Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Newmark third quarter 2018 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers remark, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I will now turn the call over to Jason McGruder, Head of Investor Relations. Sir, you may now begin.
Thank you, operator. Good morning. We issued our third quarter 2018 financial results press release and a presentation summarizing these results this morning. You can find these documents at ir.nmrk.com. Unless otherwise stated, the results provided on today's call compare only the third quarter of 2018 with the year earlier period. We will be referring to results today only on an adjusted earnings basis unless otherwise stated. We may also refer to adjusted EBITDA. Please see today's press release results under generally accepted accounting principles or GAAP. Please see the sections in the back of today's press release for the complete definitions of any such non-GAAP terms, reconciliation of these items to the corresponding GAAP results, and how, when, and why management uses them.
I also remind you that information on this call regarding our business that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934 as amended. Such statements involve risks and uncertainties. Except as required by law, Newmark undertakes no obligation to update any forward-looking statements. For a discussion of additional risks and uncertainties which could cause actual results to differ from those contained in forward-looking statements, see Newmark Securities and Exchange Commission filings, including, but not limited to, risk factors set forth in our most recent Form 10-K, Form 10-Q, or Form 8-K filings. I am happy to turn the call over to our host, Howard Lutnick, Chairman of Newmark Group Inc.
Thank you, Jason. Good morning, and thank you for joining us for Newmark's third quarter 2018 conference call. With me today are Newmark's CEO, Barry Gosin, our Chief Operating Officer, James Ficarro, and our Chief Financial Officer, Michael Rispoli. Newmark had another strong quarter, generating approximately 30% growth in revenues, adjusted EBITDA, and post-tax adjusted earnings. Our quarterly pre-tax earnings and post-tax earnings per share would have been approximately $6 million higher or $0.02 a share, respectively, absent the decline in Nasdaq stock price since August. Because we established the downside redemption value related to these expected earn-outs for 2019 through 2022 while retaining all the potential upside, our cash position will only be the same or better with respect to Nasdaq over the next four years. I am pleased to report that the company's board of directors declared a dividend for the third quarter of $0.09 per common share.
We expect our dividend to remain consistent for each of the four fiscal quarters of 2018. In addition, we recently received our credit ratings and continue to make progress towards the planned spin-off, which BGC intends to complete by the end of 2018. Mike will provide more details a little later on in the call. With that, I'll turn it all over to Barry.
Thank you, Howard. Good morning. The company had a great quarter, producing strong top-line growth across leasing, investment sales, mortgage brokerage, multifamily agency origination, servicing, valuation and advisory, management services, and global corporate services. Over 90% of Newmark's revenue growth for the quarter and year-to-date was organic. Our market share gains in the quarter were fueled by a 14% improvement in revenue per producer, and a 13% increase in the number of front office employees, both compared with a year earlier. As we continue to increase productivity and add to our revenue-generating headcount, we expect to gain further market share, grow our revenues and profits, and create value for our investors. U.S. office and industrial market conditions held steady during the third quarter. As absorption strengthened, vacancies continued to decline. Rental rates rose moderately in many markets.
Retail continues to lag, we view it as an opportunity following its pullback. Industry multifamily volumes were strong quarter-over-quarter as this property type has attracted the highest sales volumes for the past six quarters, surpassing office. National investment sales volume recorded its highest quarterly total since the fourth quarter of 2015, with volumes up 17%. In comparison, Newmark's investment sales volumes were up 20% year-over-year. Industry-wide leasing activity remains strong in many markets throughout the country. Our multifamily agency originations increased by 87%, which compares favorably with the combined increase of 3% reported by the GSEs. Given our strong pipeline of financings, we expect our full-year origination volumes to grow compared to last year, taking into consideration the $2.2 billion deal in the second quarter of 2017. With that, I'm happy to turn the call over to Mike.
Thank you, Barry. Good morning, everybody. Newmark generated overall revenues of $518.8 million, an increase of 30.3%. Our compensation expenses increased 17.3% to $291.1 million, while non-compensation expenses increased 44% to $123.6 million.
