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BGC Partners (NASDAQ:BGCP)

Q4 2008 Earnings Call

February 27, 2009, 08:30 am ET

Executives

Howard Lutnick - Chairman & Chief Executive Officer

Shaun Lynn - President

Bob West - Chief Financial Officer

Jason McGruder - Investor Relations

Analysts

Rich Repetto - Sandler O’Neill

Rob Rutschow - Deutsche Bank

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2008 BGC Partners Inc. Earnings Conference Call. My name is Josh and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answering session towards the end of this conference. (Operator Instructions) I would now like to turn the presentation over to our host for today’s call, Head of Investor Relations, Jason McGruder. You may proceed, sir.

Jason McGruder

Good morning. Before we begin, I want to make sure that you know that our fourth-quarter full year 2008 financial results press release was issued last night. It can be found at either the News Center or Investor Relations section of our website at www.BGCPartners.com. We also have a PowerPoint summarizing results in the Investor Relations section. I also refer you to the section of our press release titled ‘Discussion of Forward-Looking Statements’ contained in our financial results press release.

I remind you that the information released on this call contains forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities and Exchange Act of 1934 as amended.

Such forward-looking statements include statements about the outlook and prospects for BGC Partners and for its industry, as well as statements about our future financial and operating performance.

Such statements are based upon current expectations that involve risks and uncertainties. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied, because of the number of risks and uncertainties that include, but are not limited to the risks and uncertainties identified in the earnings release and BGC Partner’s filings with the U.S. Securities and Exchange Commission.

We believe that all forward-looking statements are based upon reasonable assumptions when made. However, we caution that it’s impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes and that accordingly you should not place undue reliance on these statements.

Forward-looking statements speak only of the date when made and we undertake no obligation to update these statements in light of subsequent events or developments. Please refer to the complete disclaimer with respect to our forward-looking statements set forth in yesterday’s earnings release and the risk factors set forth in our public filings, which we incorporate by reference.

I’d now like to turn the call over to our host Howard Lutnick, Chairman and CEO of BGC Partners Inc.

Howard Lutnick

Good morning and thank you for joining us today on our fourth-quarter 2008 conference call. With me today is Shaun Lynn, our President and Bob West, our Chief Financial Officer. Our pre-tax distributable earnings increased by 46% to $11.3 million or $0.06 per fully diluted share, while our post-tax distributable earnings increased to $8 million or $0.04 per fully diluted share compared with $1 million in the fourth quarter of last year.

As Bob will discuss in more detail, our equity-based compensation was $15 million less than what was reflected in our previous accounts. This lowered our pre-tax distributable earnings for the quarter. We believe that paying relatively more cash to employees and relatively less equity had the same effect as repurchasing $15 million worth of stock, but in a more tax efficient fashion.

We have declared a dividend equal to our post-tax distributable earnings of $0.04 per share for the fourth quarter, which is payable on March 20, to shareholders of record as of March 6. Revenues in October were up 18% year-over-year to $118 million driven by strong growth in credit and other assets. November revenues were down approximately 10% to $89 million as we had expected and December revenues were up approximately 9% to $81 million. Overall, our fourth-quarter revenues were up 5.5% compared to last year.

In January 2009, revenues were down 9% to approximately $100 million compared to January of last year 2008. Our monthly revenues for January 2007, through January 2009 can be found in the appendix of the fourth-quarter 2008 earnings presentation on our Investor Relations website as Jason so eloquently described.

I’d now like to turn the call over to Shaun Lynn.

Shaun Lynn

Thanks Howard and good morning, everybody. There has been a lot written lately about the current state of the OTC market, inter-dealer brokers in particular and the relationship of OTC revenues of central accounts party clearing. I thought it would be useful to comment from our perspective, as I mentioned on our last call BGC strongly favors open non-exclusionary central clearing and we already broke a number of OTC and exchanges product in this manner.

Our businesses thrived along with a dramatic growth in the percentage of our brokerage revenues coming from centrally cleared products. On our GAAP income statement, we break out our brokerage revenues into commissions and principal transactions.

Commission revenues involve name give up transactions that are bilaterally cleared by our clients. Principal transactions are primarily those in which our counterparty is the central clearing organization. Principal transactions accounted for 31% of BGC’s brokerage revenue in the fourth quarter of 2008 compared to less than 10% in the fourth quarter of 2007.

This has been drive both by increased central clearing in OTC markets like interest rate swaps as well as by strong growth in the broking of the listed products such as [inaudible]. Even in parts of the OTC markets where central clearing has not yet begun, we have had a strong performance.

