GFI Group's (GFIG) CEO Colin Heffron on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: GFI Group (GFIG)

GFI Group (NYSE:GFIG)

Q2 2014 Earnings Call

August 01, 2014 8:30 am ET

Executives

Mark Brazier -

Colin Heffron - Chief Executive Officer, Director and Member of Risk Policy Committee

James A. Peers - Chief Financial Officer

Analysts

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

Michael Wong - Morningstar Inc., Research Division

Operator

Good morning, and welcome to the GFI Group's Second Quarter 2014 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

And now I would like to turn the conference over to Mr. Mark Brazier. Please go ahead.

Mark Brazier

Thank you, Emily. Good morning, everyone, and welcome to the GFI Group's Second Quarter 2014 Earnings Conference Call. We issued a press release yesterday providing the financial results for our fiscal quarter ended June 30, 2014, which is available on our website at www.gfigroup.com. We've also posted monthly revenue and trading day count information for the quarter on our website, under the quarterly toolkit in our Investor Relations section.

As you may also be aware, we issued the press release with CME Group on Wednesday morning, announcing that we'd entered into a definitive agreement to create value for our shareholders through a 2-step transaction.

To begin this morning's call, Colin Heffron, GFI's Chief Executive Officer, will provide a brief summary of this transaction. He will then review our business performance for the second quarter and discuss our trading activity for July.

Jim Peers, GFI's CFO, will then review the second quarter financial results in greater detail. After Jim, Colin will conclude with a few remarks. Thereafter, we will open up the call for your questions.

Our discussions during this conference call will include certain forward-looking statements. These statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in such forward-looking statements. More detailed information about the risks, uncertainties and other factors that may cause actual results to differ from such forward-looking statements are discussed in our filings with the SEC, including our most recent annual report on Form 10-K.

Also, the discussions during this conference call may include certain financial measures that were not prepared in accordance with U.S. Generally Accepted Accounting Principles. Reconciliations of non-U.S. GAAP financial measures to the most directly comparable U.S. GAAP financial measures were included in the company's earnings press release, which was furnished on the current report on Form 8-K dated July 31, 2014.

Also, I'd like to draw your attention to the detailed forward-looking statement that was included in our earnings release yesterday.

I would now like to turn the call over to Colin Heffron, Chief Executive Officer of GFI Group.

Colin Heffron

Thank you, Mark. Good morning, everyone. Thank you for joining us today. Allow me to begin my remarks today with a recap of our announcement on Wednesday morning.

We issued a joint press release with the CME Group announcing that we'd entered into a definitive agreement that will result in the sale of our Trayport and FENICS businesses through a 2-step transaction. First, CME will acquire all the outstanding common stock of GFI for $4.55 per share and CME class A common stock. Immediately following this acquisition, a private consortium of GFI management, led by Executive Chairman, Mickey Gooch; Managing Director, Nick Brown; and myself, will acquire GFI's wholesale brokerage business, including the Kyte Group, for $165 million in cash and the assumption at closing of approximately $63 million in unvested deferred compensation and other liabilities.

The offer price of $4.55 per share of GFI stock represents a 46% premium for the closing price of GFI common stock on the day prior to the announcement. The transaction, which has been approved by the Boards of Directors of both companies, is subject to GFI shareholder and various regulatory approvals and is expected to close in early 2015. Additional information is contained in our SEC filings and the press release announcing the transactions.

Now I'd like to discuss GFI's second quarter non-GAAP results year-over-year. GFI's software, analytics and market data revenues increased 17% to $25.6 million for the quarter, on strong revenue growth from Trayport. In contrast, GFI's brokerage operations continued to face cyclical and structural headwinds, including muted volatility across asset classes, low interest rates, higher capital requirements and ongoing regulatory changes. As a result, GFI's non-GAAP brokerage and net revenues were down 11% and 7%, respectively. GFI's electronic matching sessions continued to provide sustained revenue growth in the second quarter, and cash bond products globally matching session revenues were up 14% year-over-year. In the Americas and EMEA, matching session revenues represented approximately 49% and 17% of total fixed income revenues, respectively, as compared to 42% and 11% in 2013.

In the quarter, new matching protocols were added to foreign exchange products globally, and the initial feedback from clients has been positive. Our Trayport and FENICS businesses continued to outperform as they leverage their customer bases and expand products and services. Trayport's revenues increased 22% on a U.S. dollar basis compared to a year ago.

On the cost side, we continued to transform our front office cost structure from one with a significant fixed component to one that is more performance-based and variable. These efforts were masked by the lower revenue environment, as well as an unfavorable foreign currency translation in Europe. Brokerage compensation as a percentage of brokerage revenues declined year-over-year despite an 11% decrease in brokerage revenues. Further, our continued discipline with regards to sign-on and retention bonus payments led to an improvement in expense of $2.2 million year-over-year.

