BGC Partners, Inc. (NASDAQ:BGCP)
Q3 2013 Earnings Conference Call
October 31, 2013 10:00 AM ET
Jason McGruder - IR
Howard Lutnick - CEO
Shaun Lynn - President
Good day, ladies and gentlemen, and welcome to your Q3, 2013 BGC Partners Inc. Earnings Conference Call. My name is Tulu [ph] and I will be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. If at any time during the call you require assistance (Operator Instructions). As a reminder, this call is being recorded for replay purposes.
I would now like to turn the call over to Mr. Howard Lutnick, Chairman and CEO. Please proceed sir.
Actually this is Jason, I will read the disclaimer. Good morning. Our third quarter 2013 financial results press release was issued this morning. This can be found in either the News Center or Investor Relations section of our website at bgcpartners.com. During today’s call, we will also be referring to a presentation that summarizes our results, which includes other useful information. This too can be found in the Investor Relations section of our site.
Throughout today's call, we will be referring to our results only on a distributable earnings basis. Please see today's press release for GAAP results. Please also see the section of today's press release entitled distributable earnings, distributable earnings results compared with GAAP results, reconciliation of revenues under GAAP and distributable earnings and reconciliation of GAAP income to distributable earnings for a definition of these terms and how, when and why management uses them.
Unless otherwise stated, whenever we refer to the income statement items such as revenues, expenses, pre-tax earnings or post-tax earnings, we are doing so only on a distributable earnings basis. Unless otherwise stated, all the financial comparisons we will be making on today's call will contrast the third quarter 2013 to the third quarter of 2012.
On June 28, 2013, BGC sold its full electronic trading platform for U.S. Treasury Benchmark Notes and Bonds to NASDAQ OMX Group, Inc. For the purposes of today’s call the assets sold are referred to as eSpeed. Also Newmark Grubb Knight Frank is synonymous with NGKF or Real Estate Services segment.
I also remind you that the information on this call contains forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended. Such forward-looking statements include statements about the outlook and prospects for BGC and for its industry as well as statements about our future financial 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 a number of risks and uncertainties that include, but are not limited to the risks and uncertainties identified in BGC'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 is impossible to predict actual results or outcomes or effects of risk uncertainties or other factors or anticipated results or outcomes and that accordingly you should not place undue reliance on these statements. Forward-looking statements speak only as of the date when made and we undertake no obligation to update these statements in light of subsequent events or developments. Please refer to a complete disclaimer with respect to forward-looking statements and risk factors set forth in our most recent public filings in Form 8-K, 10-K and 10-Q, which we incorporate today by reference.
I would like to turn the call over to your host, Howard Lutnick, Chairman and CEO of BGC Partners.
Good morning and thank you for joining us on our third quarter 2013 conference call. With me today are BGC's President, Shaun Lynn; our Chief Operating Officer, Sean Windeatt; and our Chief Financial Officer, Graham Sadler.
Newmark Grubb Knight Frank continued to show strong growth, generating almost 36% of BGC’s revenues in the quarter. Over the course of the year NGKF has continued to build its brand by accretively acquiring great businesses, hiring top talent here in New York and around the country and adding large global corporate service clients. We expect continuing growth in real estate revenues in the fourth quarter and expect NGKF to produce pretax earnings nearly double those of its fourth quarter of last year. With our $827 million cash position, and expected $500 million in NASDAQ OMX stock, we are a cash and asset rich company.
There are numerous ways we can deploy our capital to grow our business through accretive acquisitions and profitable hiring and we remain confident in our ability to generate growth in 2014. Overall BGC generated revenues of $414.4 million and post-tax income of $31 million in the third quarter, and Graham will discuss that a little more, later in the call.
As a result of our recent NASDAQ OMX transaction, this is the first quarter in which we do not have eSpeed, which generated $23.1 million revenues in the third quarter last year. I am happy to report that our Board declared a $0.12 dividend for the quarter. We are confident in the sustainability of our current dividend for the foreseeable future and at yesterday’s closing stock price the dividend yield on BGC was approximately 9%.
With that I will turn the call over to Shaun.
