BGC Group, Inc (BGC) Q3 2020 Earnings Report, Transcript and Summary

Hello, and welcome to the BGC Partners Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Jason Chryssicas, Head of Investor Relations. Please go ahead.

Good morning. We issued BGC's third quarter 2020 financial results press release and the presentation summarizing these results earlier this morning. You can find these at ir.bgcpartners.com. We know you can find additional details on our quarterly results in today's Press Release and Investor Presentation. Unless otherwise stated, the results provides on today's call, compared only the third quarter of 2020 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. We may refer to 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 non-controlling interest in subsidiaries. Please see today's Press Release for results under Generally Accepted Accounting Principles or GAAP. Please also see the relevant section in the back of today's Press Release for the complete and updated definitions of any non-GAAP items, reconciliations of these items to the corresponding GAAP results and how and why and when management uses such terms. Additional information with respect to our GAAP and non-GAAP results mentioned on today's call is available on our website at ir.bgcpartners.com and in our Investor Relation's Presentation. We refer to the company's fully electronic businesses as Fenics, these offerings include our fully electronic brokerage products as well as the sale of market data, software solutions and post-trade services. I also remind you that the information regarding our businesses on today's call that are not historical are forward-looking statements. These include statements about the effects of COVID-19 pandemic on the company's businesses, results, financial position, liquidity and outlook. Any forward looking statements involve risks and uncertainties, except as required by law, BGC undertakes no obligation to update any forward-looking statements. Any outlook and target we discussed on this call include no material acquisitions, buybacks, ordinary transactions or meaningful changes to the company's stock price. 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 SEC filings including, but not limited to, the Risk Factors and special note on forward-looking information set forth in these filings and any updates with such Risk Factors and special note on forward-looking information contained in the subsequent reports on Form 10-K, Form 10-Q and Form 8-K. With that, I'm happy to now turn the call over to Howard Lutnick, Chairman of the Board and CEO of BGC Partners.

Good morning and thank you for joining us for our third quarter 2020 conference call. Joining me virtually for today's call are BGC's Chief Operating Officer, Sean Windeatt; and our Chief Financial Officer, Steve Bisgay. We've made excellent progress this quarter with respect to our investments. Our Fenics brokerage revenues grew by double-digits for the second consecutive quarter. Fenics UST and Fenics GO, two of our newer fully electronic offerings, reached record levels of market share, and our insurance brokerage group is positioned to turn profitable for the fourth quarter and for the full-year of 2021. You can see these improvements as they come through our fourth quarter guide. The investments we've made in our comprehensive integrated and standalone electronic platforms leave us well-positioned to capture market share across our businesses. We view the macro trends of accelerated adoption of electronic trading, record levels of global debt issuance, and the hardening insurance market; will drive positive fundamentals for our business. In the third quarter BGC generated strong revenue growth of 20% and 9% in its Fenics and insurance brokerage businesses respectively. As a result of these improvements, we expect to match last year's fourth quarter earnings, even in this tougher market environment. We view our stock as demonstrably undervalued, as our earnings return to 2019 levels in the fourth quarter, while our current stock price is over 50% below where it was last year. So with that, I'd like to turn the call over to Sean Windeatt.

Thank you, Howard, and good day everyone. Our Fenics business continued to demonstrate strength and resilience, high performing, a challenging macro trading backdrop in the third quarter. Fenics US Treasuries and Fenics GO, two of our newer fully electronic offerings reached record levels of market share in their respective markets. In the span of just two years, Fenics US Treasuries has rapidly grown in its position to the clear number two amongst Central Limit Order Book trading platform, with an estimated 13% market share in September. Fenics US Treasuries generated substantial growth year-over-year with notional volumes up by approximately 86% year-to-date compared to a 4% increase in overall primary dealer treasury volumes. Fenics US Treasuries is estimated to have saved our clients approximately $115 million since January 2019, by offering the tightest spreads in the market. As a result of our continued technological innovations, and strong client support, we expect both volumes and market share to continue to outperform the overall market. Our Fenics GO fully electronic options trading platform more than tripled its volumes since the first quarter of 2020. Fenics GO platform went live in Euro Stoxx 50 options just over a year ago and live in Nikkei 225 options in the first quarter of this year. In this short time, we estimate Fenics GO now commands over 6% and 13% market share in Euro Stoxx's 50 and Nikkei 225 front-month block-sized options, respectively. Month-to-date in October, Fenics GO has already surpassed its previous monthly record volume. The state-of-the-art technology and trading protocols underpinning these platforms were designed to scale across products and asset classes. We plan to leverage these platform investments as we introduce new products such as Repos, NDF, and EGBs to drive full electronic growth across our businesses. Our data, software, and post-trade businesses, which are predominantly comprised of recurring revenue, grew by more than 17%. This strong performance was driven by Lucera's Connect platform winning new SaaS client contracts and the acquisition of Algomi. Lucera has a fully built scalable infrastructure that provides clients electronic trading connectivity with their counterparties within two days, as opposed to months and at a significantly lower cost. Lucera Connect is quickly becoming the industry standard for the FX market. Algomi is a DC credit marketplace for bank streaming to buy-side funds and provide the buy-side aggregated access to float bank liquidity. M: As we continue to electronify significant parts of our business, profitability and margin profile are expected to continuously improve. With that I'm now happy to turn the call over to Steve Bisgay.