I will now discuss our performance by product category for the second quarter, year-over-year. GFI's fixed income products group, which consists of cash and derivatives, represented 28% of total brokerage revenues. Fixed income product revenues declined 10%. Cash revenues were flat and represented 66% of GFI's overall fixed income business in the quarter. Revenues from fixed income derivatives decreased 25%.

Financial products, which consists largely of foreign exchange and interest rate derivative products, represented 30% of total brokerage revenues and was our largest product category. Financial product revenues declined 14%.

Equity products, which consist of cash and derivatives, represented 17% of GFI's total brokerage revenues. Equity products revenues declined 17%.

Commodities category consists of energy and other commodity products. This product category represented 25% of GFI's total brokerage revenues. Commodity product revenues decreased 1%.

From a geographical perspective, GFI's brokerage revenues were up 4% in EMEA but were down 24% and 20% in the Americas and Asia-Pacific, respectively.

Now let me review GFI's non-GAAP expenses for the quarter on a year-over-year basis. GFI's compensation ratio increased 69.4% of net revenues as compared to 68.2% in 2013. This higher compensation rate is a direct result of lower net revenues and unfavorable foreign currency translation in Europe. We continue to focus on our cost base and seek efficiencies where possible. Noncompensation expenses were higher than the prior year. Higher rent and occupancy, interest on borrowings and other expenses contributed to this increase. We generated non-GAAP cash earnings of $19.2 million, or $0.15 per diluted share in the second quarter.

July total revenues are tracking approximately 3.5% lower when compared to the same period in 2013. Before offering my concluding my remarks, I'll now turn the call over to Jim Peers, our CFO, for his comments.

James A. Peers

Thank you, Colin. Good morning, everyone. GFI's GAAP second quarter 2014 net revenues of $186.3 million decreased by $12.1 million compared to $198.4 million in the prior year's second quarter. Our non-GAAP second quarter 2014 net revenues were $184 million, compared to $197.3 million in the prior year's second quarter, a decrease of $13.3 million or 6.8%.

Our brokerage revenues in the second quarter of this year were $155.6 million compared to $174 million in the second quarter of 2013, an $18.4 million decrease or 10.6%.

Total revenues for software, analytics and market data were $25.6 million, up $3.8 million, or 17.4% from the prior year's second quarter.

On a sterling basis, Trayport revenues increased 11.6% to GBP 11.2 million in the second quarter of 2014, as compared to the same quarter last year.

On a year-to-date basis, our non-GAAP net revenues decreased $11.1 million or 2.8%, as compared to the comparable period in the prior year.

On a year-to-date basis, our non-GAAP brokerage revenues decreased $21.9 million or 6.3%, compared to the comparable period in the prior year.

On a GAAP basis, GFI's second quarter 2014 net loss was $97.8 million, which included an impairment of goodwill, net of taxes of $94.1 million, compared to net income of $6.7 million in the second quarter of 2013.

On a non-GAAP basis, GFI's second quarter 2014 net income was $1.3 million, compared to $7.1 million in the prior year second quarter. On a non-GAAP basis, GFI's net income for the year-to-date ending in June 2014 was $7.5 million compared to $14.3 million in the prior year.

GFI's diluted GAAP earnings per share for the second quarter of this year was a loss of $0.78, which included the loss related to $0.75 related to the impairment of goodwill. This compared to the earnings of $0.05 in the second quarter 2013.

Diluted non-GAAP earnings per share for the second quarter of 2014 was $0.01, compared to $0.06 in the prior year's second quarter. On a non-GAAP basis, GFI's diluted earnings per share for the year-to-date ending June '14 was $0.06, compared to $0.11 for the year-to-date ending June 2013.

Our GAAP brokerage revenues were down $18.4 million, or 10.6% when comparing the second quarter of this year to the prior year's second quarter. Fixed income was down 9.7%, with derivatives down almost 25%. Cash was up 0.5%. Equities were down 17.4%. Financials were down 14.3%. And commodities were down 1.3%.

Our sign-on and retention bonuses paid in cash in RSUs granted in the second quarter were $2 million compared to $3.6 million in the first quarter of this year and $10 million in the second quarter of last year.

Non-GAAP amortization of previously paid sign-on bonuses in both cash and RSUs was $7.8 million in the second quarter of this year compared to $10.1 million in the second quarter of last year and $8.8 million in the first quarter of this year.