Thanks Howard, and good morning everyone. As you know, our financial services business faced challenging market conditions during the quarter. Most of our large bank customers reported double digit declines in their revenues from fixed income currency and commodity trading. I attributed their results to a number of factor including the Federal Reserve maintaining its quantitative easing policy, recent budget impass in Washington, and the higher bank capital requirements on the Basel III.
Consequently volatility rates, foreign exchange and equities, all declined from their recent highs in June. Amrex [ph] opened low historical averages. This contributed to low over the counter trading volumes across most asset classes. BGC’s financial services segment generated revenues of $256.7 million and $29.7 million of pretax earnings, excluding the assets sold to NASDAQ OMX. This was a decline of 4.7%. A year earlier this segment which included the eSpeed $23.1 million in revenues and $13 million in profit, generated $292.6 million in revenues and $44.2 million in pre-tax profits.
Looking at results by asset class, our revenues from electronics rates products excluding eSpeed grew by 16.4% in the quarter, driven mainly by our interest rate derivative desks. Revenues from our overall rates business excluding the asset sold to NASDAQ OMX declined by 6.3%.
Our credit revenues declined by 19.9% to $54.4 million. Although Fully Electronic FX Notional volumes were up by 36.3% BGC’s overall voice/hybrid electronic foreign exchange revenues declined by 3.1% to $47.4 million. Our performance was better than the comparable FX volume declines reported by CME, EBS and Reuters.
Global equity markets were also challenging. For example, equity derivative volumes were down by 20% and 30% respectively according to Eurex and Euronext. In comparison, BGC’s revenues from equities and other asset classes increased by about 1% to $34.9 million. Excluding eSpeed, financial services, electronic trade and market data and software revenues declined by 7.7% to $17.8 million or 6.9% of segment revenues in the quarter compared with $19.7 million or 7.2%. The strong growth generated by our retained e-brokered rates desks was offset mainly by lower credit revenues. Our retained technology products generated a pre-tax profit margin of 45% and we believe that this fully electronic business will grow faster over time than our overall financial services segment.
On October 2, we begin operating our Swap Execution Facility offset. Mandatory Dodd-Frank compliance execution by swap dealers and major swap participants is not scheduled to commence until the first quarter of 2014. The new model of swap trading will not take effect until then and SEF volumes to date are not indicative of the overall industry results or outlook.
BGC also maintains its ownership stake in ELX, a CFTC approved designated contract market or DCM which also includes several of the world’s largest banks and equity holders. ELX has been actively planning for the launch of Dodd-Frank compliant swap futures trading.
Turning to front office headcount, we ended September with 1,545 brokers and sales people in financial services, down 11% from 1735 a year earlier. Excluding eSpeed, our average revenue per broker salesperson in the segment increased by 1%. With respect to our real estate services segment, industry metrics continue to move in a positive direction in the third quarter. The combination of modern economic growth and low interest rates in the U.S. has been a powerful stimulus for the commercial real estate, delivering steady absorption of excess space and strong investor demand for the yields available through direct ownership of assets and funds.
These macroeconomic practice combine with low level of new construction over the past few years also help push vacancy rates down for the office, retail and industrial markets. A Newmark Grubb Knight Frank research team believes that these positive U.S. sales and leasing trends will continue through the end of 2014.
With respect to anti-cash results, management services and other revenues increased 2% to $40.5 million. Anti-cash brokerage revenues improved by 10.5%, excluding the noncore purchase assets that we discussed in our earnings release while overall revenues improved by 8%.
We have broken out this non-core NGKF revenue figures for you in our earnings presentation going back to the second quarter of last year. Commercial real estate service firms tend to generate the lowest revenues and profits in the first calendar quarter and their highest in the fourth quarter. As Howard mentioned earlier, we expect our real estate services segment to benefit from the seasonal pattern.
Our real estate services segment had 887 brokers and sales people at quarter end up 5.6% compared with 840 last year. Average revenue per real estate broker was up 4.4% to approximately $119,000, excluding the noncore purchased assets. A year ago, this figure was approximately $114,000.
