ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of Newmark’s financial condition and results of operations should be read together with Newmark’s unaudited condensed consolidated financial statements and related notes, as well as the risk factors and the cautionary statements relating to forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), included in Newmark’s Annual Report on Form 10-K and in this report. When used herein, the terms “Newmark Knight Frank,” “Newmark,” the “Company,” “we,” “us,” and “our” refer to Newmark and its consolidated subsidiaries.
This discussion summarizes the significant factors affecting our results of operations and financial condition during the three and six months ended June 30, 2018 and 2017. This discussion is provided to increase the understanding of, and should be read in conjunction with, our unaudited condensed consolidated financial statements and the notes thereto included elsewhere in this report.
Overview and Business Environment
Newmark is a rapidly growing, high-margin, full-service commercial real estate services business. Since 2011, the year in which we were acquired by BGC Partners, Inc. (“BGC”), we have been the fastest growing U.S. commercial real estate services firm (when compared with our publicly traded U.S. peers), with a revenue compound annual growth rate of 36.8%. We offer a diverse array of integrated services and products designed to meet the full needs of both real estate investors/owners and occupiers. Our investor/owner services and products include capital markets, which consists of investment sales, debt and structured finance and loan sales, agency leasing, property management, valuation and advisory, commercial real estate due diligence consulting and advisory services and government-sponsored enterprise (which we refer to as “GSE”) lending and loan servicing, mortgage broking and equity-raising. Our occupier services and products include tenant representation, real estate management technology systems, workplace and occupancy strategy, global corporate consulting services, project management, lease administration and facilities management. We enhance these services and products through innovative real estate technology solutions and data analytics that enable our clients to increase their efficiency and profits by optimizing their real estate portfolio. We have relationships with many of the world’s largest commercial property owners, real estate developers and investors, as well as Fortune 500 and Forbes Global 2000 companies. For the six months ended June 30, 2018, we generated revenues of $897.1 million representing growth of 21.6%, versus the same period in the prior year.
We generate revenues from commissions on leasing and capital markets transactions, consulting and technology user fees, property and facility management fees, and mortgage origination and loan servicing fees.
Our growth to date has been focused in North America. We have more than 5,000 employees, including over 1,550 revenue-generating producers in over 120 offices in 90 cities. In addition, Newmark has licensed its name to 16 commercial real estate providers that operate out of 31 offices in certain locations, where Newmark does not have its own offices. Our partner, Knight Frank, operates out of nearly 300 offices.
The discussion of our financial results reflects only those businesses owned by us and does not include the results for Knight Frank or for the independently owned offices that use some variation of the Newmark name in their branding or marketing.
Over the past several years, we expanded our capital markets capabilities through the strategic addition of many prolific, accomplished capital markets brokers in key markets throughout the United States. We have access to many of the world’s largest owners of commercial real estate, and this will drive growth throughout the life cycle of each real estate asset by allowing us to provide best-in-class agency leasing and property management during the ownership period. We also provide investment sales and arrange debt and equity financing to assist owners in maximizing the return on investment in each of their real estate assets. Specifically with respect to multifamily assets, we are a leading GSE lender by loan origination volume and servicer, with a servicing portfolio of $58.9 billion as of June 30, 2018 (of which approximately 5.7% relates to special servicing). This servicing portfolio provides a steady stream of income over the life of the serviced loans. We have also begun a dramatic expansion of our valuation and appraisal business from which we expect to see significant growth, particularly in conjunction with our increasingly robust capital markets platform.
We continue to invest in the business by adding dozens of high profile and talented brokers and other revenue-generating professionals. Historically, newly hired commercial real estate brokers tend to achieve dramatically higher productivity in their second and third years with our company, although we incur related expenses immediately. As our newly hired brokers increase their production, we expect our commission revenue and earnings growth to strongly accelerate, thus reflecting our operating leverage. We expect our overall profitability to increase as we increase the size and scale of our business. Our pre-tax margins are impacted by the mix of revenues generated. For example, Gains from mortgage banking activities/originations, net, which includes revenues related to
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commercial mortgage origination, tends to have higher pre-tax margins than Newmark as
a whole. In addition, capital markets, which includes sales, commercial mortgage broking, and other real estate-related financial services, generally has larger transactions that occur with less frequency and more seasonality when compared with leasing ad
visory. Capital markets transactions tend to have higher pre-tax margins than leasing advisory transactions, while leasing advisory revenues are generally more predictable than revenues from capital markets. Property and facilities management, along with c
ertain of our other
Global Corporate Services (“
GCS
”)
products, generally have the most predictable and steady revenues, although pre-tax earnings margins for property and facilities management are at the lower end of those for our business as a whole. Whe
n management services clients agree to give us exclusive rights to provide real estate services for their facilities or properties, it is for an extended period of time, which provides us with stable and foreseeable sources of revenues. Newmark’s revenues
are balanced between businesses that are relatively less predictable and contractual sources that are very predictable. Approximately
67
% of our revenues and other income for the trailing twelve months ended
June 30
, 2018 were generated by our most predict
able and
highly visible
sources, including agency leasing, valuation, GCS, management services, income related to the receipt of Nasdaq shares, loan servicing
and
tenant representation leasing business. The remaining
3
3
% of revenues and other income
was
ge
nerated by our more transactional investment sales, mortgage broking, and GSE lending platforms.
Berkeley Point Acquisition
On July 18, 2017, BGC announced that it agreed to acquire Berkeley Point Financial LLC and its subsidiary (together referred to as “Berkeley Point” or “BPF”) from an affiliate of Cantor Fitzgerald, L.P. (“Cantor”). This affiliate of Cantor had acquired Berkeley Point on April 10, 2014. Berkeley Point is a leading commercial real estate finance company focused on the origination and sale of multifamily and other commercial real estate loans through government-sponsored and government-funded loan programs, as well as the servicing of commercial real estate loans, including those it originates. The acquisition of Berkeley Point was completed on September 8, 2017 (the “Berkeley Point Acquisition”). The total consideration for the Berkeley Point Acquisition was $875 million, subject to certain adjustments at closing.
On December 13, 2017, in connection with the Separation
(as defined below)
, the assets and liabilities of BPF were transferred to Newmark. This transaction has been determined to be a combination of entities under common control that resulted in a change in the reporting entity. Accordingly, our financial results have been recast to include the financial results of BPF in the current and prior periods as if BPF had always been consolidated. We believe that the addition of Berkeley Point will significantly increase the scale and scope of our business and generate substantial revenue synergies.
Initial Public Offering
On December 13, 2017, prior to the closing of Newmark’s initial public offering (the “IPO”); BGC, BGC Holdings, L.P. (“BGC Holdings”), BGC Partners, L.P. (“BGC U.S. OpCo”), Newmark, Newmark Holdings, L.P. (“Newmark Holdings”), Newmark Partners, L.P. (“Newmark OpCo”) and, solely for the provisions listed therein, Cantor and BGC Global Holdings, L.P. (“BGC Global OpCo”) entered into a Separation and Distribution Agreement (the “Separation and Distribution Agreement”). The Separation and Distribution Agreement sets forth the agreements among BGC, Cantor, Newmark and their respective subsidiaries regarding, among other things:
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the principal corporate transactions pursuant to which BGC, BGC Holdings and BGC U.S. OpCo and their respective subsidiaries (other than the Newmark Group (defined below), the “BGC Group”) transferred to Newmark, Newmark Holdings and Newmark OpCo and their respective subsidiaries (the “Newmark Group”) the assets and liabilities of the BGC Group relating to BGC’s Real Estate Services business (the “Separation”);
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the proportional distribution of interests in Newmark Holdings to holders of interests in BGC Holdings;
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the assumption and repayment of indebtedness by the BGC Group and the Newmark Group, as further described below;
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the pro rata distribution of the shares of Newmark Class A common stock and the shares of Newmark Class B common stock held by BGC (the “Distribution” or the “spin-off’), pursuant to which shares of Newmark Class A common stock held by BGC would be distributed to the holders of shares of Class A common stock of BGC and shares of Newmark Class B Common Stock held by BGC would be distributed to the holders of shares of Class B common stock of BGC (which are currently Cantor and another entity controlled by Howard W. Lutnick), which distribution is intended to qualify as generally tax-free for U.S. federal income tax purposes; provided that the determination of whether, when and how to proceed with the Distribution shall be entirely within the discretion of BGC; and
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other agreements governing the relationship between BGC, Newmark and Cantor.