For example, our quarterly credit revenues were up 31% compared to last year and were also up by double-digits in January of 2009. This growth has two drivers. First, as many of you know, BGC has always been a leading cash bond broker and we have built our credit derivatives business on top of that solid foundation.

Our growth in credits has been driven primarily by the trading of credit default swaps along with their underlying cash bond positions as opposed to stand-alone CBS trades. Therefore, BGC has benefited as bond investors increasingly seek credit protection in the current economic downturn.

Second, our scaling technology has allowed us to leverage our platform and to achieve solid growth in both hybrid and fully electronic credit broking. In the fourth quarter, we continued to see strong year-over-year increases in revenues from fully electronic credit default swap trading using BGC Trader.

We have proven that in these turbulent markets, we can continue to grow fully electronic trading of new products, which includes credit default swaps and foreign exchange options. Our significant increase in revenues from the fully electronic trading of new products was offset by lower volumes and revenues related to fully electronic U.S. treasury trading.

Overall, BGC’s revenues related to fully electronic trading was 7% of total company revenues for distributable earnings as compared to 8.2% last year. This comparison includes absorption by other clients of the businesses of Bear Stearns and Lehman Brothers, which had been large, fixed-fee, treasury customers. Because of our customers’ ongoing adoption of our technology, such as the continuing rollout of BGC Trader in Asia and the U.S, we expect that our fully electronic revenues from new products will continue to grow in 2009.

We are also just beginning to see volumes grow in U.S. treasuries on the back of increased treasury issuance and additional trading firms entering the marketplace. We continue to hire new brokers, which will add to both our revenue and profitability. As of December 31, 2008, BGC had 1,289 voice and hybrid brokers compared to 1,262 at the end of September and 1,188 as of the year-end 2007. With that, I would like to now turn the call over to Bob.

Bob West

Thank you, Shaun, and good morning. For the fourth quarter of 2008, BGC Partners generated revenues for distributable earnings of $287.6 million, up 5.5% compared to $272.7 million in the fourth quarter of 2007. Our brokerage revenues were up 7.7% to $259.8 million in the fourth quarter of 2008 versus $241.3 million recorded in the prior-year period.

In the fourth quarter of 2008, credit revenues increased by 31% to $83.3 million while other asset classes increased by 14% to $29.2 million, both compared to the prior-year period. The increase in other asset classes was driven mainly by strong organic growth in equity-related products and the acquisition of our energy broker, Radix.

Foreign exchange revenues decreased, by 10% to $30.9 million. Although, we generated a strong increase in revenues, from the fully electronic trading of foreign exchange options. Lower short-term interest rates and steepening yield curves benefited BGC’s voice and hybrid rates business where revenues increased by 8% year-over-year in the fourth quarter.

However, overall quarterly rates revenues decreased year-over-year by 1% to $116.4 million due to an industry-wide decline in U.S. treasury volumes. In the fourth quarter of 2008, rates represented 40.5% of total revenues for distributable earnings, credit 29%, foreign exchange 10.7%, and other asset classes 10.2%. Moving on to expenses compensation and employee benefits represented 63% of the Company’s revenues in the fourth quarter of 2008 on a distributable earnings basis compared with 58% in the year earlier period.

As Howard mentioned, our fourth quarter 2008 compensation expenses were approximately $15 million higher than the Company had estimated. This was due to the issuance of approximately $15 million less in equity-based compensation than had been reflected in our previous accounts. In our view, this lower equity issuance had the same effect as repurchasing $15 million in stock, but in a more tax efficient manner.

Our compensation ratio was 58.6% for the full-year 2008, which is within our expected 55% to 60% range. We view the fourth-quarter compensation adjustment as an unusual event and expect our compensation expenses will continue to remain below 60% for the first quarter of 2009 and for the foreseeable future.

We have focused on controlling our non-compensation expenses, which were $94.5 million or 32.9% of revenues on a distributable earnings basis, an improvement of over six percentage points compared to $106.9 million or 39.2% of revenues in the fourth quarter of 2007.

We anticipate our quarterly non-compensation expenses remaining at or below these levels in 2009. Our pre-tax distributable earnings were up 46% to $11.3 million or $0.06 per fully diluted share, compared to $7.8 million or $0.04 per fully diluted share in the fourth quarter of 2007.

Post-tax distributable earnings increased to $8 million or $0.04 per fully diluted share in the fourth quarter of 2008 versus $1 million or a penny per fully diluted share in the fourth quarter of 2007.

Our effective tax rate for distributable earnings was 22.1% in the fourth quarter of 2008. We expect our effective tax rate for distributable earnings to be approximately 27% for 2009 and thereafter. Our fully diluted weighted average share count was 189.1 million for the fourth quarter of 2008 compared to 184.2 million in the year earlier period.