BGC’s overall front office headcount decreased by 5.6% to 2,432 brokers and sales people. Our total average revenue per front office employee was down approximately 4% to $144,000, excluding the non-core purchased assets and eSpeed.
With that I would now like to turn the call over to Graham.
Thank you, Shaun and good morning everyone. BGC generated revenues of $414.4 million, down 7% compared with $445.7 million. Our revenues from the Americas were down approximately 4% excluding eSpeed. Revenues from Europe, Middle East and Africa were up by approximately 5% to $170 million and Asia Pacific revenues decreased by approximately 16% to $43 million.
Excluding both the real estate services segment and eSpeed, our global July 2013 revenues were down by approximately 1% to $90 million. August declined by approximately 11% to $76 million while September was down by approximately 4% to $100 million, all when compared with the year earlier.
Turning to consolidated expenses, compensation and employee benefits were 62% of revenues, compared with 59.8%. Our compensation ratio increased mainly due to a larger proportion of revenues coming from real estate services and because eSpeed had a relatively low compensation ratio. Non-compensation expenses were down on an absolute basis and as a percentage of revenues to 29%, compared with 29.7%, the decrease in non-compensation expenses were across all of our GAAP line items due largely to our ongoing cost reduction program as well as to lower revenues on the sale of eSpeed.
We remain on target to reduce overall cost by $50 million on a go forward basis by the end of 2013, as compared with the second half of 2012 run rate. We also expect to reduce costs over the course of 2014 by another $50 million, bringing our total projected cost reduction to an annual run rate of $100 million. Our pretax earnings were $37.4 million, compared with $46.7 million. Our pretax margin this quarter was 9%, compared with 10.5%. However because we sold our eSpeed business, these comparisons are apples-to-apples.
BGC’s effective tax rate for distributable earnings was unchanged at 14.5%. Our post tax distributable earnings were $31 million or $0.10 per fully diluted share, compared with $38.6 million or $0.13. Our post tax earnings’ margin was 7.5%, compared with 8.7%.
BGC had a fully diluted weighted average share count of $355.2 million in the third quarter of 2013 for both GAAP and distributable earnings. This compares with $325.7 million for distributable earnings and $146.7 million for GAAP a year earlier.
The GAAP share count was lower a year ago because it excluded share equivalents, including partnership units and the convertible senior notes in order to avoid anti-dilution. The year-over-year increase in share count for distributable earnings was due in part to issuances related to acquisitions as well as equity related employee compensation. This was partially offset by the net $33.2 million fully diluted share count reduction over the previous two quarters.
As of September 30, 2013, our fully diluted share count was $356.4 million, assuming conversion of the convertible senior notes. We expect to decrease the absolute level of share issuance per quarter. Absent acquisitions or significant hiring, we expect our fully diluted share count growth to be significantly less than the first half of the year.
With respect to our receipt of NASDAQ OMX shares, the $31.9 million of revenue associated with BGC is expected receipt of approximately 992,000 shares, was recorded in GAAP revenue as other revenues in the financial services segment during the quarter and was based on the September 30 closing price of $32.11.
BGCs expect to receive the same amount of shares in each of the next 14 years. Certain acceleration events occur including NADAQ OMX undergoing a change of control. Whatever remains of the share earn out will be paid immediately at that time.
As of the most recent closing price, the value of these expected 14.9 million shares is approximately $532 million. The value of 25% of these earn out shares was included in distributable earnings for this quarter all we recorded each in the next three quarters. The dollar amounts included in both GAAP and distributable earnings in the future periods may be adjusted to reflect any potential hedging and/or mark-to-market movements.
As of September 30, 2013, the Company’s cash position, which we define as cash and cash equivalents, marketable securities and un-incumbent securities owned was $827 million. Those payable and collateralized borrowings and those payables related parties were $423 million. Book value per common share was $2.25 while total capital, which we define as redeemable partnership interest, non-controlling interest in subsidiaries and total stockholders’ equity was $808.5 million.
In comparison, as of December 31, 2012, our cash position was $420.4 million. Debts payable and collateralized borrowings and debts payable to related to parties were $451.4 million and book value per common share was $2.11, while total capital was $506.3 million.