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In connection with the Separation and the IPO, on December 13, 2017, the applicable parties entered into the following additional agreements:
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an Amended and Restated Agreement of Limited Partnership of Newmark Holdings, dated as of December 13, 2017;
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an Amended and Restated Agreement of Limited Partnership of Newmark OpCo, dated as of December 13, 2017, as amended;
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a Second Amended and Restated Agreement of Limited Partnership of BGC U.S. OpCo, dated as of December 13, 2017;
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a Second Amended and Restated Agreement of Limited Partnership of BGC Global OpCo, dated as of December 13, 2017;
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a Registration Rights Agreement, dated as of December 13, 2017, by and among Cantor, BGC and Newmark;
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a Transition Services Agreement, dated as of December 13, 2017, by and between BGC and Newmark;
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a Tax Matters Agreement, dated as of December 13,2017, by and among BGC, BGC Holdings, BGC U.S. OpCo, Newmark, Newmark Holdings and Newmark OpCo;
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an Amended and Restated Tax Receivable Agreement, dated as of December 13, 2017, by and between Cantor and BGC;
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an Exchange Agreement, dated as of December 13, 2017, by and among Cantor, BGC and Newmark;
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an Administrative Services Agreement, dated as of December 13, 2017, by and between Cantor and Newmark; and
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a Tax Receivable Agreement, dated as of December 13, 2017, by and between Cantor and Newmark.
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Newmark is a holding company with no direct operations and conducts substantially all of its operations through its operating subsidiaries. Virtually all of Newmark’s consolidated net assets and net income are those of consolidated variable interest entities. Newmark Holdings is a consolidated subsidiary of Newmark for which Newmark is the general partner. Newmark and Newmark Holdings jointly own Newmark OpCo, the operating partnership.
Immediately prior to the Separation, the limited partnership interests in Newmark Holdings were distributed to the holders of limited partnership interests in BGC Holdings, whereby each holder of BGC Holdings limited partnership interests at that time received a BGC Holdings limited partnership interest and a corresponding Newmark Holdings limited partnership interest, equal to a BGC Holdings limited partnership interest multiplied by one divided by 2.2 (the “contribution ratio”), divided by the ratio by which a Newmark Holdings limited partnership interest can be exchanged for a number of Newmark Class A common stock (the “exchange ratio.”) Initially, the exchange ratio equaled one, so that each Newmark Holdings limited partnership interest is exchangeable for one Newmark Class A common stock, however, the exchange ratio is subject to adjustment. For example, for reinvestment, acquisition or other purposes, Newmark has determined on a quarterly basis to distribute to its stockholders a smaller percentage than Newmark Holdings distributes to its equity holders (excluding tax distributions from Newmark Holdings) of cash that it received from Newmark OpCo. In such circumstances, the Separation and Distribution Agreement provides that the exchange ratio will be reduced to reflect the amount of additional cash retained by Newmark as a result of the distribution of such smaller percentage, after the payment of taxes.
On December 19, 2017, Newmark closed its IPO of 20 million shares of Newmark’s Class A common stock at a price to the public of $14.00 per share. A registration statement relating to these securities was filed with, and declared effective by, the U.S. Securities and Exchange Commission. In addition, Newmark granted the underwriters a 30-day option to purchase up to an additional 3 million shares of Newmark’s Class A common stock at the IPO price, less underwriting discounts and commissions (the “overallotment option”). Subsequent to the IPO, the underwriters exercised the overallotment option in full. Upon the closing of the overallotment option, which occurred on December 26, 2017, Newmark’s public stockholders owned approximately 9.8% of what was then Newmark’s 234.2 million fully diluted shares outstanding. Newmark received aggregate net proceeds of $295.4 million from the IPO, after deducting underwriting discounts and commissions and estimated offering expenses.
Accordingly, our financial results reflect the agreements discussed above related to the IPO. In addition, since the IPO, we have improved the credit profile of Newmark. The combination of our lower long-term debt and higher total equity have improved our credit ratios with specific regard to debt to equity. Newmark intends to continue to benefit from these strengths and
pursue its own credit rating. We aim to obtain an investment grade rating to assist us in refinancing our $659.7 million of long-term debt owed to or guaranteed by BGC.
On March 7, 2018, BGC Partners and its operating subsidiaries purchased 16.6 million newly issued exchangeable limited partnership units (the “Newmark Units”) of Newmark Holdings for approximately $242.0 million (“BGC’s Investment in Newmark”). The price per Newmark Unit was based on the $14.57 closing price of Newmark’s Class A common stock on March 6, 2018 as
50
reported on the NASDAQ Global Select Market. These newly-issued Newma
rk Units are exchangeable, at BGC’s discretion, into either shares of Class A common stock or shares of Class B common stock of Newmark. BGC’s Investment in Newmark was made pursuant to an Investment Agreement
,
dated as of March 6, 2018
,
by and among BGC,
BGC Holdings, BGC Partners, L.P., BGC Global Holdings, L.P., Newmark, Newmark Holdings and Newmark Partners, L.P. BGC’s Investment in Newmark and related transactions were approved by the Audit Committees and Boards of Directors of BGC and Newmark. BGC and
its
operating
subsidiaries funded BGC’s Investment in Newmark using the proceeds of BGC’s CEO sales program. Newmark used the proceeds to repay the balance of the outstanding principal amount under its unsecured senior term loan credit agreement with Bank
of America, N.A., as administrative agent, and a syndicate of lenders. In addition, upon the spin-off, the Newmark Units
then held by BGC Partners
will be exchanged into Newmark Class A or Class B common stock, and will be included as part of the Newmark
Distribution to holders of shares of
BGC
Class A or Class B common stock.
On
March 19
, 2018, Newmark and BGC Partners entered into an Amended and Restated Intercompany Credit Agreement (the “Intercompany Credit Agreement”) and on the same date Newmark borrowed $150.0 million from BGC pursuant to the facilities under the Intercompany Credit Agreement. On June 28, 2018, Newmark borrowed an additional $70.0 million under the Intercompany Credit Agreement. The interest rate as of June 30, 2018 was LIBOR plus 3.25%, or 5.31%, which may be adjusted based on the higher of BGC’s or Newmark’s short-term borrowing rate then in effect at such time plus 100 basis points, or such other interest rate as may be mutually agreed between BGC and Newmark. Newmark has transferred these proceeds to its restricted cash account pledged for the benefit of Fannie Mae. As of June 30, 2018, Newmark’s total net borrowings under the Intercompany Credit Agreement are $270.0 million.
BGC expects to pursue a distribution to its stockholders of all of the Class A shares common and Class B common shares of Newmark (collectively, the “Newmark common shares”) that BGC then owns in a manner that is intended to qualify as generally tax-free for U.S. federal income tax purposes. BGC has indicated that it intends to complete the necessary steps to achieve the spin-off by the end of 2018. As currently contemplated, shares of Class A common stock of Newmark held by BGC would be distributed to the holders of shares of Class A common stock of BGC, and shares of Class B common stock of Newmark held by BGC would be distributed to that holders of shares of Class B common stock of BGC. Key steps that Newmark plans to take towards the tax-free spin-off include: first, Newmark intends to attain its own credit rating; second, Newmark expects to repay or refinance its $659.7 million of long-term debt owed to or guaranteed by BGC; and third, Newmark expects to repay or refinance the $270.0 million of borrowings from BGC outstanding under the Intercompany Credit Agreement, of which $258.7 million is pledged for the benefit of Fannie Mae in excess of the minimum required balance. These steps are necessary for the spin-off to be tax free. Newmark’s management is currently in the process of pursuing its own credit rating.
Had the spin-off occurred immediately following the close of the second quarter of 2018, the ratio of Newmark common shares to be distributed in respect of each BGC common share would have been approximately 0.4647. However, the exact ratio of Newmark common shares to be distributed in respect of each BGC common share in the spin-off will depend on, among other things, the number of BGC common shares outstanding and the number of Newmark common shares (including Newmark common shares underlying units of Newmark OpCo) owned by BGC as of the record date of the spin-off. The spin-off is subject to a number of conditions, and BGC may determine not to proceed with the spin-off if the BGC board of directors determines, in its sole discretion, that the spin-off is not in the best interest of BGC and its stockholders. Accordingly, the spin-off may not occur on the expected timeframe, or at all.