As a percentage of revenue, compensation expenses represented 56.1% in the third quarter versus 62.3% in the same period a year ago. Non-compensation expenses for adjusted earnings include the additional $21.1 million of pass-through expense related to ASC 606. Excluding these items, non-compensation expenses for adjusted earnings increased by approximately 19% in the third quarter of 2018 and would have represented 20.6% of revenues versus 21.5% a year earlier. More than 70% of our overall expenses are variable in nature and tied directly to revenue. Because of the seasonality of commercial real estate revenues, the first quarter generally has the lowest revenues and operating margin of the year. This seasonality is typically reversed in the second half of the year, making our third and fourth quarters our most profitable. Turning to our quarterly earnings. Our adjusted EBITDA improved by 30.7% to $204.6 million, a 39.4% margin.
Our pre-tax adjusted earnings for the quarter were up by 23.5% to $177.6 million, a 34.2% margin. This represents a slight year-over-year decrease in margin, which was largely due to the additional $21.1 million of pass-through expense related to ASC 606. Our tax rate for adjusted earnings was 13.3% for the quarter versus 18% a year earlier. Our tax rate declined due to the U.S. Tax Cuts and Jobs Act. Our post-tax earnings increased 29.9% to $153.5 million. Our post-tax earnings per share increased 15.7% to $0.59. Newmark's fully diluted weighted average share count for the quarter was 185.1 million for GAAP and 262.5 million for adjusted earnings. The GAAP weighted average share count excluded certain share equivalents in order to avoid anti-dilution. The year earlier weighted average share count for adjusted earnings was $230.9 million.
Newmark had no statistics for GAAP earnings per share prior to our IPO in the fourth quarter of 2017. Newmark's fully diluted share count increased mainly due to the first quarter 2018 sale to BGC of approximately 16.6 million units for $242 million, or $14.57 per unit. We generated income from Nasdaq in the third quarter of $84.9 million and expect to receive the shares in November. I would like to take a moment to discuss the Nasdaq monetization transactions. As a result of the Nasdaq transactions, our total equity increased by approximately $325 million, including the receipt of $266 million of cash and the value of the forwards. The transactions established the downside redemption value of the Nasdaq shares for the 2019 through 2022 earn-outs while maintaining all the potential appreciation above the applicable strike prices.
In addition to these monetized Nasdaq shares, Newmark expects to receive an additional approximately five million Nasdaq shares, which are worth more than $400 million based on yesterday's closing price. The consolidated balance sheet does not yet reflect these shares because the payments are contingent upon Nasdaq generating at least $25 million in gross revenues annually. Nasdaq generated gross revenues of approximately $4 billion in 2017 and net revenues of $2.4 billion. We used the proceeds from these transactions to pay down $266 million in debt. As a result, our net debt, which we define as unsecured debt less cash and cash equivalents, improved to approximately 1x trailing 12-month adjusted EBITDA. Our target for net debt to adjusted EBITDA is to remain below 1.5x. Moving on to the balance sheet. As of quarter end, our cash and cash equivalents were $70.6 million. Restricted cash was $261 million.
Our unsecured debt was $546.5 million, including the $112.5 million of intercompany borrowings we used to call the 8.125% retail notes. Total equity was $1.0124 billion. Subsequent to the end of the third quarter, Newmark withdrew $252 million of restricted cash that had been pledged for the benefit of Fannie Mae and used that cash to repay intercompany debt. Net of all acquisitions and hiring, we expect to add at least $80 million to our cash position, bringing total cash expected at the end of the fourth quarter to at least $150 million, all else equal. We believe that the combination of lower long-term debt, increased total equity, and improving adjusted EBITDA has significantly strengthened Newmark's balance sheet and further solidified our credit ratios. Now I'd like to provide an update on Newmark's expected spin.