Our brokerage personnel headcount at the end of second quarter of 2014 was 1,057, down 105 and down 27 from the first quarter of 2014. Our broker productivity of 145,000 in the second quarter of 2014 was down 5,000 from 150,000 in the second quarter of 2013.

On a GAAP basis, our pretax margin, as a percentage of net revenue for the second quarter of 2014 was negative 69.2%. Pretax margin was negative 3.9% if you exclude the impairment of goodwill. This compares to 3.9% in the same quarter last year of 2.7% -- sorry, last year.

On a non-GAAP basis, pretax margin for the second quarter of 2014 was negative 0.9% compared to 4.6% in the second quarter of last year. On a non-GAAP basis, our pretax margin for the year-to-date June 2014 was 1.7% compared to 4.6% for the year-to-date June 2013.

In summary, our key performance drivers on a non-GAAP basis for the second quarter of 2014 are as follows: Our non-GAAP net revenues were down $13.3 million or 6.8% compared to the second quarter of 2013. Our compensation cost, which includes all employees, not just our brokers, was 69.4% of net revenues in the second quarter of this year compared to 68.2% for the second quarter of 2013.

Despite lower brokerage revenues, our first half '14 front office compensation ratio in the brokerage business is the lowest it has been in 5 years. This is a result of cost savings initiatives taken place, as well as improvement in the expense related to sign-ons and performance bonus RSUs.

Our non-compensation costs were 31.5% of net revenues compared to 27.2% for the second quarter of 2013. The negative 2014 tax rate was largely a result of regional shifts in taxable income. Currently, profits in Europe are more than offset by losses incurred in the U.S. business, resulting in a consolidated future tax benefit.

Our second quarter non-GAAP items are as follows: On the revenue side, our second quarter non-GAAP results exclude a gain of $2.7 million related to a mark-to-market adjustment to the current value for the Contigo [indiscernible]. Our second quarter also results -- exclude a loss of $400,000 related to the sale of an available-for-sale investment.

As I've highlighted on our previous calls, we are long euros on the revenue side and short sterling on the cost side in Europe. Accordingly, GFI continued and entered into a number of FX forward contracts which serve as an economic hedge of our exposure to certain euro and sterling cash flows. Our euro revenue hedges were marked to market at the end of the second quarter, resulting in an unrealized noncash pretax gain of approximately $100,000. These gains were excluded from our non-GAAP results.

On the expense side, under U.S. GAAP, normally the company reviews its goodwill annually in the fourth quarter unless events in an interim period indicate that goodwill may be impaired, in which case a review of impairment occurs in that interim period. As a result of the pending transaction with the CME Group, GFI has taken a noncash, pretax goodwill impairment charge on its brokerage and clearing businesses for $121.6 million in the second quarter. The remaining goodwill on our books relates to Trayport and FENICS.

Our non-GAAP results also excludes $2.4 million of expenses related to the amortization of acquired intangibles, $3.3 million for professional fees related to the pending transaction, and $2.3 million of modification of stock awards and other compensation arrangements for departing executives.

Our SEF cost related to startup and compliance for the second quarter of this year was approximately $2 million compared to $300,000 in the second quarter last year, and $2.5 million in the first quarter of '14. Our cash earnings per share for the second quarter of 2014 is $0.15, compared to $0.22 in the same period last year. This non-GAAP performance metric is reconciled on our Investor Relations website.

On a trailing 12-month basis, we generated adjusted EBITDA of $107.8 million compared to $118.5 million in the same period in 2013. The reconciliation of GFI's adjusted EBITDA is included in our Investor Relations website and adjust GAAP net income for interest, taxes, depreciation, amortization, non-GAAP items and the non-cash amortization of our RSUs and sign-on bonuses.

Our balance sheet continues to be strong. And our cash position, which includes cash and cash equivalents, clearing cash, but excludes client money, was $231 million at the end of June of this year, compared to $227 million at the end of December in 2013.

GFI's total balance sheet cash per share was $1.83 at the end of June of this year, compared to $1.84 at the end of December of 2013.

The number of weighted average diluted shares for the quarter ended June 30, 2014 were 124.9 million shares on a GAAP basis and 130.9 million shares on a non-GAAP basis. The number of actual shares outstanding at the end of June of this year was 126.5 million shares.

For the second quarter, the company has amended its bank covenants such that the goodwill impairment charge has no impact on covenant compliance. The amendment states that the consolidated capital must exceed $375 million, plus any goodwill or asset impairment charge taken in the second quarter through the fourth quarter of this year. This amendment was effective for the quarter ending June 30, 2014. GFI remains in compliance with all its bank covenants. Currently our consolidated capital must be greater than $253 million, and we're at $310 million. Leverage ratio cannot exceed 3x, and we are at 2.3x. And our fixed charge must be greater than 1.4x, and we're currently at 1.6x.