Nasdaq Transaction
On June 28, 2013, BGC sold certain assets of its on-the-run, electronic benchmark U.S. Treasury platform (“eSpeed”) to Nasdaq, Inc. (“Nasdaq”). The total consideration received in the transaction included an earn-out of up to 14,883,705 shares of Nasdaq common stock to be paid ratably over 15 years, provided that Nasdaq, as a whole, produces at least $25.0 million in consolidated gross revenues each year. The earn-out was excluded from the initial gain on the divestiture and is recognized in income as it is realized and earned when these contingent events have occurred, consistent with the accounting guidance for gain contingencies (the “Nasdaq Earn-out”). The remaining rights under the Nasdaq Earn-out were transferred to Newmark on September 28, 2017. Any Nasdaq shares that were received by BGC prior to September 28, 2017 were not transferred to Newmark.
In connection with the Nasdaq Earn-out, Newmark received 992,247 shares during the year ended December 31, 2017. Newmark will receive a remaining earn-out of up to 9,922,470 shares of Nasdaq common stock ratably over the next approximately 10 years, provided that Nasdaq, as a whole, produces at least $25.0 million in gross revenues each year. In November of 2017, Newmark sold 242,247 shares of the 992,247 Nasdaq shares received. During the first quarter of 2018, Newmark sold an additional 650,000 Nasdaq shares and currently holds 100,000 as of June 30, 2018.
Exchangeable Preferred Partnership Units and Forward Contract
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On June 18, 2018, Newmark's principal operating subsidiary, Newmark OpCo, issued approximately $175 million of
exchangeable preferred limited partnership units ("EPUs") in a private transaction to The Royal Bank of Canada ("RBC") (the “Newmark OpCo Preferred Investment”). Net of transaction costs, Newmark received $152.9 million of cash during the three months end
ed June 30, 2018 with respect to this transaction.
The EPUs were issued in two tranches and are separately convertible by either RBC or Newmark, into a fixed number of
shares of
Newmark’s Class A common stock, subject to a revenue hurdle, in the fourth qua
rters of 2019 and 2020 for the first and second tranche, respectively. As the EPUs represent equity ownership of a consolidated subsidiary of Newmark they have been included as “Non-controlling interest” on the unaudited condensed consolidated statement of
changes in equity. The EPUs are entitled to a preferred payable-in-kind dividend, which is recorded as accretion to the carrying amount of the EPUs as “Retained earnings” on the unaudited condensed consolidated statement of changes in equity and included
in “
c
onsolidated net income (loss) available to common stockholders” for purposes of calculating earnings per share.
Contemporaneously with the issuance of the EPUs, a newly formed special purpose vehicle entity that is a consolidated subsidiary of Newmark, entered into two variable postpaid forward contracts with RBC (together, the "RBC Forward"). The RBC Forward provides the option to both Newmark and RBC for RBC to receive up to 992,247 shares of Nasdaq common stock, received by Newmark pursuant to the Nasdaq earn-out (see Note 6 – Marketable Securities), in each of the fourth quarters of 2019 and 2020 in exchange for either cash or redemption of the EPUs, solely at Newmark’s option. The Nasdaq Earn-Out is related to the BGC’s sale of its eSpeed business to Nasdaq, Inc. on June 28, 2013. The purchase consideration consisted of $750 million in cash paid upon closing, plus an expected payment of up to 14.9 million shares of Nasdaq common stock to be paid ratably over 15 years beginning in 2013, assuming that Nasdaq, as a whole, generates at least $25 million in gross revenues each of these years. In connection with the separation of Newmark from BGC, during the third quarter of 2017 BGC transferred to Newmark the right to receive the remainder of the Nasdaq earn-out payments.
As the RBC Forward provides Newmark with the ability to redeem the EPUs for Nasdaq stock, and the two instruments are not legally detachable, they represent a single financial instrument. The financial instrument’s EPU redemption feature for Nasdaq common stock is not clearly and closely related to the economic characteristics and risks of Newmark’s EPU equity host instrument and therefore, it represents an embedded derivative that is required to be bifurcated and recorded at fair value on the Newmark’s unaudited condensed consolidated statements of operations, with all changes in fair value recorded as a component of ”Other income (loss)” on Newmark’s unaudited condensed consolidated statements of operations.
Growth Drivers
The key drivers of revenue growth for U.S. commercial real estate services companies include the overall health of the U.S. economy, the institutional ownership of commercial real estate as an investible asset class and the ability to attract and retain talent. In addition, in our capital markets business growth is driven by the availability of credit to purchasers of and investors in commercial real estate. In our multifamily business, delayed marriages, an aging population and immigration to the U.S. are increasing a pressing need for new apartments, with an estimated 4.6 million needed by 2030, according to a recent study commissioned by the National Multifamily Housing Council and the National Apartment Association. This should continue to drive investment sales, GSE multifamily lending and other mortgage brokerage and growth in our servicing portfolio for the foreseeable future. Berkeley Point’s origination business is impacted by the lending caps imposed by the Federal Housing Finance Agency. As of June 30, 2018, the industry-wide caps are set at $70 billion, excluding loans exempt from the caps, such as loans in the affordable and underserved market segments, or that finance water and energy efficiency improvements. These excluded categories can make up a significant portion of the overall market. For example, in 2017, more than half of the loan production reported by Fannie Mae and Freddie Mac was excluded from the Federal Housing Finance Agency lending caps.
Economic Growth in the United States
The U.S. economy expanded at an annualized rate of 4.1% during the second quarter of 2018, according to a preliminary estimate from the U.S. Department of Commerce. This growth compares with an annualized increase of 3.0% during the second quarter of 2017. The consensus is for U.S. gross domestic product to expand by 2.5% and 1.8% in 2019 and 2020, respectively, according to a recent Bloomberg survey of economists. This moderate pace of growth should help keep interest rates and inflation low by historical standards.
The Bureau of Labor Statistics reported that employers added a monthly average of 230,000 net new payroll jobs during the second quarter of 2018, which was above the prior year period’s 190,000 and the seasonally adjusted average of 182,000 per month in 2017. Despite the return to pre-recession unemployment rates (4.0% as of June 2018), the number of long-term unemployed and the labor force participation rate (the latter of which is remains near a 30-year low) remained disappointing for many economists, but these indicators are less important to commercial real estate than job creation.
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The 10-year Treasury yield ended the
second
quarter of 2018 at 2.
86
%, up
approximately 56
basis points from the year-earlier date. In addition, 10-year Treasury yields
have remained well below their 50-year average of approximately 6.
4
%, in large part due to market expectations that the Federal Open Market Committee (“FOMC”) will only moderately raise the federal funds rate over the next few years. Interest rates are als
o relatively low due to even lower or negative benchmark government interest rates in much of the rest of the developed world, which makes U.S. government bonds relatively more attractive.
The combination of moderate economic growth and low interest rates that has been in place since the recession ended has been a powerful stimulus for commercial real estate, delivering steady absorption of space and strong investor demand for the yields available through both direct ownership of assets and publicly traded funds. Steady economic growth and low interest rates have helped push vacancy rates down for the office, apartment, retail and industrial markets over the current economic expansion, now in its ninth year. Construction activity, though it is ramping up, remains low compared with prior expansion cycles and low relative to demand and absorption, which means that property leasing markets continue to tighten. Overall, demand for commercial real estate remains strong. While the vast majority of new supply is going to just the top 10-15 markets, there is healthy demand among investors for well positioned suburban value add assets in secondary and tertiary markets, according to NKF Research. Asking rental rates posted moderate gains across all property types during 2017.
The following key trends drove the commercial real estate market during the second three months of 2018:
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Sustained U.S. employment growth and rising home values have fueled the economy and generated demand for commercial real estate space across all major sectors;
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Technology, professional and business services and healthcare continued to power demand for office space, although technology occupiers have turned more cautious;
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E-commerce and supply-chain optimization pushed industrial absorption to 32 consecutive quarters of positive net absorption, creating tenant and owner-user demand for warehouses and distribution centers;
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Apartment rents benefited from sustained job growth, and underlying demographic trends towards urban living among two key age groups: millennials and baby boomers; and
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Continued corporate employment growth, combined with increased leisure travel, generated demand for hotel room-nights.
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The recently enacted U.S. tax cuts could lift growth, along with leasing activity. Rising inflation and interest rates, a byproduct of faster growth, could deliver a mixed outcome: Rising interest rates could pressure cap rates, but stronger rent growth and sustained investor demand could support property values.