Turning to the balance sheet, as of December 31, 2008, the Company’s cash position, which is defined as cash and cash equivalents as segregated under regulatory requirements and reverse repurchase agreements, was $361.3 million, while long-term debt was $150 million.

BGC Partners’ book value per share was $2.31 while total equity, which is comprised of redeemable partnership interest, minority interest, and total stockholders’ equity, totaled $443.8 million as of December 31, 2008. Now I would like to turn the call back over to Howard.

Howard Lutnick

Thanks, Bob. For the month of January we averaged approximately $5 million per day. However, the first two weeks of February were slower for us where we averaged approximately $4.4 million a day, which was somewhat due to the rare, extreme snowfall in London, which closed or reduced trading activity for many of our customers during that period. This week, for example, we have returned back to near January levels. This quarter, the first quarter, has 61 trading days. Following that, we therefore expect distributable earnings of revenues to be between $275 million and $300 million in the first quarter of 2009.

We, therefore, expect first quarter 2009 pre-tax distributable earnings of between $16 million and $26 million and post-tax distributable earnings of between $12 million and $19 million. We are confident in the ability of our management, partners, and employees to effectively navigate these turbulent market conditions.

We continue to grow our brokerage team even as we take steps to control costs in other areas. We remain focused on growing our business and maximizing profitability. Operator, we would now like to turn the call over to be able to answer questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your next question comes from Rich Repetto - Sandler O’Neill.

Rich Repetto - Sandler O’Neill

I guess the first question is; can you walk through the accounting on the comp and how that comes, if you paid it in stock than what would be the ballpark EPS in the accounting? Because, that is what I am unclear and then the follow-on to that what is your rationale? I assumed, because the stock price was low. And why couldn’t this happen again in other quarters? That is the question. I will leave it there.

Howard Lutnick

Well, I think and this generally would be true for any time, so it’s sort of a generic example. But if we paid $15 million more stock than we would pay $15 million less cash, our earnings would be higher by $15 million and we would have issued $15 million more in stock, which we would then amortize for instance, depending on what kind of stock we gave. But assuming we gave RSUs, ordinary three-year restricted stock, you would amortize that over three years.

So in this generic average issuing more stock would obviously replace cash and you would have earnings in that period. And so, the issuance of less stock reduces your earnings, but also reduces the issuance of stock.

Rich Repetto - Sandler O’Neill

The comp charge, if you issued $15 million of RSUs would be spread out. Instead of $15 million in the current quarter, would be $15 million spread out over three years. Is that correct?

Howard Lutnick

Correct.

Rich Repetto - Sandler O’Neill

And you would have the increase in share, well, the increase in share count?

Howard Lutnick

Of course.

Rich Repetto - Sandler O’Neill

And then I guess the next question, Howard, and for your team is you talked about the increase in principal trading and centrally cleared. That makes very good sense. I am just trying to see, how is it from a risk perspective, if the principal trading is much more a piece of the pie than commission trading prior. You are taking a principal position, even if it is for a split second and how do you look at the risk?

Howard Lutnick

Shaun’s example was trying to show that we are brokers and that the two primary ways we make our money are name give up and matched principal. So when, for instance, in U.S. treasuries a client types into our system a 14 bid and another client types in a 14 offer and they match and do a trade, there were no seconds that we had any principal risk.

However, we are at the central counterparty a matched principal, meaning we have bought from client A and have sold to client B at the central counterparty. The central counterparty novates us out, so initially we are a principal in the central counterparty then since we have bought and sold the central counterparty just sort of nicks both of our lines and we have nothing to do, because we don’t have a position nor any market exposure.

So what Shaun was trying to point out, was that our business is two-fold and we enjoy our business whether name give up or central counterparty. The benefit for us of central counterparty is, you can see from our balance sheet we have $127 million of receivables, which we collect when we do this name give up business over the next 30, 60, 90 days, whereas, when we do business at central counterparty, we get paid the next day.

So it would be a very pleasant thing for us to turn our business entirely into a matched principal business, because that $127 million would turn to cash. Instead of having $361 million in cash, $150 million in debt, and $127 million in receivables, we would have closer to $500 million in cash and $150 million in debt, and no receivables. So we, as Shaun expressed, are huge, huge positive fans of central counterparty, because it has no impact on our business other than it gets us paid much quicker.