Thank you, Sean, and hello everyone. Our insurance brokerage group grew it's brokerage revenues by 9% this quarter driven by new hires in aviation and reinsurance. Peak, our aerospace insurance brokerage business achieved a significant milestone by winning Rolls-Royce as a client during the quarter. We expect around 20% top-line growth in this business next quarter to over $50 million as previous front-office hires and newly launched business lines increased productivity. Furthermore, our insurance brokerage group has reached its size and scale. We're expected to be profitable for the fourth quarter and improve BGC's bottom-line by over $25 million in 2021 compared to 2020. Moving on to Fenics. This quarter BGC's quarterly GAAP pre-tax earnings would have been $18.4 million higher but for the impact of our continued investment in our standalone Fenics offerings and insurance brokerage business. As we expand our product offerings, optimize our commercial agreements, and add new clients across our electronic platforms, we continue to expect profitability in our newer Fenics stand-alone businesses, which includes Fenics UST, Fenics GO, and Lucera, to improve by $40 million and collectively break-even next year. This improvement in Fenics, combined with the $25 million improvement in insurance brokerage profitability, will drive overall pre-tax adjusted earnings and adjusted EBITDA at least $65 million higher in 2021, all else equal. This is a further increase of $15 million above what we expected last quarter. Moving to our quarterly results. Starting with our revenues by geography: Europe, Middle East and Africa revenues declined by 11.8%; the Americas were down by 15.7%; while Asia-Pacific revenues declined by 10.4%. In terms of expenses, we remain focused on reducing our cost base to improve margins. Our compensation expenses under adjusted earnings decreased as a result of lower commissionable revenues as well as our $35 million cost reduction program. Our non-compensation expenses decreased primarily due to lower selling and promotion expenses. The decline in selling and promotion expenses was due to a continued focus on tighter cost management as well as the obvious impact of the COVID-19 pandemic. The decrease in these expenses was partially offset by an increase in interest expense, driven by the $300 million of 3.75% Senior Notes due 2024 and the $300 million of 4.375% Senior Notes due 2025, less lower interest expense on a revolving credit facility, which would be paid in full during the quarter. Moving on to our adjusted earnings. Our pre-tax income was $69.2 million compared with $87.7 million. Our post-tax earnings were $61.9 million or $0.11 per share compared with $77.3 million or $0.15 per share. Turning to share count. Our fully diluted weighted average share count increased by 3.9% to 549.2 million under adjusted earnings in the third quarter of 2020. As of September 30, 2020, our spot share count was 548.1 million, an increase of 0.3% sequentially. We expect to use relatively more cash with respect to compensation and acquisitions to minimize dilution. We still expect our 2020 year-end fully diluted share count to increase by approximately 4% to around 550 million. With respect to our balance sheet, as of September 30, 2020, our liquidity was $549.1 million compared with $473.2 million as of year-end 2019. Notes payable and other borrowings were $1,318.5 million compared with $1,142.7 million and total capital was $825.9 million compared with $767.4 million. The quarter end balance sheet figures reflect the issuance of $300 million of 4.375% Senior Notes due 2025 to pay down our revolving credit facility in full, $44 million of tender 5.125% Senior Notes due May of 2021, and on ordinary movements in working capital. And with that, I'm happy to turn the call back over to Howard.

Thank you, Steve. Turning to our outlook for the fourth quarter of 2020 as compared with a year earlier, BGC's revenues were approximately 4.4% lower year-on-year for the first 17 trading days of the fourth quarter of 2020. We are beginning to see evidence of a return to growth. For example, in the first 17 trading days of the fourth quarter of 2020, our Asia-Pacific revenues have increased around 5% and Continental Europe is running up over 10%. These represent our first regional increases in revenue since the start of the pandemic. So looking forward for the fourth quarter, we expect to generate total revenues between $440 million and $490 million and that compares with $487.2 million. We anticipate pre-tax adjusted earnings to be in the range of $65 to $85 million that's compared to $73.2 million. And we anticipate our full-year 2020 adjusted earnings tax rate to be in the range of 10% to 12% and that compares to 11.4% for the full-year of 2019. Beginning at the end of December, we will be modifying the way we update guidance. Going forward, we plan to either affirm our quarterly guidance range or provide an update if we expect the results to be above or below the previously guided range. With that, operator, we'd like to open the call for questions.