Market Statistics
Although overall industry metrics are not necessarily correlated to our, they do provide some indication of the general direction of the business. The U.S commercial property market continues to display strength as commercial property prices rose in primary markets, according to Real Capital Analytics (“RCA”). Demand for institutional quality product remains strong and cash available for investment in commercial real estate is plentiful. Institutional-grade U.S. commercial real estate capitalization rates have compressed by a further 10 basis points, tempering concerns related to rising treasury rates. On average, capitalization rates offered a 278 basis point premium over the 10-year Treasury yield in the second quarter, well above the pre-recession low of 165 basis points. Demand for commercial real estate is expected to reflect the steady expansion of the greater macro economy, which is benefiting from high levels of consumer spending and the prospect of larger corporate profits. The spread between local 10-year benchmark government bonds and U.S. cap rates was even wider with respect to major countries including Japan, Germany, the U.K. and France during the quarter, as has been the case since monetary easing programs were implemented in those countries, in response to the global financial crisis in 2007. The favorable rate spread coupled with the lack of available product at home, will continue to provide international groups with ample investment opportunities in the larger U.S market.
According to RCA, the dollar volume of property sales in the second quarter of 2018 totaled approximately $119 billion in the U.S, an increase of 2%. According to a May 2018 MBA forecast, originations of commercial/multifamily loans of all types are projected to be down 2% in terms of dollar volume for the year ended December 31, 2018. In comparison, our capital markets businesses, which includes investment sales and commercial mortgage brokerage, increased its second quarter revenues by approximately 7% year-over-year, primarily due to organic growth.
Our loan origination volumes are driven more by the GSE multifamily financing volumes than the activity level of the overall commercial mortgage market. During the three months ended June 30, 2018, GSE multifamily volumes increased 15% year-over-year. In comparison, our GSE and FHA multifamily loan origination volume decreased by 51.8% and our revenues from mortgage banking activities/originations decreased by 43.1%. The timing of these loan originations can often vary from period to period, which makes
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full year comparisons more meaningful. For example, in the first quarter of 2017, our loan originations were down by 5.2% year-on-year, while they were up by 177.2% in the second quarter of 2017, with the lat
ter due mainly to one large transacti
on
. Excluding this one transaction in the year ago period, our second quarter 2018 origination volume would have increased by approximately
6.7
%
year-on-year.
According to NKF Research, the combined average vacancy rate for office, industrial, and retail properties ended the second quarter at 7.3%, down from 7.4% a year earlier, and a 100 basis point drop over the past 12 months. Rents for all property types in the U.S. continued to improve across all 3 sectors. NKF Research estimates that while leasing activity remained strong in many markets throughout the country, overall U.S. leasing activity in the quarter slowed down from a year ago, as the expansion has decelerated in recent quarters following consistent growth since the start of the current cycle. In comparison, revenues from our leasing and other commissions business increased by 23%.
Regulatory Environment
See “Regulatory Requirements” herein for information related to our regulatory environment.
Liquidity
See “Financial Position, Liquidity and Capital Resources” herein for information related to our liquidity and capital resources.
Hiring and Acquisitions
Key drivers of our revenue are producer headcount and average revenue per producer. We believe that our strong technology platform and unique partnership structure have enabled us to use both acquisitions and recruiting to profitably increase our front-office revenue per producer.
We have invested significantly to capitalize on the current business environment through acquisitions, technology spending and the hiring of new brokers, salespeople, managers and other front-office personnel. The business climate for these acquisitions has been competitive, and it is expected that these conditions will persist for the foreseeable future. We have been able to attract businesses and brokers, salespeople, managers and other front-office personnel to our platform as we believe they recognize that we have the scale, technology, experience and expertise to succeed in the current business environment. See “Business—Our History” in Part I, Item 1 of our Annual Report on Form 10-K for a description of our acquisitions since 2012.
As of June 30, 2018, our producer headcount was 1,569 brokers and salespeople. For the six months ended June 30, 2018, average revenue generated per producer increased by 5% for the same period from a year ago to approximately $397,000. This growth can be attributed to increased sales and leasing activity and to the ramp up of brokers we hired over the past year.
On September 8, 2017, we completed our acquisition of Berkeley Point. Berkeley Point is principally engaged in the origination, funding, sale and servicing of multifamily and commercial mortgage loans.
Financial Overview
Revenues
We derive revenues from the following four sources:
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Leasing and Other Commissions
. We offer a diverse range of commercial real estate brokerage and advisory services, including tenant and agency representation, which includes comprehensive lease negotiations, strategic planning, site selection, lease auditing, appraisal services and other financial and market analysis.
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Capital Markets
. Our real estate capital markets business specializes in the arrangement of acquisitions and dispositions of commercial properties, as well as providing other financial services, including the arrangement of debt and equity financing, and loan sale advisory.
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Gains from Mortgage Banking Activities/Originations, Net.
Gains from mortgage banking activities/origination are derived from the origination of loans with borrowers and the sale of those loans to investors.
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Management Services, Servicing Fees and Other
. We provide commercial services to tenants and landlords in several key U.S. markets. In this business, we provide property and facilities management services along with project management and other consulting services, as well as technology, to customers who may also utilize our commercial real estate brokerage services. Servicing fees are derived from the servicing of loans originated by us as well as loans originated by third parties.
|
54
Fees are generally earned when a lease is signed in leasing. In many cases, landlords are responsible for paying the fees. In capital markets, fees are earned and recognized when the sale of a
property closes and title passes from seller to buyer for investment sales and when debt or equity is funded to a vehicle for debt and equity transactions. Gains from mortgage banking activities/origination, net are recognized when a derivative asset is re
corded upon the commitment to originate a loan with a borrower and sell the loan to an investor. The derivative is recorded at fair value and includes loan origination fees, sales premiums and the estimated fair value of the expected net servicing cash flo
ws. Gains from mortgage banking activities/origination, net are recognized net of related fees and commissions to affiliates or third-party brokers. For loans we broker, revenues are recognized when the loan is closed. Servicing fees are recognized on an a
ccrual basis over the lives of the related mortgage loans. We typically receive monthly management fees based upon a percentage of monthly rental income generated from the property under management, or in some cases, the greater of such percentage or a min
imum agreed upon fee. We are often reimbursed for our administrative and payroll costs, as well as certain out-of-pocket expenses, directly attributable to properties under management. We follow
accounting principles generally accepted in the U.S., or “U.S
.
GAAP
”
, which provides guidance when accounting for reimbursements from clients and when accounting for certain contingent events for Leasing and Capital Markets transactions.
(
See Note 3—Summary of Significant Accounting Policies
)
to our unaudited conden
sed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for a more detailed discussion.
Expenses
Compensation and Employee Benefits
The majority of our operating costs consist of cash and non-cash compensation expenses, which include base salaries, broker and producer commissions based on production, discretionary and other bonuses and all related employee benefits and taxes. Our employees consist of brokers and other commissioned producers, executives and other administrative support. Our brokers and other producers are compensated based on the revenue they generate for the firm, keeping these costs variable in nature.
As part of our compensation plans, certain employees have been granted limited partnership units in BGC Holdings and Newmark Holdings, which generally receive quarterly allocations of net income, that are cash distributed on a quarterly basis and that are generally contingent upon services being provided by the unit holders. As prescribed in U.S. GAAP guidance, the quarterly allocations of net income on such limited partnership units are reflected as a component of compensation expense under “Allocations of net income and grant of exchangeability to limited partnership units” in our unaudited condensed consolidated statements of operations.
Certain of these limited partnership units entitle the holders to receive post-termination payments. These limited partnership units are accounted for as post-termination liability awards under U.S. GAAP guidance, which requires that we record an expense for such awards based on the change in value at each reporting period and include the expense in our unaudited condensed consolidated statements of operations as part of “Compensation and employee benefits.” The liability for limited partnership units with a post-termination payout amount is included in “Accrued compensation” on our unaudited condensed consolidated balance sheets.
Certain limited partnership units in BGC Holdings are granted exchangeability into BGC Partners’ Class A common stock on a one-for-one basis (subject to adjustments and other requirements as set forth in the BGC Holdings limited partnership agreements). Certain limited partnership units in Newmark Holdings are granted exchangeability into Newmark Partners’ Class A common stock on a 1 to 0.9919 basis (subject to adjustments and other requirements as set forth in the Newmark Holdings limited partnership agreements). At the time exchangeability is granted, we recognize an expense based on the fair value of the award on that date, which is included in “Allocations of net income and grant of exchangeability to limited partnership units” in our unaudited condensed consolidated statements of operations.