As Howard stated, today we received a standalone BBB- stable credit rating from Fitch and a BB+ stable rating from S&P. We have a strong credit profile based on our earnings and adjusted EBITDA growth, net debt to adjusted EBITDA ratio of one times, the remaining $400 million of unencumbered available Nasdaq payments, and the $405 million of mortgage servicing rights value carried on our balance sheet at amortized cost, which are worth an additional $40 million at fair value. Newmark's credit metrics, together with our target net leverage ratio of 1.5 times or less, compare favorably to our full-service real estate peers. In addition, we announced earlier this morning our intention to commence an offering of senior unsecured notes subject to market conditions and other factors.
The company intends to use the net proceeds from the offering to repay outstanding debt owed to BGC, thus completing the additional steps necessary for the tax-free spin-off to occur. Although the spin-off is subject to certain conditions, BGC expects to announce the record date for the distribution upon the successful completion of Newmark's debt offering. BGC expects to complete the spin-off in a reasonable time thereafter, but no later than the end of 2018. With that, I'm happy to turn the call back over to Barry.
Thank you, Mike. Our updated full year outlook is as follows. We expect to generate revenues of between $1.975 billion and $2.025 billion, or an increase of 24%-27% compared with last year. We continue to anticipate our 2018 tax rate for adjusted earnings to be in the range of 12%-14%, versus 18% in 2017. We expect our 2018 earnings per share to be between $1.45 and $1.53 as compared to $1.15 last year, or an increase of 26%-33%. We estimate our adjusted EBITDA to be between $518 and $538 million, an increase of 39%-44% compared with 2017. Our full year 2018 outlook issued approximately three months ago assumed other income related to the Nasdaq payment of approximately $91 million based on that stock's August 1st, 2018 closing price of $91.39.
Newmark's updated outlook assumes other income of approximately $81 million related to the Nasdaq earn-out based on yesterday's closing price. Operator, we'd like to open the call for questions. Thank you.
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone keypad. We'll pause for a moment to compile the Q&A roster. Your first question comes from Jade Rahmani with KBW. Your line is open.
Thanks very much. The commercial real estate brokerage stocks are all off about 10%-20% over the last month, most are off over 20% the last three months. I wanted to ask if you could say anything about the 2019 outlook, just more broadly. With the Fed intent on raising rates further, I think investors are concerned that a few more rate hikes could tip the market into a softer environment in terms of transaction volumes and real estate prices. We're also seeing this play out in the residential housing market. Could you give any color on your confidence in the outlook for 2019 regarding transaction volume growth and leasing and what you're currently hearing from clients?
The categories of multifamily and industrial have a pretty good track. I mean, all the metrics look encouraging for those. The West Coast doesn't look like it's missing a beat. It's incredibly active. Certain markets, the Northwest, Southern California. Technology, the combination of content convergence with technology is really lighting a fire under the Southern California market. There are markets that are a little more pricey and a little more sensitive to cap rate changes and interest rate changes, there is a tremendous amount of liquidity. There's a lot of money. The U.S. is a safe place to invest. We continue to hire really great talent and win market share, perform better than the market. We know there are always a certain amount of headwinds in an interest rate increase environment. In some respects, the spreads have narrowed and liquidity is still there.
The interest of growing institutional investment in real estate is fueling the market for some time to come. Also, we have a big runway in the mortgage business, and our finance business is growing at a pretty rapid pace. We keep adding talent, opportunities. Our ability to provide structured finance. Financing is still important regardless of whether it's on investment sale occurs, you still need financing. In some cases, we're providing either mezzanine debt financing, other forms of structured finance. The amount of creativity we have built into our model, our understanding of the global Capital Markets is unique and robust, and we've been able to navigate and create value for clients who are concerned with exactly what you just said.
In terms of the tone from clients, are you hearing increased concerns from commercial real estate investors? I think some of the surveys have actually showed intentions to increase allocations next year. Any risks of deals getting pushed out beyond 4Q, delayed closings, retrades, et cetera?
We're seeing a lot of activity and a lot of interest.
Okay. Just turning to Newmark on a trailing 12-month basis. Your slides show an adjusted EBITDA margin of 25.7%. Just looking at the business mix, GSE multifamily, typically in the 30%-40% range, Capital Markets 20%-25%, and the other businesses leasing in the 10%-15% range. What do you think drives Newmark's higher margin than peers, given its business mix?