Thank you. We will now begin the question and answer session. [Operator Instructions]. Our first question comes from Rich Repetto of Piper Sandler. Please go ahead.

Yes. Good morning, Howard and Sean and Steve. So the first question is on Fenics. The intercompany revenues went down as quoted a 14 million the data, software, post-trade revenues intercompany. So that's the first time it's been, it went down 30%. I think the first time it's been down below the 20 million think a little in the past four or five quarters. So can you give a little color or feedback what's going on there?

Sure, Rich. It's Sean here. You may remember in the past that we said as the revenue moves into our -- into fully electronic which is, of course, what we want to say the -- we said there will be some revenue or we will go from the intercompany into fully electronic as it becomes fully electronic revenue that that has happened. And then secondly, it's also remember Fenics provides the technology trading for our voice businesses and when the voice business is a fractionally lower by definition as a percentage, the -- that that business or that line is fractionally lower as well.

So the electronic revenue, then -- I'm sorry -- the electronic revenue of Fenics in a company which isn't broken out as intercompany anymore. Does that -- can you give us a feel for how much that is?

No, so, so again -- so two -- there is two parts to the intercompany is where the, our technology platform, Fenics company provides the technology for our voice side with business and for that charges a fee. And then that's number one. So, of course, that would go down if the revenues of our businesses declined, and our revenues fractionally declined in the -- in the third quarter. Equally though, our aim is as we discussed before, as those voice hybrid revenues become electronic revenues, they -- those revenues move into our electronic brokerage design as we convert that voice business into electronic. And so you see increases in our electronic revenue line. So it's a mixture of those two.

Okay. All right. And then, I guess, another question how -- like you make a good point about how earnings are on par with last year, but the stock price is down materially. The one big difference is also is there's no dividend now compared to last year. So any updates that you have on the capital return policy -- I know you've talked about year-end, but do you see that as a difference too? And what can we -- is there anything you can update us on that?

Hey, Rich, it's Steve Bisgay. The Board is currently considering its cap return policy and we will be prepared to discuss that in our next conference call. But one point where the note is at historically, as you're aware, the firm has been entirely dividend focused. And as part of our planning, we will definitely consider evaluating share buybacks as part of our capital return policy, but we will have more to say certainly next quarter.

Okay. And I guess the last question is, it looks like your net debt is up about $100 million year-to-date and it doesn't seem like it's capturing all the cash, the pay downs of the revolver, et cetera. I was just wondering whether you could just walk through cash flows on that you paid down debt and why isn't the net debt higher than that $99 million or so year-to-date?

Well, we have -- our total liquidity is up, it's up to about $550 million, well, $549 million, so it's certainly up significantly year-to-date. We did do a tender, as you know, of $44 million to $45 million this quarter, that's a part of it. We paid down the revolver entirely as well. The $30 million note that we took was effectively a pre-funding for the May 2021 that are coming due. So bear in mind that's -- that the case as well.

[Operator Instructions]. Our next question comes from Patrick O'Shaughnessy of Raymond James. Please go ahead.

Hey, good morning. To build off of that last question from Rich, Steve, so maybe to lay it on different way, year-to-date adjusted earnings have been a little bit more than $240 million, net debt increased by about $100 million so that is directly $340 million of cash flow in, dividends from distributions year-to-date I think have been around $90 million. So what are some of the other big uses of your cash flow year-to-date?

Well, it's definitely CapEx, there's no question about that. On a quarterly basis we average roughly $20-ish million of CapEx. We have continued to -- although we're turning the corner, as we've said, certainly on -- we're looking towards profitability for the insurance business and historically has been a bit of a drag, no question about that. And as had our investment in Fenics, well, that also is turning the corner as well. So we're looking very much forward to much shorter cash generation as planned going forward.

Got it. And then speaking of the insurance brokerage business, you've mentioned that you've done some hiring to build that up. Has there been a lot of signing bonuses paid up front to those folks to bring them on board?

Yes. Pat, when we hire big producers with long-terms they often have upfront payments have them sign their long-term contracts. So, yes, that has historically been our model and that is our model here and as those profits turn, the business will be cash flow positive and be able to grow using its own cash and contributing to the cash of the company. So we are -- that investment period has been significant in the past few years, but it's really a good feeling to be in the fourth quarter and to say that that has turned as of now. And literally in the fourth quarter, the company will be profitable. And we expect, as Steve said, it to be $25 million more positive than it was in 2019. So the turn from 2019 to 2020, from 2020 to 2021 will be an improvement of $25 million. And so we can continue to grow that business, invest in these people. As you said, hiring talented producers for the long-term and do that on the profits of the business, which is now driving. So I think we're in an excellent position to grow that business.