We have also awarded preferred partnership units in BGC Holdings and Newmark Holdings. Each quarter, the net profits of BGC Holdings and Newmark Holdings are allocated to such units at a rate of either 0.6875% (which is 2.75% per calendar year) or such other amount as set forth in the award documentation, which is deducted before the calculation and distribution of the quarterly partnership distribution for the remaining partnership units in BGC Holdings and Newmark Holdings, respectively. The quarterly allocations of net income on these preferred partnership units are also reflected in compensation expense under “Allocations of net income and grant of exchangeability to limited partnership units” in our unaudited condensed consolidated statements of operations.
We have entered into various agreements with certain of our employees and partners whereby these individuals receive loans, which may be either wholly or in part repaid from the distribution earnings that the individual receives on their limited partnership interests in BGC Holdings and Newmark Holdings or may be forgiven over a period of time. The repayment of these loans is derived from a cash flow source already accounted for through partnership distributions at BGC U.S. OpCo, BGC Global OpCo and Newmark OpCo. The forgivable portion of these loans is recognized as compensation expense over the life of the loan or the estimated life of the partner.
55
From time to time, we may also enter into agreements with employees and partners to grant bonus and salary advances or other types of loans. These advances and loans are repayable in the timeframes outlined in
the underlying agreements. In addition, we also enter into deferred compensation agreements with employees providing services to us. The costs associated with such plans are generally amortized over the period in which they vest.
(s
ee Note 28—Compensation
and Note 29—Commitment and Contingencies
)
, to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.
Other Operating Expenses
We have various other operating expenses. We incur leasing, equipment and maintenance expenses. We also incur selling and promotion expenses, which include entertainment, marketing and travel-related expenses. We incur communication expenses, professional and consulting fees for legal, audit and other special projects, and interest expense related to short-term operational funding needs, and notes payable and collateralized borrowings.
We pay fees to BGC Partners and Cantor for performing certain administrative and other support, including charges for occupancy of office space, utilization of fixed assets and accounting, operations, human resources, legal services and technology infrastructure support. Management believes that these charges are a reasonable reflection of the utilization of services rendered. However, the expenses for these services are not necessarily indicative of the expenses that would have been incurred if we had not obtained these services from BGC Partners or Cantor. In addition, these charges may not reflect the costs of services we may receive from BGC Partners or Cantor in the future.
Other Income (Losses), Net
Other Income (Losses)
Other income is comprised of the gains associated with the earn-out shares related to the Nasdaq transaction and the movements related to the mark-to-market and/or hedges on marketable securities that are classified as trading securities. Additionally, other income included gains (losses) on equity method investments which represent our pro rata share of the net gains (losses) on investments over which we have significant influence but which we do not control.
Provision for Income Taxes
We incur income tax expenses based on the location, legal structure, and jurisdictional taxing authorities of each of our subsidiaries. Certain of the Company’s entities are taxed as U.S. partnerships and are subject to the Unincorporated Business Tax (which we refer to as “UBT”) in New York City. U.S. federal and state income tax liability or benefit related to the partnership income or loss, with the exception of UBT, rests with the partners (see Note 2 – Limited Partnership Interests) rather than the partnership entity.
Financial Highlights
For the three months ended June 30, 2018, Newmark’s total revenues increased by 15.2% as compared to the three months ended June 30, 2017. This improvement was led by a 58.1% increase in management services, servicing fees and other, an almost entirely organic 23.1% increase in leasing and other commissions, and a 6.9% increase in revenues from capital markets brokerage, offset by a 43.1% decrease in Gains from mortgage banking activities/origination, net. $24.5 million of the increase in management services, servicing fees and other related to additional pass-through revenues resulting from the adoption and implementation of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (as we refer to as “ASC 606” herein). Total expenses increased approximately $91.4 million to $440.6 million, due to a $41.2 million increase in allocations of net income and grant of exchangeability to limited partnership units, as well as a $30.5 million increase in compensation and employee benefit expenses. Operating, administrative and other expenses increased $20.6 million, of which $24.5 million is directly related to additional pass-through expenses resulting from the implementation of ASC 606.
For the six months ended June 30, 2018, Newmark’s total revenues increased by 21.6% as compared to the six months ended June 30, 2017. This improvement was led by a 58.4% increase in management services, servicing fees and other, a 24.0% increase in leasing and other commissions, and a 17.7% increase in revenues from capital markets brokerage, offset by a 32.0% decrease in Gains from mortgage banking activities/origination, net. $42.9 million of the increase in management services, servicing fees and other related to additional pass-through revenues resulting from the implementation of ASC 606. Total expenses increased approximately $178.6 million to $823.9 million, due to a $56.3 million increase in allocations of net income and grant of exchangeability to limited partnership units and a $68.0 million increase in compensation and employee benefit expenses. Operating, administrative and other expenses increased $48.7 million, of which $42.9 million is directly related to additional pass-through expenses resulting from the implementation of ASC 606. We believe that we gained market share in capital markets as we outpaced relevant industry volume metrics. Our growth has outpaced the overall market as we continue to hire high quality brokers, strategically acquire local and
56
regional firms and enhance our cross-selling capabilities across business lines as prior acquisitions and hires become more acclimated to th
e platform.
We expect our revenues and earnings to grow over time as we continue to invest in our business and to reap the benefits from our recent acquisitions and front-office hires. We
believe that our stock price does not accurately reflect the more th
an $
725
million of additional Nasdaq shares (based on the
August
1
, 2018 closing
price) we anticipate receiving over time, which are not reflected on our balance sheet. We anticipate having substantial resources with which to pay dividends, repurchase shar
es and/or units, profitably hire, and make accretive acquisitions, all while maintaining or improving our core business.
Impact of Adopting Revenue Recognition Guidance
On January 1, 2018, we adopted ASC 606, which provides accounting guidance on the recognition of revenues from contracts with customers and impacts the presentation of certain revenues and expenses in our condensed consolidated statements of operations. Newmark elected to adopt ASC 606 using a modified retrospective approach with regard to contracts that were not completed as of December 31, 2017, and prospectively from January 1, 2018 onward. Accordingly, our financial information have not been revised for historical comparable periods and are presented under the accounting standards in effect during those periods. Due to the adoption of ASC 606, for all periods from the first quarter of 2018 onward, Newmark did not and will not record revenues or earnings related to “Leasing and other commissions” with respect to contingent revenue expected to be received in future periods as of December 31, 2017, in relation to contracts signed prior to January 1, 2018, for which services have already been completed. Instead, the Company recorded this contingent revenue and related commission payments on the balance sheet on January 1, 2018, with a corresponding pre-tax improvement of approximately $22.7 million and Newmark recognized an increase of
$16.5 million and $2.3 million to beginning retained earnings and non-controlling interest, respectively,
as a cumulative effect of adoption of an accounting change. Over time, the Company expects to receive $23 million of cash related to these “Leasing and other commissions” receivables, primarily over the course of 2018 and 2019. This cash, however, will not be recorded as GAAP net income. Additionally, prior to the adoption of ASC 606, Newmark presented certain management services expenses incurred on behalf of customers, subject to reimbursement, on a net basis. Under ASC 606, Newmark concluded that it controls the services provided by a third party on behalf of customers and, therefore, acts as a principal under those contracts and will present the related expenses on a gross basis in our condensed consolidated statements of operations, with no impact on net income available to common stockholders.
ASC 606 does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other U.S. GAAP guidance, and as a result, did not have an impact on the elements of our condensed consolidated statements of operations most closely associated with financial instruments, including Commissions, Gains from mortgage banking activities/originations, net and Servicing fees.
There was no significant impact as a result of applying ASC 606 to our results of operations for the three and six months ended June 30, 2018, except as it relates to the recognition and presentation of Management services, servicing fees and other revenues that contained future contingencies and certain Operating, Administrative and Other expenses subject to reimbursement.
Refer to Note 3-“Summary of Significant Accounting Policies” and Note 12-“Revenues from Contracts with Customers” in our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, for further information.