Rich Repetto - Sandler O’Neill

Then the very last thing is on the non-comp expense, and I always fiddle with your guidance, Howard. If you held at least the way I look at this guidance, I look at the midpoints, I look at the high-end, and the low-end. If you held that non-comp and I sort of line it up like that. If you held the non-comp at $95 million and you did three, let’s just say you did the high-end, it will always work out to a comp ratio of almost close to 60%, 59.7%. Is that just me being too detailed with the guidance or I guess that is probably a little bit of conservatism in the guidance or so?

Howard Lutnick

No, I think what has happened is because of the variability of the U.S. Treasury business, it used to be a very steady concept and then you have seen the volumes industry-wide across the CME and otherwise dramatically deteriorated for a period of time. As Shaun mentioned, we have seen just lately and I mean just lately with the new three-year node and the new issuance from the Treasury stopping issuing just daily management bills and starting to go out into the two-years and three-years and five-year notes, seven-year notes.

So now we are starting to see an up-tick, but because of that we tend to lean our guidance towards the high-end of our range. And then if U.S. Treasuries come back that will help us reduce the range and will let us exceed that guidance. But, of course, our guidance is meant to be from our perspective that which we are comfortable that we can meet or exceed, not miss.

Operator

Your next question comes from Rob Rutschow - Deutsche Bank.

Rob Rutschow - Deutsche Bank

I was hoping I could follow up on Rich’s question about expenses. In terms of the non-compensation expense, I think you had some seasonal items that were a little higher this quarter and so flat guidance going forward would seem to imply that you will see increases in other areas. So I am wondering where you might be able to cut if things remain weak and in particular your T&E ratio seems a little bit higher than some of your peers.

Bob West

This is Bob speaking. In terms of the non-comp the last two quarters, you can see it’s at the $94 million dollar range. We have been aggressively managing our non-comp expenses. In terms of things on the fourth quarter, yes, there always are some unusual items that we have in each fourth quarter. And in the first quarter this year we don’t see anything that would be of an unusual nature, so given our trend of aggressive management, we could see that number trending down. But I don’t have anything that we are really ready to talk about in terms of things that are going to move that number other than the normal things that we have in our business. As we continue to grow the business, and of course you would expect it to not necessarily decline, if we hire a lot more people, there is some incomparable costs associated with that number.

Rob Rutschow - Deutsche Bank

So the T&E I should read into that that you are still in expansion mode?

Howard Lutnick

Most assuredly.

Rob Rutschow - Deutsche Bank

Can you give us any idea in terms of what the bonus payments that are coming up this year contractually that you have to your employees relative to last year and maybe looking ahead into next year also, 2010?

Howard Lutnick

Our business and our contracts are broadly percentage based. So, dramatically so, that I don’t know of any, I can’t even think of any particular compensation person that would matter at all, even for me to know it. We pay our people on variable percentages, so their compensation would be dictated by how they did.

We have some desks that are paid monthly; most desks are paid quarterly or semi-annually and some are paid annually. But virtually all of them, if not all of them, have a relationship, a direct relationship to a percentage based on their revenues. So we don’t have anything outstanding that would be dislocated from the then quarterly revenue. Was that the question?

Rob Rutschow - Deutsche Bank

Then on the revenue side, can you give us an idea of where you are seeing the most strength so far this quarter? Then also if you can give us an idea of what your credit looked like in terms of cash versus CDS in the fourth quarter?

Shaun Lynn

Hi, Rob. This is Shaun. Our strength in this quarter has mainly come from our credit sector. It has been very, very strong; just fixed income bonds. We have seen recently, as Howard already mentioned, U.S. Treasury I think maybe, we are hoping from this point going forward, resurgence of strength in treasuries.

Also, on equity derivatives it has been very, very strong for us over the last six months as we have expanded into that market over, we have mentioned it for about the last year now, but really in the last six months, we have been very fortunate to attract some very, very good people. I would say that going forward; credit is still going to continue to be very strong throughout this whole year.

Operator

(Operator Instructions) Your next question comes from Rich Repetto - Sandler O’Neill.

Rich Repetto - Sandler O’Neill

Just following up on your comments on the interest rates, I think I understand why credit has been strong, at least relatively stronger than your peers. On the interest rate, I am just trying to understand more the industry as credits decline. Could you give us what you think are the biggest factor and we know there is plenty of them out there like the Lehman restructuring, etc., de-leveraging, spreads, less mortgage-backed issuance, etc., or securitization. But what do you see as the things that caused the decline and what is helping it come back and what could help it come back more on the interest rates?

Howard Lutnick

Our general interest rate trading actually was quite reasonable. The headwind in the business was that we have a very strong and very material U.S. treasury business, which saw a dramatic reduction in volume that came from our loss both from Bear Stearns, which was much earlier in the year, and then obviously Lehman Brothers in September.