With that I am happy to turn the call back over to Howard.
Thank you, Graham. Excluding real estate services and eSpeed, our preliminary revenues for the first 22 trading days of October were down by around 3%, compared with a year earlier. For the fourth quarter 2013, we expect to generate distributable earnings revenues of between $400 million and $425 million. This compares with $436.3 million last year and we expect pretax distributable earnings to be between $36 million and $44 million and that compares with $35.1 million last year. We anticipate our effective tax rate for distributable earnings to remain at approximately 14.5% and we intend to update our fourth quarter outlook around the third week of December.
So with that operator, I would now like to open this call for questions please.
Thank you. (Operator Instructions). Your first question is from the line of Julian Miller. Please go ahead.
So I guess just starting with SEF rules and what you are seeing there, I know part of this thesis was that once the SEF compliance kind of went into force, the smaller competitors with less resource may be forced out of the market and that would create some acquisition opportunities for you guys. So just wanted to kind of get an update of what you are seeing -- what kind of opportunity you might have, especially given your cash position. Thanks.
Will I think that the thesis remains, that the rules that come into effect in middle of the first quarter or that's what people anticipate are creating issues for small people who don't have the capacity to assess and they need to find new ways to solve their regulatory problem and they will do that either by deal making or by deal making. One way or another they have to do it. So what type of deals and who they do them with, open minded but you are correct, we are at the party with a very strong balance sheet and a lot of money and I think that makes us an attractive partner, given we have technology and money, we should be able to do some very interesting things going forward.
Okay. And have you guys seen any kind of fundamental changes in the market since some of these SEF rules have been I guess partially in place, not entirely yet but are you seeing anymore electronic trading, any diversity in their participant base or shifts in market share re-pricing. Or is it basically business as usual for the time being?
It's been business as usual to a large extent. We expect obviously this is going to potentially change leading up to the first quarter of next year, but it’s very early days. We have entered just into this sector of the market now where the rules are starting to taking place, and we expect things potentially will change over the course of next three or four months.
But as an example we have seen an increase recently of fully electronic transactions in some of our market place and that's why you see our rates, fully electronic business increase by 16%. So the world is beginning, it is beginning.
And then just one final question from me. On the extension of your cost cuts, I guess the new cost reduction program for next year, is that a reflection of kind of your outlook for trading activity in 2014? Like are you expecting another difficult year and that's why you see this is necessary or is it just I guess some excess fat in the organization after integrating the real estate businesses that you think needs to be cut kind of regardless of your activity outlook?
We had a significant structural surround to our treasury business, that has a backed R&D associated with it. I think this is really a retooling and re-examination or where the world is going, how we want our technology to invest in it and how we expect things to back our business going forward and I think with that we also have the advantage of really examining our business and being able to skin yourselves down, and be ready for the future and I think this is an opportunity for us to do that on the back of the eSpeed transaction, to modify the way we invest in some areas of our technology and then to have our business fit -- our expenses fit our business as we see going forward.
Thank you. The next question is from the line of Rich Repetto. Please go ahead.
I guess just to back into the guidance on the real estate revenue, excuse me pretax distributable earnings for 4Q, so at the midpoint, we're coming up with about $18 million if we compare it to last year. Is that correct? When you say it’s going to double.
I would have thought substantially higher than that.
Just the real-estate portion?
I think real estate portion, I think we have around $13 million from last year. So we're saying in approximately double could be better.
So then given that's the case, let's just use a number of 25 or so, could be better 25 to 30. If $40 million is the midpoint that means financial services is going to be significantly $15 million or less. Is that -- am I backing into the right numbers for pretax for the financial services sector?
Well historically the fourth quarter with Thanksgiving and Christmas is the slowest quarter for financial services. If you just took the third quarter the way it was and take ordinary fourth quarter, you have our revenues decline, historically probably around 10% and give and take around there. So that's the normal seasonality is there, and obviously you have seen in the third quarter, with the changes in the swap execution rules, the business itself has declined because people are trying to figure out the new order of things and the new way to do their business. And when you are talking to your clients instead of talking about directional and about compliance and things like that. That obviously holds back some volumes in the near term. And then also you have to remember that because we sold eSpeed, the comparison as Graham aptly put it isn’t apples-to-apples.