57
Results of Operations
The following table sets forth our unaudited condensed consolidated statements of operations data expressed as a percentage of total revenues for the periods indicated (in thousands):
|
|
Six Months Ended June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
Actual
Results
|
|
|
Percentage
of Total
Revenues
|
|
|
Actual
Results
|
|
|
Percentage
of Total
Revenues
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Leasing and other commissions
|
|
$
|
337,513
|
|
|
|
37.6
|
|
|
$
|
272,249
|
|
|
|
36.9
|
|
Capital markets
|
|
|
203,055
|
|
|
|
22.7
|
|
|
|
172,557
|
|
|
|
23.4
|
|
Gains from mortgage banking activities/origination, net
|
|
|
80,791
|
|
|
|
9.0
|
|
|
|
118,808
|
|
|
|
16.1
|
|
Management services, servicing fees and other
|
|
|
275,720
|
|
|
|
30.7
|
|
|
|
174,039
|
|
|
|
23.6
|
|
Total revenues
|
|
|
897,079
|
|
|
|
100.0
|
|
|
|
737,653
|
|
|
|
100.0
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
521,675
|
|
|
|
58.2
|
|
|
|
453,663
|
|
|
|
61.5
|
|
Allocations of net income and grant of exchangeability
to limited partnership units
|
|
|
90,835
|
|
|
|
10.1
|
|
|
|
34,500
|
|
|
|
4.7
|
|
Total compensation and employee benefits
|
|
|
612,510
|
|
|
|
68.3
|
|
|
|
488,163
|
|
|
|
66.2
|
|
Operating, administrative and other
|
|
|
155,475
|
|
|
|
17.3
|
|
|
|
106,786
|
|
|
|
14.5
|
|
Fees to related parties
|
|
|
13,195
|
|
|
|
1.5
|
|
|
|
8,885
|
|
|
|
1.2
|
|
Depreciation and amortization
|
|
|
42,714
|
|
|
|
4.8
|
|
|
|
41,455
|
|
|
|
5.6
|
|
Total operating expenses
|
|
|
823,894
|
|
|
|
91.9
|
|
|
|
645,289
|
|
|
|
87.5
|
|
Other income (losses), net:
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
0
|
|
Other income (loss)
|
|
|
5,342
|
|
|
|
0.6
|
|
|
|
(1,308
|
)
|
|
|
(0.2
|
)
|
Total other income (losses), net
|
|
|
5,342
|
|
|
|
0.6
|
|
|
|
(1,308
|
)
|
|
|
(0.2
|
)
|
Income (loss) from operations
|
|
|
78,527
|
|
|
|
8.8
|
|
|
|
91,056
|
|
|
|
12.3
|
|
Interest (expense) income, net
|
|
|
(23,991
|
)
|
|
|
(2.7
|
)
|
|
|
2,515
|
|
|
|
0.3
|
|
Income (loss) before income taxes and noncontrolling
interests
|
|
|
54,536
|
|
|
|
6.1
|
|
|
|
93,571
|
|
|
|
12.6
|
|
Provision for income taxes
|
|
|
17,755
|
|
|
|
2.0
|
|
|
|
1,407
|
|
|
|
0.2
|
|
Consolidated net income (loss)
|
|
|
36,781
|
|
|
|
4.1
|
|
|
|
92,164
|
|
|
|
12.4
|
|
Less: Net income attributable to noncontrolling
interests
|
|
|
16,045
|
|
|
|
1.8
|
|
|
|
308
|
|
|
|
-
|
|
Net income (loss) available to common stockholders
|
|
$
|
20,736
|
|
|
|
2.3
|
|
|
$
|
91,856
|
|
|
|
12.4
|
|
Three months ended June 30, 2018 compared to the three months ended June 30, 2017
Revenues
Leasing and Other Commissions
Leasing and other commission revenues increased by $33.5 million, or 23.1%, to $178.1 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. The increase was primarily due to organic growth.
Capital Markets
Capital markets revenue increased by $6.5 million, or 6.9%, to $101.7 million for the three months ended June 30, 2018, as compared to the three months ended June 30, 2017. The increase was primarily driven by a 4.0% increase in investment sales volume driven by our multifamily business.
Gains from Mortgage Banking Activities/Originations, Net
Gains from mortgage banking activities/origination, net decreased by $31.7 million, or 43.1%, to $41.9 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. The decrease was driven by a 51.8% decrease in GSE and FHA lending to $2.0 billion as compared to $4.1 billion in the prior annual period. In the second quarter of 2017 Berkeley
58
Point’s GSE and FHA multifamily loan originations included a single large $2.2 billion transaction. Excluding the impact of this large transaction, the Company’s loan origination volumes increased by approximately 6.7
% year-on-year in notional terms.
A portion of our gains from mortgage banking activities/originations, net, relate to non-cash gains attributable to originated mortgage servicing rights (which we refer to as “OMSRs”). We recognize OMSR gains equal to the fair value of servicing rights retained on mortgage loans originated and sold. For the three months ended June 30, 2018 and 2017, we recognized $24.7 million and $42.6 million of non-cash gains, respectively, related to OMSRs.
Management Services, Servicing Fees and Other
Management services, servicing fees and other revenue increased $53.2 million, or 58.1%, to $144.9 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. $24.5 million of the increase was related to additional pass-through revenues resulting from the implementation of ASC 606, while $16.8 million was related to the valuation and appraisal business. Additionally, $5.5 million was related to servicing fee revenues. The remainder of the increase is primarily due to acquisitions.
Expenses
Compensation and Employee Benefits
Compensation and employee benefits expense increased by $30.5 million, or 12.8%, to $269.0 million for the three months ended June 30, 2018, as compared to the three months ended June 30, 2017. The main drivers of this increase were $18.0 million of additional payments directly related to the increase in revenues, and the remainder related to acquisitions and new hires.
Allocations of Net Income and Grant of Exchangeability to Limited Partnership Units
The Allocations of net income and grant of exchangeability to limited partnership units increased by $41.2 million, or 172.6%, to $65.0 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. This increase was primarily driven by an increase of $42.7 million in exchangeability charges.
Operating, Administrative and Other
Operating, administrative and other expenses increased $20.6 million, or 34.8%, to $80.0 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. This increase was primarily driven by $24.5 million directly related to additional pass-through expenses resulting from the implementation of ASC 606.
Fees to Related Parties
Fees to related parties increased by $2.1 million, or 51.2%, to $6.3 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. Fees to related parties are allocations paid to BGC Partners and Cantor for administrative and support services.
Depreciation and Amortization
Depreciation and amortization for the three months ended June 30, 2018 decreased by $3.0 million, or 13.0%, to $20.2 million as compared to the three months ended June 30, 2017. This decrease is due to a $3.3 million decrease in mortgage servicing rights amortization.
Because the Company recognizes OMSR gains equal to the fair value of servicing rights retained on mortgage loans originated and sold, it also amortizes mortgage servicing rights (which we refer to as “MSRs”) in proportion to the net servicing revenue expected to be earned. Subsequent to the initial recording, MSRs are amortized and carried at the lower of amortized cost or fair value. For the three months ended June 30, 2018 and 2017, our expenses included $15.7 million and $19.0 million of MSR amortization, respectively. Included in the $15.7 million is a reversal of $4.1 million recorded during the three months ended June 30, 2018 related to a previously recorded valuation allowance.
59
Other Income (Losses), Net
Other losses of $0.4 million in the three months ended June 30, 2018 is primarily due to the mark-to-market adjustment related to the variable share forward of $2.8 million, offset by earnings from the Real Estate LP of $1.8 million, plus recognition of income from the change in value of Nasdaq shares of $0.5 million.
Interest (Expense) Income, Net
Interest expense of $10.6 million during the three months ended June 30, 2018 is primarily related to $12.9 million of interest expense on the Company’s debt, offset by $2.3 million of interest income primarily related to income on employee loans.
Provision for Income Taxes
Provision for income taxes increased by $9.4 million for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. This increase was primarily driven by an increase in the mix of allocable revenue among legal entities as a corporation versus flow through resulting from our Separation. In general, our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings. The Tax Act is expected to have a favorable impact on Newmark’s effective tax rate and net income as reported under generally accepted accounting principles in the reporting period to which the Tax Act is effective.
Net Income (Loss) Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests was $3.6 million for the three months ended June 30, 2018. The increase was attributable to the change in Newmark’s corporate structure related to the Separation and IPO.
Six months ended June 30, 2018 compared to the six months ended June 30, 2017
Revenues
Leasing and Other Commissions
Leasing and other commission revenues increased by $65.3 million, or 24.0%, to $337.5 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. The increase was due to organic growth.
Capital Markets
Capital markets revenue increased by $30.5 million, or 17.7%, to $203.1 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. The increase was driven by a 12.5% increase in investment sales volume and a 17.6% increase in mortgage brokerage volume.
