product. And we continue to grow in that on that foundation as we bring other products to the marketplace.

[Patrick O'Shaughnessy, analyst]

Great. And actually, one more for me. Just kind of came to me. Within foreign exchange that you're speaking to, CME Group is definitely excited about the prospect of new, uncleared swap margin rules, moving more foreign exchange volumes on to exchange and in the futures contracts. Is that a shift that you would expect as well? And if so, is that a positive for you, is that a negative for you, is it a nonevent?

[Shaun Lynn, executive]

I think it is a positive. I think that clearly FX option is something that we've all been looking forward to potentially coming to the marketplace. And I think that is something that's going to be played out in the relative exchanges across the globe. We're excited about it. FX option is one of a -- a strong market, and you should expect to see us take full advantage of that.

[Operator]

[Operator Instructions] And we have no further questions at this time. I'd like to hand the call back over to Howard Lutnick, Chairman and CEO, for closing remarks.

[Howard W. Lutnick, executive]

Well, thank you very much everybody, and we look forward to updating you towards the end of the quarter and speak to you again next quarter. For those of you who are participating in the Newmark call, I look forward to speaking to you with Barry Gosin in about a half hour. Thanks, everybody. We'll speak to you then.

[Operator]

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