Earnings Call Transcript - BGC Q2 2022

Operator, Operator

Welcome to the BGC Partners, Inc. Second Quarter 2022 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to the speaker today, Jason Chryssicas, Head of Investor Relations. Thank you, and please go ahead.

Jason Chryssicas, Head of Investor Relations

Good morning, everyone. We issued BGC's second quarter 2022 financial results press release and presentation summarizing these results this morning. You can find these at ir.bgcpartners.com. Please note you can find additional details on our quarterly results in today's press release and investor presentation. Unless otherwise stated, the results provided on today's call compare only the second quarter of 2022 with the prior year period and compare revenue excluding insurance due to its sale on November 1, 2021. 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 our liquidity, which we define as cash and cash equivalents plus marketable securities that have not been financed, reverse repurchase agreements and securities owned, less securities loaned and repurchase agreements. We define total capital as redeemable partnership interest, total stocks equity and noncontrolling interest in subsidiaries. This quarter, BGC is providing revenue year-over-year comparisons on a constant currency basis. BGC generates a significant amount of its revenue in non-U.S. dollar-denominated currencies, particularly in the euro and pound sterling in order to present a better comparison of the company's revenues during the period, which exhibited volatile foreign exchange movements. BGC's constant currency movements assume foreign exchange rates used to determine the company's prior period revenues applied to the current period revenues. Please also see today's press release for results under generally accepted accounting principles, or GAAP. Please also see the relevant sections in the back of today's press release with the complete and updated definitions of any non-GAAP terms, reconciliations of these items to the corresponding GAAP results and how, when and why 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 presentation. We refer to the company's technology-driven business as Fenics. Fenics offerings include Fenics Markets and Fenics Growth platforms. I also remind you that information regarding our business on today's call that are not historical are forward-looking statements. These include statements about the effects of the COVID-19 pandemic on the company's business results, financial position, liquidity and outlook. Any forward-looking statements involve risks and uncertainties. And except as required by law, BGC undertakes no obligation to update forward-looking statements. Any outlook and targets discussed on this call assume no material acquisitions, buybacks, extraordinary 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 to such risk factors and special note on forward-looking information contained in subsequent reports on Form 10-K, Form 10-Q or Form 8-K. With that, I'm now happy to turn the call over to Howard Lutnick, Chairman of the Board and CEO of BGC Partners.

Howard Lutnick, Chairman & CEO

Thank you, Jason. Good morning, and thank you for joining us for our second quarter 2022 conference call. With me today are BGC's Chief Operating Officer, Sean Windeatt; and our new Chief Financial Officer, Jason Hauf. I would like to start by welcoming Jason to BGC, and welcoming him to his first BGC conference call as our new CFO. I am pleased to announce that the Joint Committee of our independent directors of the Board, which was constituted to consider the conversion to a corporate structure has agreed to pursue and move forward with the corporate conversion subject to documentation. This conversion is intended to be effective January 1, 2023, subject to the regulatory process. We believe this change will improve operational efficiencies and benefit our shareholders and stakeholders by implementing a more simple, transparent corporate structure. BGC's adjusted earnings margin continued to improve, representing the seventh consecutive quarter of year-over-year margin expansion. Our sustained margin improvement reflects higher levels of automation and digitization across our overall business. Fenics registered another quarter of double-digit revenue growth, outpacing the industry and our overall business. Fenics now represents over 25% of our overall revenues, its highest mark ever. We continue to make progress developing our comprehensive cryptocurrency offering, which includes the expansion of Lucera's infrastructure across the cryptocurrency ecosystem as well as the recently announced plans for a cryptocurrency exchange, which we anticipate will be launched late in the fourth quarter or early in the first. Additionally, BGC arranged the first intermediated block trade of CME Bitcoin options in Asia in July. With that, I'll turn the call over to Jason.