Gains from Mortgage Banking Activities/Originations, Net
Gains from mortgage banking activities/origination, net decreased by $38.0 million, or 32.0%, to $80.8 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. The decrease was driven by a 38.0% decrease in GSE and FHA lending to $3.7 billion as compared to $5.9 billion in the prior annual period. In the second quarter of 2017 Berkeley Point’s GSE and FHA multifamily loan originations included a single large $2.2 billion transaction. Excluding the impact of this large transaction, the Company’s loan origination volumes were relatively in-line year-on-year in notional terms.
A portion of our gains from mortgage banking activities/originations, net, relate to non-cash gains attributable to originated mortgage servicing rights (which we refer to as “OMSRs”). We recognize OMSR gains equal to the fair value of servicing rights retained on mortgage loans originated and sold. For the six months ended June 30, 2018 and 2017, we recognized $45.8 million and $71.9 million of non-cash gains, respectively, related to OMSRs.
Management Services, Servicing Fees and Other
Management services, servicing fees and other revenue increased $101.7 million, or 58.4%, to $275.7 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. $42.9 million of the increase was related to additional pass-through revenues resulting from the implementation of ASC 606, while $27.7 million was related to the valuation and appraisal business. Additionally, $9.6 million was related to servicing fee revenues. The remainder of the increase is due to management services of which acquisitions contributed to more than 50% of the growth.
60
Expenses
Compensation and Employee Benefits
Compensation and employee benefits expense increased by $68.0 million, or 15.0%, to $521.7 million for the six months ended June 30, 2018, as compared to the six months ended June 30, 2017. The main drivers of this increase were $40.4 million of additional payments directly related to the increase in revenues, and the remainder related to acquisitions and new hires.
Allocations of Net Income and Grant of Exchangeability to Limited Partnership Units
The Allocations of net income and grant of exchangeability to limited partnership units increased by $56.3 million, or 163.3%, to $90.8 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. This increase was primarily driven by an increase of $58.4 million in exchangeability charges.
Operating, Administrative and Other
Operating, administrative and other expenses increased $48.7 million, or 45.6%, to $155.5 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. This increase was primarily driven by $42.9 million directly related to additional pass-through expenses resulting from the implementation of ASC 606. The remainder is due to increases in selling and promotional and other expenses associated with acquisitions and new hires.
Fees to Related Parties
Fees to related parties increased by $4.3 million, or 48.5%, to $13.2 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. Fees to related parties are allocations paid to BGC Partners and Cantor for administrative and support services.
Depreciation and Amortization
Depreciation and amortization for the six months ended June 30, 2018 increased by $1.3 million, or 3.0%, to $42.7 million as compared to the six months ended June 30, 2017. This increase is due to a $0.6 million increase in mortgage servicing rights amortization and the remainder is primarily due to leasehold improvements placed in service due to the continued expansion of our business.
Because the Company recognizes OMSR gains equal to the fair value of servicing rights retained on mortgage loans originated and sold, it also amortizes mortgage servicing rights (which we refer to as “MSRs”) in proportion to the net servicing revenue expected to be earned. Subsequent to the initial recording, MSRs are amortized and carried at the lower of amortized cost or fair value. For the six months ended June 30, 2018 and 2017, our expenses included $33.6 million and $32.9 million of MSR amortization, respectively. Included in the $33.6 million is a reversal of $5.4 million recorded during the six months ended June 30, 2018 related to a previously recorded valuation allowance.
Other Income (Losses), Net
Other income of $5.3 million in the six months ended June 30, 2018 is primarily due to the recognition of income from the change in value of Nasdaq shares of $2.9 million, plus earnings from the Real Estate LP of $5.0 million, offset by the mark-to-market adjustment related to the variable share forward of $2.8 million.
Interest (Expense) Income, Net
Interest expense of $24.0 million during the six months ended June 30, 2018 is primarily related to $27.7 million of interest expense on the Company’s debt, offset by $3.7 million of interest income primarily related to income on employee loans.
Provision for Income Taxes
Provision for income taxes increased by $16.3 million for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. This increase was primarily driven by an increase in the mix of allocable revenue among legal entities as a corporation versus flow through resulting from our Separation. In general, our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings. The Tax Act is expected to have a
61
favorable impact on Newmark’s effective tax rate and net income as reported under generally accepted
accounting principles in
the
reporting periods to which the Tax Act is effective.
Net Income (Loss) Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests was $16.0 million for the six months ended June 30, 2018. The increase was attributable to the change in Newmark’s corporate structure related to the Separation and IPO.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth our unaudited quarterly results of operations for the indicated periods (in thousands). Results of any period are not necessarily indicative of results for a full year and may, in certain periods, be affected by seasonal fluctuations in our business. Certain reclassifications have been made to prior period amounts to conform to the current period’s presentation.
|
|
June 30,
2018
2
|
|
|
March
31,
2018
2
|
|
|
December 31,
2017
2
|
|
|
September 30,
2017
1,2
|
|
|
June 30,
2017
1
|
|
|
March 31,
2017
1
|
|
|
December 31,
2016
1
|
|
|
September 30,
2016
1
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions
|
|
$
|
279,833
|
|
|
$
|
260,735
|
|
|
$
|
312,992
|
|
|
$
|
256,918
|
|
|
$
|
239,848
|
|
|
$
|
204,958
|
|
|
$
|
245,348
|
|
|
$
|
230,204
|
|
Gains from mortgage banking
activities/origination, net
|
|
|
41,877
|
|
|
|
38,914
|
|
|
|
41,737
|
|
|
|
45,455
|
|
|
|
73,546
|
|
|
|
45,262
|
|
|
|
54,378
|
|
|
|
65,378
|
|
Management services, servicing fees
and other
|
|
|
144,909
|
|
|
|
130,811
|
|
|
|
105,847
|
|
|
|
95,848
|
|
|
|
91,677
|
|
|
|
82,362
|
|
|
|
87,860
|
|
|
|
77,046
|
|
Total revenues
|
|
|
466,619
|
|
|
|
430,460
|
|
|
|
460,576
|
|
|
|
398,221
|
|
|
|
405,071
|
|
|
|
332,582
|
|
|
|
387,586
|
|
|
|
372,628
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and employee benefits
|
|
|
268,980
|
|
|
|
252,695
|
|
|
|
295,577
|
|
|
|
270,943
|
|
|
|
238,518
|
|
|
|
215,145
|
|
|
|
231,910
|
|
|
|
239,690
|
|
Allocations of net income and grant of
exchangeability to limited
partnership units
|
|
|
65,026
|
|
|
|
25,809
|
|
|
|
61,940
|
|
|
|
18,217
|
|
|
|
23,851
|
|
|
|
10,649
|
|
|
|
32,315
|
|
|
|
16,568
|
|
Total compensation and
employee benefits
|
|
|
334,006
|
|
|
|
278,504
|
|
|
|
357,517
|
|
|
|
289,160
|
|
|
|
262,369
|
|
|
|
225,794
|
|
|
|
264,225
|
|
|
|
256,258
|
|
Operating, administrative and other
|
|
|
80,048
|
|
|
|
75,427
|
|
|
|
60,064
|
|
|
|
52,313
|
|
|
|
59,404
|
|
|
|
47,382
|
|
|
|
53,115
|
|
|
|
44,546
|
|
Fees to related parties
|
|
|
6,301
|
|
|
|
6,894
|
|
|
|
6,531
|
|
|
|
5,355
|
|
|
|
4,167
|
|
|
|
4,718
|
|
|
|
2,348
|
|
|
|
5,821
|
|
Depreciation and amortization
|
|
|
20,201
|
|
|
|
22,513
|
|
|
|
24,438
|
|
|
|
29,922
|
|
|
|
23,218
|
|
|
|
18,237
|
|
|
|
13,841
|
|
|
|
20,918
|
|
Total operating expenses
|
|
|
440,556
|
|
|
|
383,338
|
|
|
|
448,550
|
|
|
|
376,750
|
|
|
|
349,158
|
|
|
|
296,131
|
|
|
|
333,529
|
|
|
|
327,543
|
|
Other income (losses), net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (loss)
|
|
|
(365
|
)
|
|
|
5,707
|
|
|
|
(2,029
|
)
|
|
|
77,264
|
|
|
|
(715
|
)
|
|
|
(593
|
)
|
|
|
(684
|
)
|
|
|
17,849
|
|
Total other income (losses), net
|
|
|
(365
|
)
|
|
|
5,707
|
|
|
|
(2,029
|
)
|
|
|
77,264
|
|
|
|
(715
|
)
|
|
|
(593
|
)
|
|
|
(684
|
)
|
|
|
17,849
|
|
Income (loss) from operations
|
|
|
25,698
|
|
|
|
52,829
|
|
|
|
9,997
|
|
|
|
98,735
|
|
|
|
55,198
|
|
|
|
35,858
|
|
|
|
53,373
|
|
|
|
62,934
|
|
Interest (Expense) Income, net
|
|
|
(10,582
|
)
|
|
|
(13,409
|
)
|
|
|
(1,453
|
)
|
|
|
1,724
|
|
|
|
1,381
|
|
|
|
1,134
|
|
|
|
1,021
|
|
|
|
1,009
|
|
Income before income taxes and
noncontrolling interests
|
|
|
15,116
|
|
|
|
39,420
|
|
|
|
8,544
|
|
|
|
100,459
|
|
|
|
56,579
|
|
|
|
36,992
|
|
|
|
54,394
|
|
|
|
63,943
|
|
Provision (benefit) for income taxes
|
|
|
10,822
|
|
|
|
6,933
|
|
|
|
54,082
|
|
|
|
1,989
|
|
|
|
1,422
|
|
|
|
(15
|
)
|
|
|
2,010
|
|
|
|
1,125
|
|
Consolidated net income (loss)
|
|
|
4,294
|
|
|
|
32,487
|
|
|
|
(45,538
|
)
|
|
|
98,470
|
|
|
|
55,157
|
|
|
|
37,007
|
|
|
|
52,384
|
|
|
|
62,818
|
|
Less: Net income (loss) attributable to
noncontrolling interest
|
|
|
3,555
|
|
|
|
12,490
|
|
|
|
633
|
|
|
|
(337
|
)
|
|
|
12
|
|
|
|
296
|
|
|
|
(69
|
)
|
|
|
(556
|
)
|
Net income (loss) available to
common stockholders
|
|
$
|
739
|
|
|
$
|
19,997
|
|
|
$
|
(46,171
|
)
|
|
$
|
98,807
|
|
|
$
|
55,145
|
|
|
$
|
36,711
|
|
|
$
|
52,453
|
|
|
$
|
63,374
|
|
1
|
Financial results have been retrospectively adjusted to include the financial results of Berkeley Point. See “Berkeley Point Acquisition and Related Transactions” herein for a summary of the impact on Newmark’s Quarterly and Annual Results of Operations.