That concludes my remarks. Now I will turn the presentation back to Colin for some closing comments.

Colin Heffron

Thank you, Jim. GFI's second quarter non-GAAP revenue results echoed those of the broader OTC enlisted markets. Muted volatility across asset classes, low interest rates, higher capital requirements and ongoing regulatory changes have reduced trading activity. Despite difficult trading conditions, matching session revenues continued to grow in fixed income products, and we are seeing increased usage in financial products. We will continue to push our matching protocols globally.

We remain focused on reducing and adjusting expenses to become more variable in nature. These efforts are highlighted by lower brokerage compensation, as a percentage of brokerage revenue and a lower sign-on and retention bonus expense in the second quarter of 2014. We will continue to seek efficiencies in both the front and back offices.

Thank you for your time and attention today. We are now ready to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Niamh Alexander of KBW.

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

If you could, just the process for the sale, just walk me through the process and your thoughts on if there were others involved and whatnot. And then talk to me about, specifically as well, taking the inter-dealer broker private, how you think about the valuation of the business there.

Colin Heffron

Niamh, I guess -- the company will be filing a proxy statement in the coming months in relation to the transaction with all the details. I ask that you refer to that document when filed for all the relevant information about the transaction and the process.

Operator

Our next question is from Chris Donat of Sandler O'Neill.

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

I guess I want to ask about the pending transaction. So just looking at your brokerage revenues and the geographic mix, the United States -- or America, sorry, was down 24%, the lowest revenue number I have on record. Anything particular you'd point there? Is there more of an equity component in that mix or anything related to the evolving SEF status that's having an effect on Americas revenue?

Colin Heffron

No. I think the basic story is that while commodities globally was only down 1%, it's very, very unbalanced because it was up significantly in Europe and down significantly in America. So that's really where you're going to see most of that America decline.

Christopher R. Donat - Sandler O'Neill + Partners, L.P., Research Division

Okay. And I saw or read the statement last night, heard again today about the -- where July was volume-wise, but just with the market activity yesterday, I have an opinion -- I think Mickey said in the past, basically, there's a view that there's good volume -- or good volatility and bad volatility and sometimes in a -- a negative hit can be -- have negative implications for volumes going forward. Just any comments about for your general view on volume and volatility given what we've seen this week?

Colin Heffron

Sure. I agree with Mickey that, who's here, by the way. There's good volatility and bad volatility, but I think yesterday's volatility, while I haven't seen any results globally or any numbers, we'd probably refer to as good volatility. I mean, bad volatility, we -- just as anecdotally is when you're north of 25%, 35%. Or you're sustained back in the end of '08 or '09 when it was -- got way too high in the 60s and 70s. When the VIX was there, it kind of shuts down the markets. But in terms of some decent unemployment numbers, some increased wages that came out last week, that's probably good volatility. It starts to offer more of an idea of maybe the curve will change and interest rates will rise. And you could see the equity markets opened up lower, and so I would describe that as good volatility. If we saw a sustained amount of that, I'd be pretty content.

Operator

Our next question is from Michael Wong of MorningStar Equity Research.

Michael Wong - Morningstar Inc., Research Division

Though it's implied, since the strategic transaction includes a private consortium buying the wholesale brokerage, I just want to generally confirm that the private consortium supports the deal?

Colin Heffron

Can you explain the question again?

Michael Wong - Morningstar Inc., Research Division

I mean, on just -- though the private consortium is buying the wholesale brokerage and it seems like it's pretty integral to the transaction, I just want to generally confirm that the private consortium supports the deal.

Colin Heffron

Yes.

Michael Wong - Morningstar Inc., Research Division

Okay. And will the private consortium or the eventual wholesale brokerage include the electronic trading businesses like CreditMatch?

Colin Heffron

Yes.

Michael Wong - Morningstar Inc., Research Division

Okay. And I guess my final question, is there any advantage to becoming a private brokerage? And do you think that will change the inter-dealer industry dynamics at all?

Colin Heffron

One minute, please.

James A. Peers

Well, I think that will -- I would refer to the proxy statement and everything else and read the documents that had been filed yesterday. I think that spells it out there.

Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Mark Brazier for any closing remarks.

Mark Brazier

Thank you, Emily. This concludes the GFI Group's Second Quarter 2014 Earnings Conference Call. Thank you, all, for joining us this morning.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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GFI Group (NYSE:GFIG): FQ1 EPS of $0.01 misses by $0.01. Revenue of $218.1M (-10.0% Y/Y) misses by $5.73M.