Jason Hauf, CEO

Thank you, Howard, and hello, everyone. It is a pleasure to speak here today and join BGC at such an interesting time in the company's journey of digitizing the wholesale capital markets. BGC generated total revenue of $435.8 million, a decline of 4.9% compared to last year. However, on a constant currency basis, we were virtually flat when excluding insurance. Total revenue would have been $19.9 million higher and in line with the previous year's figures if not for the strengthening of the U.S. dollar. By asset class, FX and rates increased by 2.1% and 0.5%, respectively, while equities, energy and commodities, and credit decreased by 4.2%, 10.8%, and 15.6%, respectively. On a constant currency basis, rates, FX, and equities increased by 7.3%, 3.4%, and 1.4%, respectively. By geography and excluding insurance, revenue from the Americas increased by 4.5%, while revenues from Europe, the Middle East and Africa, and Asia Pacific decreased by 8.9% and 9.8%, respectively, compared to last year. The company continues to make progress in automating its overall business. Fenics, BGC's higher-margin technology-driven business, now represents for the first time over 25% of BGC's total revenue, growing at a strong pace of 13% or 18.1% on a constant currency basis. The company remains focused on converting its large Voice/Hybrid revenue base to Fenics revenue, thereby driving margins higher. Adjusted earnings margins and average front office productivity both improved year-over-year for the seventh consecutive quarter. Fenics generated record second quarter revenue of $109.6 million, representing an increase of 13% or 18.1% on a constant currency basis. Fenics growth platforms recorded revenue of $12.4 million, an improvement of 16.9% or 18.6% on a constant currency basis. Fenics Markets generated revenue of $97.2 million, an increase of 12.5% or 18% on a constant currency basis and achieved a pretax adjusted earnings margin of 32.2%, an improvement of 243 basis points. Moving on to expenses, our compensation and employees' benefits under both GAAP and adjusted earnings decreased in the second quarter of 2022 due to increased automation, the sale of the insurance brokerage business, lower commission revenues, and the FX impact on the company's U.K. and European operations. Our adjusted earnings compensation as a percentage of total revenue was 48.4%, which was over 400 basis points lower compared to a year ago. Our non-compensation expenses under GAAP and adjusted earnings decreased by 10.1% and 10.4%, respectively, driven by lower occupancy and equipment expenses resulting from the sale of our insurance brokerage business, as well as reductions in professional and consulting fees, interest, and communication expenses. These expense reductions were partially offset by increased selling and promotion charges as COVID-19 restrictions eased in many major geographies where we operate. Regarding our adjusted earnings, our pretax income was $90.2 million with a margin expansion of 168 points to 20.7%. We recorded post-tax adjusted earnings of $84.7 million, generating a second quarter adjusted EBITDA of $113.9 million. In terms of share count, our weighted average share count increased 0.8% sequentially to 507 million, down 10.1% year-over-year. Our fully diluted spot share count as of June 30 decreased 0.4% sequentially to 500.7 million. Compared to a year ago, BGC's fully diluted spot share count has decreased by 38.6 million or by 7.2%. During the second quarter, we repurchased and redeemed 9.7 million Class A common shares and units, with the majority of this activity occurring in the latter part of the period, which is nearly reflected in the fully diluted weighted average share count under both GAAP and adjusted earnings. Share and unit issuance has typically been the greatest in the second quarter due to the timing of year-end bonus awards. As of June 30, our liquidity was $535 million compared with $594.8 million as of year-end 2021. The change in our liquidity reflects payments for year-end bonuses, tax payments, acquisitions, new hires, and share and unit repurchases and redemptions. Cash and cash equivalents stood at $496.5 million versus $553.6 million as of December 31, 2021. Notes payable and other borrowings were $1,051 million compared with $1,052.8 million at year-end. Total capital was $747.1 million compared with $682.1 million as of year-end 2021. Additionally, we expect to provide more information on the estimated tax rate, synergies, and other efficiencies related to our intended corporate conversion in our next earnings call.