So both their fees and their volume declined and then we saw a dramatic pullback in the number of trading firms. As they de-leveraged their balance sheets they had to take off volumes, because they had to get their leverage ratios back in line. Now the treasury business tends, for those clients, to be a very high profitable business as compared to its capital and usage.

So it is one of the best uses of their capital, because it is not particularly capital-intensive, my understanding of their business. However, when you are extended across 12 businesses and you are trading at 15 times leverage and the banks are starting to pull your lines, you need to cut everything down until you can get out of everything to get back to your first best use.

So we think many of these high-frequency traders will begin to re-emerge as they have cleaned up their balance sheets and have money available for this business, which is a very, as I said, high-value business. And we have begun to see some of that. The other things we have seen is that, we have seen traders leaving some of the big banks and getting jobs at some of the smaller firms.

You have seen some announcements of people saying that they are going to try to become primary dealers. To try to become a primary dealer means they are going to try to trade a bunch more U.S. treasuries, which sounds excellent when people say we are going to now start to trade a lot more U.S. treasuries than we have ever done before.

I think the opportunity is in U.S. treasuries, meaning the spreads have widened. It means the profitability of trading U.S. treasuries has increased more and more participants will come into the market. Will that help us today? A teeny bit. Will it help us tomorrow? I think it begins to show that the future is bright.

With the issuance of the U.S. Treasury market it seems to me to be impossible for me to bet against the franchise of rates and U.S. treasuries in particular. $1.75 trillion budget deficit historically was this company’s birthday. You can’t imagine a better piece of news on the cover of the paper than that, but for some reason volumes have in the short term declined because the Treasury has issued that in cash management bills. That will eventually change and we will eventually, I think, see returns of treasury volumes to extraordinary levels which will be dramatically beneficial for the company.

So I think those are the underlying structure, more volume issuance in benchmarks from the Treasury and new clients coming online paying variable fee. And, if things go well, becoming primary dealers and then becoming fixed-fee clients. ELX coming online, which the newspaper reported was planned to be in the spring, which last I checked is the next season from the one we are in.

So opening in the spring will bring us more users of our system and the ability to trade futures and cash on the same system, which will be an excellent thing for U.S. treasuries. And, again, we see the beginning, maybe like the spring, the beginnings of the resurgence of U.S. treasuries as instead of a headwind becoming a tailwind.

Rich Repetto - Sandler O’Neill

Howard, you did mention ELX, that will be my last question. At least that same article sort of inferred that it was a delay from the, I think it’s the CFPC approval process. Is that correct or am I interpreting the article wrong or was the spin from the article incorrect or right?

Howard Lutnick

I will leave the spin of the article to that person. We are in the winter. The article said it expects to open in the spring. I do not recall there being a time since I have been associated with ELX where it was planning to open and any comments made other than the spring.

So if one is now dictating from whence within the spring it opens, I don’t know, but I like the concept of the papers saying spring. Spring is next quarter. Next quarter works us. It is up to ELX, it is up to all sorts of Is dotting, T crossing, regulatory approvals, and all the like which Neal Wolkoff and the Management of ELX is working on. We as an organization and a technology system are ready.

Operator

Your next question comes from Rob Rutschow - Deutsche Bank.

Rob Rutschow - Deutsche Bank

Just one follow-up, can you tell us what the pre-tax margin on your treasury business is, relative to some of the other businesses?

Howard Lutnick

I don’t think we have ever said that particular margin, but we always express that since our voice brokerage compensation tends to be in the high 50s, or let’s call it 60%, and our electronic compensation tends to be 15%. We generally say that fully electronic trading when it’s mature, which U.S. treasuries is, tends to have a margin of 45 points higher.

So it just took our regular margin of our voice brokerage business and added 45 points. We would generally say, we don’t talk about treasuries, because there is really no consequential difference between electronic treasuries versus electronic other products, what we would say it would be in the 75%-plus range.

Rob Rutschow - Deutsche Bank

I apologize if you already disclosed this, can you tell us what the electronics revenues were this quarter?

Howard Lutnick

I’m sorry, and by the way, those margins are incremental margins, because obviously we have substantial fixed costs. So growth comes at a very high profit. And what did you say, our fully electronic revenues were 7%.

Operator

At this time, we are showing no further questions available. Mr. Lutnick, you may proceed, sir.

Howard Lutnick

Well, I would like to thank you for joining us for this call. We continue to focus on hiring quality personnel and growing our business. We are focused on our bottom line and we are focused on maximizing profit. We look forward to talking to you next quarter and telling you about our progress. Thank you everyone and have a good day today.

Operator

Thank you for your participation in this conference. This concludes the presentation. You may now disconnect. Have a great day.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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