I think it's a couple things. Of course, we're leading with technology on the corporate side as opposed to some of the lower margin businesses, which we have less revenue in. That helps drive our margin higher. You can see we're driving our compensation ratios down over time, which is also helping increase our overall margins. You can see our non-comp as a % of revenue is going down as well. As we're growing the business, we're consolidating and centralizing operations and squeezing more margin out of our businesses. I think when you put all those things together, plus the mix of business, that's what allows us to maintain a bit of a higher margin than some of our peers.
In terms of your cash flow expectations, just wondering if you could share an outlook for the fourth quarter and for the full year. I think year to date, you're at $134 million of operating cash, which is about 11% of revenue, excluding non-cash MSR gains and what we estimate for client pass-through costs. Any expectation for the full year?
We've said that we expect to end the year with more than $150 million of cash on the balance sheet. We have $70 million at the end of the third quarter. We're going to generate $125 million roughly for the fourth quarter in terms of adjusted EBITDA. We'll be generating significant amounts of cash flow. We'll still look to continue to reinvest in the business. I think what you've seen through three quarters is we've invested roughly $84 million in continuing to hire talent. We've announced recently in the quarter some acquisitions, which is a use of cash. We'll continue to generate significant amounts of cash flow, and we'll continue to look to invest, and generate 15-plus % returns on those investments.
Is the $150 million of cash by year-end before or net of additional hiring and acquisitions?
That would be at least $150 after all of our hiring and acquisition that we expect to do in the fourth quarter.
Okay. Thanks very much.
You're welcome.
Your next question comes from the line of David Ridley-Lane with Bank of America Merrill Lynch. Your line is open.
Good morning.
Morning.
Good morning. Wondering what the percentage of Capital Markets transactions in the multifamily space were financed by Berkeley Point or Newmark in the third quarter, or if you have that data for year to date.
We were 19%, around approximately.
That's up significantly from where we started the year. If you remember, we started around 13% last year, and we've been hovering around the high teens this year as we expect to continue to drive that up towards the roughly 40% we expect over time.
Got it. Based on your progress to date in hiring in the Capital Markets sales offices, could you give us a little bit more details or color around the timeline in reaching that 40% conversion goal?
Look, we continue to make improvement. An example might be New York, where we have our multifamily people completely embedded with our debt people. Where that happens, our capture rate is even higher than the 40%, way higher than the 40% we had used as our suggested glide path too. It's really a function of some of it's physical and leases and consolidating and getting people used to each other. I think we're making good progress every quarter.
Got it. Last question from me. Mike, could you help walk through the sort of puts and takes on the pro forma balance sheet? Because there's a few moving parts. You're going to withdraw restricted cash to repay the intercompany loans. Did you give a dollar amount on that? Could you potentially size, I don't know if you can, the expected debt offering, what that approximately would be?
Sure. We withdrew $252 million out of the restricted liquidity account, 100% of that was used to pay down intercompany debt. We have not given the size of the offering, certainly you can see our balance sheet and our outstanding debt. Our goal is to pay off all the related party debt, do the spin as quickly as we possibly can.
Thank you very much.
You're welcome.
Your next question comes from the line of Peter Christiansen with Citi. Your line is open.
Hey, guys. Good job. Just two quick questions. I know you mentioned that capital has been really strong, even though you're seeing narrow spreads. It seems like there's been more activity shifting from major metros to maybe secondary or even tertiary markets. How do you think Newmark is positioned in that situation regionally, to take advantage of that?
Actually, we're positioned pretty well. We're doing a lot of suburban portfolios now. Certainly in the multifamily space, that's historically been a big part of the Capital Markets business in the multi. It's getting bigger in the industrial side of things. There is capital moving to better opportunities to earn higher rates of return in the suburbs. It's an ebb and flow always in the suburbs, but we're doing fairly well. Some suburbs are doing better than others. We're pretty well positioned for that.
That's helpful, caller. Given the 30 basis points change in interest rates, on the transaction and leasing side, what are you seeing in terms of some of your inventory levels, and how is that impacting inventories?