Sean Windeatt, COO

Thanks, Jason, and good day, everyone. Fenics, our technology-driven higher-margin business, continued to grow strongly. Our Fenics strategy remains focused on converting the company's $1.4 billion Voice/Hybrid revenue base into higher-margin technology-driven Fenics markets revenues while also scaling its advanced fully electronic Fenics growth platforms, which include FMX and electronic cryptocurrency offerings. Looking at Fenics in more detail, our Fenics Growth platform's revenue increased 16.9% or 18.6% on a constant currency basis from a year ago, driven by growth in Fenics U.S. Treasuries, Lucera, Fenics FX, Fenics GO, and Portfolio Match. Fenics UST revenues rose over 30%, aided by a 22% increase in ADV, new product offerings, and more traders using the platform. The market share for Fenics U.S. Treasury CLOB increased 162 basis points year-over-year to 19% in the second quarter. Fenics UST's newer T-bill offerings gained traction during the quarter with ADV exceeding $1 billion for June and reaching $3 billion on certain days. Lucera, our infrastructure and software business, experienced robust double-digit revenue growth with a 25% year-over-year increase. This growth stemmed from acquiring new clients, expanding existing relationships, and introducing new cryptocurrency clients. Lucera is offering connectivity to 30 of the world's leading crypto liquidity pools through its premier infrastructure, with a growing pipeline. Fenics FX, our ultra-low latency electronic FX trading platform, achieved another record quarter, generating significant volume growth of 47%, which surpassed performances by other FX platforms and the overall market. Fenics FX has developed superior transaction costs, liquidity, and market impact tools, providing clients with essential information unique to the platform. These trading tools, coupled with the technological support from Lucera, have accelerated Fenics FX's market share gains and led to consistent double-digit volume growth throughout the year. Fenics GO, our global options electronic trading platform, expanded its market share mainly due to robust growth across its Asian index business. For the first six months of 2022, Fenics GO's revenues and volumes have already significantly exceeded its total performance for 2021. Portfolio Match, our session-based credit matching platform, continued to gain traction during the quarter, with revenue more than doubling compared to a year ago. Portfolio Match currently supports U.S. and European investment-grade credit and European high yield. The platform is scaling its client base while rolling out new technology to fully automate the entire credit trading process. Regarding Fenics markets, revenues grew by 12.5% or 18% on a constant currency basis, driven by strong growth in FX, credit, and market data. Fenics market data signed 60 new contracts in the second quarter, with total contracted value increasing by 27% from a year ago. There is strong demand for its regulatory interest rate, inflation, and FX data packages, with additional products to be introduced throughout the year. Fenics market data, which operates on a highly recurring and compounding subscription revenue model, grew over 17% year-over-year. Fenics Direct, our web-delivered multi-dealer FX options platform, saw ADV grow by 95% in the second quarter compared to the previous year. Fenics Direct's volume has more than quadrupled since the second quarter of 2020, driven by onboarding new clients and evolving client demand for electronic FX options trading. Fenics MIDFX, the leading wholesale FX hedging platform, continued to see strong client demand in the second quarter, with its Asian NDF offering achieving a 54% increase in ADV as clients seek the efficient risk-neutral qualities that the platform provides. Our Voice/Hybrid business generated revenues of $326.2 million, down 9.7% or 5.5% on a constant currency basis, excluding insurance, due to the ongoing transition of Voice/Hybrid to Fenics markets revenue. The recent shift in Central Bank monetary policies away from zero interest rates, amid the highest inflation in decades, has paved the way, starting in 2023, for a resurgence in secondary market trading volumes in rates, credit, and foreign exchange, where we hold leading positions. We expect the current rising interest rate environment will create an uneven market for the industry over the next two or three quarters, with some product categories seeing significant growth while others face short-term challenges as key market participants adapt to rising interest rates. This performance has been evident across various asset classes during the quarter. For instance, we saw strong growth in short-term interest rate products, government bonds, interest rate options, U.S. investment-grade credit, spot FX, and LatAm FX. While the rising interest rate environment has presented near-term challenges for businesses, including longer-dated interest rate swaps, European credit, G10 FX forwards, Central European FX options, and even inflation products, we anticipate that these will rebound strongly next year. Now, looking ahead to our third quarter 2022 outlook, BGC's revenues were approximately 1.8% lower for the first 20 trading days of the third quarter compared to the same period last year, excluding insurance. We expect to generate total revenue between $395 million and $445 million, or $412 million to $462 million on a constant currency basis, compared to $422.1 million last year, which excludes $51.6 million of insurance revenue. This guidance reflects ongoing FX headwinds for the euro and pound sterling. So far this quarter, both the euro and pound sterling are tracking over 13% lower against the U.S. dollar compared to the year-ago period. We anticipate pretax adjusted earnings to fall within the range of $73 million to $93 million compared to $79.1 million, and we expect our full year 2022 adjusted earnings tax rate to be between 8% and 10% versus 6.4% for the full year 2021. Now, I would like to turn it back to Howard for closing remarks.