Right, but we’re still looking at going from I believe roughly at $30 million pretax distributable earnings, 3Q this year without eSpeed down to something that looks like somewhere around half? Is that -- do I get the right picture there?
Right, put it them together if it’s round - your analysis isn’t incorrect. So the real estate right would be the higher number and financial services in the fourth low and then of course financial services does much better in the first quarter as things bounce back and real estate, it’s not at its best in the first quarter.
Yes, I understand and I got the extremes where real estate does its best and brokerage does not so good seasonally. And anyway, I guess, next question would be my last out. On the sets [ph] we’re hearing not only -- how do I put this, that during this period up until it’s mandatory that people start trading that you get that, made available to trade mandates that actually see in activity pull back from normal activity, because well they’re not trading on sets [ph] hardly at all but you registered -- you would have to fully become a member and when they don’t have to, when they can still trade the old way. Is that a reasonable picture, what’s going on out there?
Yes, I agree. The volumes are weaker now but ultimately -- our deal would be -- ultimately clients will still going to want it to swap business and buy-side firms tend not to do business without the buy-side firms. That’s why they called buy-side firm, that I call sell-side firm. That is the history of those kinds of firms. When they all get together and try to do business with each other, there is lot of buying and not much selling and therefore not much transactions. So they need the Wall Street Firms banks to be middle man, to be greased the skids and to help this kind of business flow and that we expect to continue to happen and as those banks find a way to do business with their clients in the new rules, then they will need to mitigate their risk by reducing their risk trading with each and that structure will find its way.
You are absolutely right it is slower today as people are trying to consider how they going to go forward. And new rules really take effect February 15. So whatever you view the business as between now and February 15, you have to realize that it’s going to improve. That will be the first day of the rest of our lives and then from there it will begin. I am not saying on February 16, it starts to rock it, I’m saying that is the beginning of the movement going forward.
Just one follow-up. The process, I believe, needs to get kick started by -- this made available to trade the termination, which then requires some of these swaps to be traded on sets. But you didn’t request and I don’t’ believe and the only ones I believe have is -- I think Javelin and maybe Bloomberg, but there is only a couple. Was there a reason why you haven’t started the process to get products approved to trade?
No, I don’t think there is any particular reason. Well, we take advice and we expect to be there on first day. We expect to be there.
Thank you. The next question is from the line of Michael Wong. Please go head, sir.
Okay so eventually your rising interest rates and the related rates change have been a cornerstone of your eventual earnings growth story for a year or so? In general, what would you say are your largest opportunities now?
To the rates market, we are getting still getting the rates market globally. We are focusing on growth in energy commodities, real estate, and all of that kind of sectors. We haven’t changed attack in anyway. We are doing as much as we can to the more market electronic. We feel bullish on the market prices. We always have done. Of course it’s gone through a difficult time for everybody with the new rules coming in with Basel III taking effect and the pullback from some of the major banks, but we think that’s amazing opportunity for us going forward, with regards to acquisitions, with regards to the way the markets are changing, which is going to play out really well for us. And as Howard has said, with our financial situation, being as strong as we are, it’s the same business for us as usual. We’re still going to grow, build and expand into this.
And in general, how would characterize, I guess, the hiring or compensation environment right now? It seems like, would you characterize it as more rationale as it seems, like the brokerages are cutting headcount even for an office much more than hiring?
Yes, sure, I mean I think, it’s easier to hire but you always got to upgrade ways you see potential, you’ve always got to cut costs as Graham has been speaking. And just because someone offers you something doesn’t mean to say you always want it. You’ve got to be looking forward to where the market is going to be, what’s the part of the market you want to be in. There is no point in going into old business that effectively are not going to be the flavor next year. You want to be focused on the new businesses that are up coming and how the markets evolving and making sure you’re at the forefront of that, with the right staff and with the right compensation packages, which incentivize people to work hard and grow and build the business electronically, not just in the old fashioned way.