Got it. And then, as we think about modeling our cash flow expectations for next year, would you expect any moderation in terms of the upfronts to higher producers or your capital expenditures or it's just kind of a good run right to be thinking of.

Okay. I think it's actually -- it's probably a reasonable run rate to think of, as we continue-- that we continue to hire great producers, both in our -- in our insurance, and in our financial services business. So I think it's a good run rate to think of for the time being.

Got it. And then, so you guys -- you brought up that Fenics plus insurance brokerage business is expected to provide an incremental $65 million of EBITDA in 2021 relative to 2020. Last quarter, that was an incremental $50 million. So where did that incremental $15 million that you're speaking to this quarter come from?

Came from both improvements in our expectation of insurance and improvements in our expectations of benefits actually, both -- both the numbers have improved and therefore, we feel good about upping our expectation of -- of improvements from those two line items to our adjusted earnings and EBITDA for next year.

Is it more on the insurance brokerage front just because I think that the language for Fenics remained that it's going to be break-even next year. So I guess that implies that the incremental upside is more specific to insurance brokerage. Am I thinking about that the right way?

That is absolutely correct, Patrick. As I said, it is both but it is definitely more insurance at this point.

Okay. Got it. TP ICAP announced an acquisition of Liquidnet a few weeks back. Would you guys look at buying something like J. B. Moore buy-side connectivity? Obviously, we've just talked about cash and this other priorities for your cash, but strategically, how would you guys look at adding buy-side connectivity to what's historically been a interdealer business model?

I think we, we made a strategic acquisition granted comparatively small in Algomi which we talked about on the call, which is it allows banks to stream credit product to their clients, and allows and then we have an aggregator that we have that the buy-side can use to aggregate all the different seeds from the banks, and present it in an attractive app aggregated manner to the buy-side. And so that combination of banks driving their liquidity as to the buy-side and the buy-side, our provision of an aggregator to the buy-side is our way of growing that business. I think it leverages our position, leverages our network, and it drives our bottom-line. So I think the difference is we have all these pieces built and now we're going to -- we're just driving that business with -- we already are connected to all the banks, and the banks are helping us to add buy-side clients. The Algomi had a substantial number of buy-side clients on it. They just didn't have the bank connectivity which we had. So that that combination, I think bodes well for us. And so, no, we're not -- I don't think we have a big strategic acquisition like they have, but I think that you should not expect that from us. But I think you should expect us to pound forward with our strategy and I think you're going to see us perform -- you'll see us perform admirably over the coming year.

Okay. That makes sense. So this past quarter, the big banks all had another blowout quarter in terms of fixed income sales and trading and I totally get that. Your revenue doesn't necessarily correlate to their revenue because they have spreads and gains and other things that factor into that. But are there indirect effects on BGC and maybe I'm thinking in terms of bank capital available for trading, banks maybe being optimistic in hiring into their trading desks? Are there any kind of second order effects that you think are going to be beneficial to BGC?

Actually, yes. We have always viewed ourselves as sort of a rubber band against our clients when -- so, for instance, if the markets were horrible, then the volumes during the horrible period would be very high. But then the banks would lose money and then six months later, their volumes would be paired back because they -- they just are feeling that wings clip. And so when they have blowout quarters, we don't necessarily make money on those spread trades or math, but the strengthening of their feelings, the strengthening of the bank, the scale by which they're now willing to invest in trades only bodes well for our future. So we tend to be a six-month lag and so the next six months I think coming are good. The more the banks make, the more we grew from banks make, makes feel good they trade more and that's good for our bonds.

Got it. And then one last one from me. Within Fenics, the thing that stood out to me this quarter was the FX business and the revenues they were up about $6 million on a sequential basis. And I think that was despite volumes basically being flat in FX on a quarter-over-quarter basis. Was there anything unusual in one-time in your Fenics FX revenues or is this -- it was maybe just a positive mix shift and sustainable going forward?

The good news is it's the latter. There was nothing one-time in there, it is -- it's just there. I think, as we mentioned before, it's -- has a good asset class for us part of the business and is performed strongly this quarter.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Lutnick for any closing remarks.

Well, thank you for joining us today and we hope you stay safe and stay healthy. And we look forward to coming back and talking to you next quarter in the New Year. Thanks everybody. And we look forward speaking again soon.