Howard Lutnick, Chairman & CEO

Thank you, Sean. We are in deep discussions with our bank and trading partners for our FMX business. We look forward to announcing their investments before we open in the fourth quarter of 2022. We are proud that Fenics now represents over 25% of our overall revenue, enabling us to expand our margins and productivity for 7 consecutive quarters, a trend we expect to continue. With that, operator, we're happy to open the call for questions.

Operator, Operator

Our first question today comes from the line of Gautam Sawant from Credit Suisse.

Gautam Sawant, Analyst

Congratulations on the C-corp conversion announcement. I wanted to know if you could potentially expand on the FMX platform launch with the 2 new additions to the Board there and how you think about which partners are going to come on board to help build treasury volumes and interest derivative volumes?

Howard Lutnick, Chairman & CEO

Sure. So we added 2 extremely experienced professionals to the Board as we prepare the process of opening our Futures initiative at the end of this year. We are talking to a number of banks, and there are more than 5 banks and a few high-frequency trading firms. Our objective would be in the range of more than 5 and less than 10 partners as we go into this opening. Our expectation is we will have more than 5 and a maximum of 10 partners, but we are talking to basically those who trade the most and those who are most committed to our platform. This is very exciting since the fourth quarter is not that far away, since we're already in the third quarter, we're heading to its conclusion. We're working on the details with the CFTC. We're working through the details with LCH. This is connecting and making sure we're connecting all of the trading firms. The fact is our treasury system is connected to virtually everybody. It's not everybody. And we're on the path. So we are very excited about the prospects and really dotting Is and crossing Ts towards its opening.

Gautam Sawant, Analyst

And can you just provide an update on your economic outlook and how you see, I guess, inflation trending and potentially what kind of volumes or trading the treasury market should, I guess, be pursuing over the next 6 to 12 months with quantitative tightening starting? Is that going to be happening more on coupon bonds or treasury bills?

Howard Lutnick, Chairman & CEO

Zero interest rates created an odd market environment. And with that, finally being in our rearview mirror, we expect volumes across the rates and credit and foreign exchange product categories to start to grow materially and consistently going forward. The process to get from here to there over the next 2 or 3 quarters, as we said in our prepared remarks, might be uneven for certain product categories. For example, the fact that inflation-related bonds volumes were lower this quarter. You would say, 'Oh, come on. Man, how could inflation be lower?' The fact is it's idiosyncratic through the violent swings that have happened in inflationary expectations and some market participants have not done as well as others, and therefore, that creates sort of unusual short-term volume swings. But our expectation, of course, is that inflation-based products will have dramatic and exciting growth prospects going forward, as I think what everybody would agree. So I think we think coupons will be dramatically continuing to grow. So we like benchmarks, which will continue to grow and issuance will continue to grow, and we like trading of those products. Treasury bills going from 5 basis points to 285 basis points. I mean, now you have a reason to trade treasury bills. When they were 5 basis points, really, what was the volume reason to trade treasury bills? There was no reason. Just as a simple example for you. In 2007, the volume of corporate bonds traded was 2.5x larger in 2007 than it was in 2021. That is a factor of low interest rates, just reducing volumes because just the reason to trade is lower. As those reasons dissipate because rates come back into our world, I think you're going to see an improved outlook for our business in general, rates in particular, credit, in particular, and foreign exchange, in particular, you're going to see those businesses improve, starting in '23 in a more smooth way and thereafter.