Could you explain the question?
What are you seeing in terms of listings or impetus to transact, given the change in rates lately?
People are listing. In certain markets, the liquidity and the spread narrowing has overcome any change in the interest rates. In some markets, there has been a little bit of an impact and a little bit of a reticence to trade. Again, going to better opportunities to increase your IRR by going to industrial, going to the suburbs. People are moving capital around. You're seeing historically, traditionally, institutional investments are used to core investments are going to value-added and going to other, more creative opportunities and more risky. You're seeing foreign investors go into industrial and healthcare and other things that they wouldn't ordinarily go into. It actually opens the field a bit, creates more opportunity for investment sales as a combination of, and in aggregation.
Great. Have there been any changes on some of your hiring plans going forward, whether it be across certain segments of the business or just overall in general?
We have a very solid, clear strategy of hiring the best talent there is in the marketplace, in all the markets, in all the food groups. That will not change.
Okay. Thank you.
Again, if you would like to ask a question, please press star, then 1 on your telephone keypad. Your next question comes from Alexander Goldfarb with Sandler O'Neill. Your line is open.
Morning.
Morning.
Thank you. Morning. How are you guys? First, congrats on the announcement on the private placement, and then also on the rating agencies. Obviously, you guys worked hard to get here. Just a few questions on this. When we look at your balance sheet and your leverage, it looks pretty good. In our numbers, maybe 0.5-2 times debt to EBITDA certainly seems pretty low leverage. The ratings that you initially cited, BB+ from S&P and the BBB- from Fitch, just sound, I'm surprised a bit.
Just sort of curious, given how much work you guys have done on capital with the 2 Nasdaq transactions and other things this year, why did the ratings come out the way they did, and what were the key pushbacks that they cite, just given overall your business, at least from where we sit, doesn't seem to be over-levered to warrant these ratings. Just curious on this.
Sure, Alex, this is Mike. You're right. We've done a tremendous amount of work in improving the credit metrics of the company. We've paid down more than $500 million of debt since the end of last year. We've increased our adjusted EBITDA by 30% year-to-date, and we're now at about one times net debt to EBITDA leverage. We think these are really strong credit metrics. Clearly very strong credit metrics that compare very favorably to our full-service peers. You see the credit ratings. You can read the reports and see why and how they view the company. We obviously view the company as an investment-grade company. We'll continue to strive to get S&P up to triple B minus over time. We've stated our leverage target at 1.5 times net debt to the EBITDA or less.
We will continue to run the business that way, and we'll continue to grow the business and just stay focused on growing and building a great company.
Mike, what were some of the things that they're pushing back on? Because you guys have been pretty consistent all year that, hey, we think we are investment grade, and it kept getting pushed back, and now we see this. What are some of the key points that they said, "Hey, Newmark, we don't like this feature." Is it like a volatile revenue stream, or is it the intercompany stuff? What were some of the things that are holding them up?
Sure. If you read the report, what they say is that the anchor rating is a BBB-, but they modify it down because of what they call unfavorable comparable ratings. Because we're not international, because we're smaller in size and scale, they've notched us down for those reasons. That's their discretion.
Okay. That seems to be weird. In REIT land, there are a lot of domestic-only companies, much smaller than you guys, who have better ratings. That just seems odd. I'll have to dig up that report and take a look at it. The next question is.
Great point, Alex. That is a great point, Alex.
Very a compliment. I'll treasure this.
Proud of you.
Listen, Barry, I'm proud of you, and I am proud that you're proud of me. The next question is on adjusted earnings for next year. In the press release, you guys talked about changing the way you're going to treat the equity comp on the exchangeability units, and now you're going to add back all of the equity comp. Can you just walk through what the practical impact on earnings is as we think about our 2019 estimates? Are we bumping it up a few pennies, taking it off a few pennies? Net, it's really not an impact because it's a deduction on one side, an add back in the other, so net, it's not something for us to really get too caught up in at this point.