(Operator Instructions). And the next question is from the line of Nima Alexandra. Please go ahead.
On the real estate business I know you kind of wanted to spend more time focusing on markets, it's more of a growth story right now. It looks like it’s pretty impressive, what you're going to do in terms of the earnings jump in the fourth quarter and help me think about what specifically is driving that? Is it kind of part of the cost saves that you put through this year starting to play out in there as well or is it all kind of coupling revenue driven with the seasonality and we should kind of more go backwards to see it kind of kicking into double digit margins there for the first time and I’m just wondering if that's a good run rate to think about of the margin potential, especially if the big financial services segment the margin's deteriorating.
It's twofold, it's both a topline revenue growth model and we continue to see strong topline revenue growth, but it's also a mix issue, which is we have been winning global corporate service clients, and the global corporate clients have a higher margin to their business, because this is more of a consultant brings transaction rather than just broker brings transaction, and as you do the analysis of these large global corporate transactions and you analyze these companies on a global basis, you end up being in transactions all over the world on better financial terms, as compared to how much percentage we have to pay our brokers.
So the bigger the global corporate services business, the better our margins in that business and in the fourth quarter we've had and we are seeing an excellent return from global corporate services and that will improve our margins, but that sort of [indiscernible] experience, it's a mix issue. There'll be many quarters where that's not the case but when global corporate services hits, we bring big money to the bottom line and in the fourth quarter of this year we expect that to happen.
And then on the cost saves, the additional 50, like where should we be looking for that? Is it a lower comp ratio, is it somebody's non-comp expenses coming down?
I think there'll be some in the compensation line. Primarily I think you'll see it in non-comp expense. As I said, I focus on making sure our technology is focused on the areas we need it to, and in the processes we need to. We don’t need to be in the every three months rat race of making our system 2 microseconds faster than it was yesterday. Rather we can look at things from a holistic approach and try to come at things from an entirely different perspective and that is refreshing and relieving in a way and I think we will do -- I think we will do very-very well with it. So I think we’ll be able to refocus our technology expense and refocus the business on the expenses that we need to support our business going forward.
Okay, and then lastly on the staff, you know we've seen some of your competitors come in, number one and two are kind of coming in with stronger volume and I get that it's very early days and your clients are still figuring out what is it that they need to do but would you be, is it an okay spot to be kind of number three or don't you want to be number one or two in the space to kind of make sure that you're getting most of the trades routed to your venue going forward and that's primarily in REITs. In credit I'm just a little concerned with the deterioration of the revenue there, relative to some of your peers. I know the market's been soft but I'm just wondering have you lost some share there, maybe as it went on screen you saw more of the index business go on screen?
As you know we are not the biggest and the strongest in every product category and there're certain indexes. Shaun, you want to talk about things we do and what we don’t do.
So basically, it's very-very early days. These initial numbers that are out there are specific to the [indiscernible] CDS market. We’ve never been strong in the CDS market but we’re very strong in other parts of the market. So that number isn't captured in those early day graphs, with regard to rates we're still growing and building in that market. We're not fazed by the numbers that are actually out there at the moment.
I would not consider us number three, certainly inside this company we do not see those statistics or those things making a hill of beans at all to us we have great technology, we have great position and we feel that our opportunity is superb right here and right now, and there's a lot of work to do to make that come to pass but I would not bet against us. I would not.
Okay, fair enough and then on the cash, the dues -- repayment of debt is kind of on your first list of kind of what your priority. Was there something specific you had in mind? I know there were some restrictions conversation you had with Cantor but is that you're trying to work through maybe to kind of reduce that leverage a bit earlier?
If we can we would but I think when it matures, it won't be replaced.
Thank you, we have no further question in the queue. With that, I will now turn the call back to Mr. Howard Lutnick for closing remarks.
Well thank you all for joining us today. We look forward to updating you at the end of the fourth quarter and speaking to you next quarter. Thanks everyone, have a great day and happy Halloween to you all. Bye, bye.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.
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