Operator, Operator

The next question today comes from the line of Rich Repetto from Piper Sandler.

Rich Repetto, Analyst

Howard and team, I apologize for joining late. My first question is about the corporate conversion. I apologize if this has already been discussed. I know you expect synergies, but can you explain the balance of the synergies compared to what might be a more normalized tax rate?

Howard Lutnick, Chairman & CEO

Yes. We will provide more detailed information on our next quarterly call. Essentially, our recent acquisitions have resulted in corporate partnerships that lead to inefficient capital structures and significant audit and accounting work across our platform. We anticipate that simplifying these structures will generate synergies and capital efficiencies that we can leverage, which should help alleviate, to some extent, the anticipated increase in our tax rate. While we believe that the synergies from simplification and capital efficiency will largely offset the impact on the tax rate, they will not eliminate it entirely.

Rich Repetto, Analyst

I have a question regarding the profitability of Fenics markets, which I understand has a pretax margin in the range of 30% or slightly more. I'm curious about the growth platforms and the investments being made there. Can you discuss the margin trajectory? I realize that there have been additional investments related to crypto in these growth platforms. Do you have any insights on when they might reach breakeven?

Howard Lutnick, Chairman & CEO

We are currently investing in our Futures initiative and our crypto exchange initiative, both of which are not yet operational. These two initiatives are part of our growth platform category, which is where we are allocating funds. We anticipate that profit margins and growth will exceed 50%. We expect these to operate as fully electronic markets, with technology and sales being the main drivers in clearing costs. Based on our analysis of other similar fully electronic platforms, we foresee profit margins for this product category exceeding 50%.

Rich Repetto, Analyst

And one last question. Regarding FMX or the Futures Exchange, could you provide more information about the team you’re building and the Board that is being assembled along with the ownership? I understand you plan to make a comprehensive announcement when everything is finalized. However, can you share any insights into the composition of the potential investors for FMX now that you are disclosing Board members?

Howard Lutnick, Chairman & CEO

We are engaged in in-depth discussions with the key trading banks in the rates sector. Additionally, we are in talks with several high-volume, high-frequency trading firms. These discussions are progressing and we anticipate finalizing them before we launch our business. In terms of the major trading banks, we are considering all of them, from top to bottom, as they are actively involved and interested. While I cannot guarantee a specific outcome, the situation feels promising, which is why we are discussing it this way.

Operator, Operator

Thank you. That concludes today's question-and-answer session. I would now like to pass the conference back over to Mr. Lutnick for closing remarks.

Howard Lutnick, Chairman & CEO

So we appreciate you joining us. We look forward to updating you further on our corporate conversion next quarter with more details. We look forward to the announcement of our partners in FMX between now and the end of the year. And we look forward to an ever-improving underlying set of economic conditions for this company. As rates have come back in, imagine 15 years of 0 interest rates finally being behind us, and now we will have an ordinary set of markets starting in 2023 in which to perform our services. If you want to look back at who we were before interest rates went to 0 in the whole Lehman Brothers world, you will see a much, much larger company because volumes were just much bigger back then. It will raise all boats, but BGC has great, great businesses in rates, credit and foreign exchange, and we expect to be a wonderful beneficiary of those sets of changes. We look forward to speaking to you next quarter and updating you along the way. Thank you, everybody.

Operator, Operator

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.