Yeah, I wouldn't get too caught up on it. All we're really doing is for adjusted EBITDA, we add back all of our stock compensation today. For adjusted earnings going forward, we'll do the same. The component that was in adjusted earnings was relatively minor. When we do update the numbers, and start reporting that way in 2019, we'll obviously give you the exact amount of the impact for each period so that you can see it, but it's not going to be anything material.
Okay. From a growth perspective, we shouldn't expect any material change in whatever we're expecting for adjusted earnings growth.
Not at this time, no.
Okay. Thank you very much.
You're welcome.
Your next question comes from the line of Jade Rahmani with KBW. Your line is open.
Thanks very much. Just a couple of clarifying questions. Is the total amount of indebtedness to BGC currently $223.8 million based on the $475.8 million on slide 27, less the $252 million of restricted cash that was used to pay down debt?
Yeah. Let me try and break it down. The total number is $546.5 million. If you look at the balance sheet, there's $133,950,000 of what's called long-term debt. That debt is due to the banks, but guaranteed by BGC, so we'll repay that. The line below that is long-term debt payable to related parties. That's $300 million. That's due directly to BGC. Then within the current portion of payables to related parties, there's the $112.5 million that we borrowed from BGC during the third quarter to repay the 8% plus retail notes. If you add those three pieces together, that's $546.5 million.
Of which $252 million has already been repaid based on the restricted cash.
No. That is after the $252 million repayment.
Okay.
The $546.5 is what we owe today.
Okay. Just the current portion of payables related to parties on the balance sheet, it's $398 million, and in the slides, slide 27, it's $112.5 million. What's the difference between those two numbers?
It's the $252 million that we repaid. There's just some normal back and forth for some of the services that are provided from the parent. All of that will be paid as normal course of business.
The $112.5 million that's on that slide 27, current portion of debt payable to related parties, that's after the $252 million? Because the slide says as of 9/30.
Yeah, it's both as of 9/30 and as of today. The $546.5 is the amount that we owe back to BGC for long-term debt.
Got it. Okay. Thanks very much.
You're welcome.
Your next question comes from Patrick O'Shaughnessy with Raymond James. Your line is open.
Good morning. A question about the RKF acquisition. I know there was some stuff written during the quarter about maybe it was taking longer to close or the talent wasn't coming over as you had expected. Can you maybe clarify on the talent and the expected revenues from that business? And is it consistent with your expectations when you announced the deal?
Well, in all of our acquisitions, we have at least 70% of the brokers signing contracts long-term. When you do that, 70% creates a halo, and that's usually very close to 100%, because the senior people who produce and originate yield work for other people that get paid on it. It's consistent with what we had bought.
Got it. Maybe another macro question for you, Barry. I think there's maybe some concern now with rates moving up, you're going to start to see cap rates move up, and we haven't really seen that to date. Would your expectation be that cap rates start moving up, or is there just so much money on the sidelines and so much interest in commercial real estate that you think they'll actually remain relatively stable?
We see money coming from all over. If you look at the market this year, the Chinese have been somewhat absent and replaced by the Canadians. The Japanese are very interested in the U.S. Look at the returns that you can get in Japan. Returns look pretty good. We have a lot of room to hit the returns in Japan. They put their first foot in by buying stock in real estate companies, then doing joint ventures. They're now starting to look directly at real estate again as an alternative to investing in their local market where they can. There's enormous amount of interest in real estate in the U.S. At some point, the cap rates will have more of an impact. At the moment, the levels of change hasn't been significant enough to make that that much of a difference.
Got it. Maybe one last one from me. Once the debt raise and the spin-off process are complete, and you turn your focus to 2019, should we be thinking about you guys maybe looking to expand internationally in 2019, or is that still maybe a few years away?
I can't really say at this time. We have plenty of white space in the U.S. We have even more white space in Europe, Middle East, and Asia. That's an opportunity for us, and a runway. We're excited about that.
Okay. Thank you.
There are no further questions at this time. Barry Gosin , I turn the call back over to you.
All right. I want to thank you all for joining us today. We look forward to speaking to you again next quarter.
Thanks, everyone.
Thank you. This concludes today's conference call. You may now disconnect.