|
2
|
Amounts include the gains related to the Nasdaq Earn-out associated with the Nasdaq transaction recorded in Other income (loss).
|
62
Financial Position, Liquidity and Capital Resources
Overview
The primary source of liquidity for our business is the cash flow provided by our operations. Prior to the Separation and IPO, our cash was transferred to BGC Partners to support its overall cash management strategy. Transfers of cash to and from BGC Partners’ cash management system have been reflected in related party receivables and payables in the historical unaudited condensed consolidated balance sheets and in payments to and borrowings from related parties in the financing section of the unaudited condensed consolidated statements of cash flows. Cash and equity issued for acquisitions have been reflected in BGC Partners’ net investment in the historical unaudited condensed consolidated balance sheets and statement of changes in equity.
Following the completion of the Separation and IPO, we maintain separate cash management and financing functions for operations. Additionally, our capital structure, long-term commitments and sources of liquidity will change significantly from our historical capital structure, long-term commitments and sources of liquidity.
In connection with the Separation, we assumed from BGC Partners the Term Loan and the Converted Term Loan. Newmark OpCo also assumed from BGC U.S. OpCo the BGC Notes (referred to as the 2042 Promissory Note and the 2019 Promissory Note, together the “BGC Notes”). We contributed all of the net proceeds of the IPO to Newmark OpCo in exchange for a number of units representing Newmark OpCo limited partnership interests equal to the number of shares issued by us in the IPO. Newmark OpCo used all of such net proceeds to partially repay intercompany indebtedness owed by Newmark OpCo to us in respect of the Term Loan (which intercompany indebtedness was originally issued by BGC U.S. OpCo and will be assumed by Newmark OpCo in connection with the separation). On March 7, 2018, BGC, including through its subsidiary invested $242.0 million in Newmark limited partnership interests. Newmark has used the proceeds from this transaction plus all of the repayment from Newmark OpCo, and cash on hand to repay in full the $270.7 million remaining balance of the Term Loan. Following the IPO, in the event that any member of Newmark receives net proceeds from the incurrence of indebtedness for borrowed money or an equity issuance (in each case subject to certain exceptions), Newmark OpCo will be obligated to use such net proceeds to repay the remaining intercompany indebtedness owed by Newmark OpCo to us in respect of the Converted Term Loan (which in turn we will use to repay the Converted Term Loan). Following the repayment of the remaining amount outstanding on the Converted Term Loan, in the event that any member of the Newmark Group receives net proceeds from the incurrence of indebtedness for borrowed money (subject to certain exceptions), Newmark OpCo will be obligated to use such net proceeds to repay the BGC Notes. In addition, we will be obligated to repay any remaining amounts under the BGC Notes prior to the distribution. We intend to replace the financing provided by the Converted Term Loan and BGC Notes that remain outstanding with new senior term loans (which may be secured or unsecured), new senior unsecured notes, other long- or short-term financing or a combination thereof.
Our future capital requirements will depend on many factors, including our rate of sales growth, the expansion of our sales and marketing activities, our expansion into other markets and our results of operations. To the extent that existing cash, cash from operations and credit facilities (including the Intercompany Credit Agreement with BGC) are insufficient to fund our future activities, we may need to raise additional funds through public equity or debt financing.
Balance Sheet
Total assets at June 30, 2018 were $2,837.1 million as compared to $2,273.0 million at December 31, 2017. $185.3 million of the increase in total assets can be attributed to loans held for sale. The Company’s restricted cash and cash segregated under regulatory requirements increased by $262.6 million and receivables increased by $107.2 million, primarily as a result of the adoption of ASC 606. Total liabilities at June 30, 2018 and December 31, 2017 were $2,058.9 million and $2,029.6 million, respectively. $180.1 million of the increase in total liabilities can be attributed to borrowings from our warehouse facilities and $233.2 million is due to an increase in current portion of payables to related parties. The increase in liabilities was offset by a reduction in the Company’s long-term debt of $423.6 million.
Liquidity
Prior to December 13, 2017, the date of the Separation, BGC Partners funded our growth through contributing acquired companies and related party payables. The related party payables are net of related party receivables which were generated from our earnings as BGC Partners sweeps our excess cash to manage treasury centrally. Additionally, prior to its acquisition by BGC, Berkeley Point and its parent company, Cantor Commercial Real Estate Company, L.P. (which we refer to as “CCRE”), loaned money to each other. In connection with the Separation and IPO, Newmark settled its intercompany payable to BGC. Subsequent to the IPO, Newmark’s total net borrowings under the credit facility between BGC and Newmark were $270.0 million as of June 30, 2018, which are reflected as current portion of payables to related parties on the June 30, 2018 balance sheet. The total net payable to related parties at June 30, 2018 was $267.4 million as compared to a net payable at December 31, 2017 of $34.2 million. Loans held for sale were financed from the warehouse notes payable, net at June 30, 2018. Fees to related parties that are charged by BGC Partners and
63
Cantor to Newmark are reflected as cash flows from op
erating activities in the unaudited condensed consolidated Statement of Cash Flows for each period presented. For the
six
months ended
June 30
, 2018, these fees and charges totaled $
13.2
million. Additionally, prior to the Berkeley Point Acquisition, Berke
ley Point loaned excess cash to CCRE to fund CCRE’s lending business. These amounts are presented as investing activities on the Statement of Cash Flows for all periods presented. All other amounts sent to or from BGC Partners are reflected as cash flows f
rom financing activities in the unaudited condensed consolidated Statement of Cash Flows for each period presented.
For the six months ended June 30, 2018, net cash used in operating activities was $121.0 million and for the six months ended June 30, 2017, net cash provided by operating activities was $190.8 million. Cash flows from operating activities included $11.6 million of cash paid to BGC Partners, related to grant of exchangeability to limited partnership units for the six months ended June 30, 2017. As of the Separation and IPO, these charges became non-cash in nature to the extent they relate to limited partnership units in Newmark, and therefore are excluded from cash outflows from operating activities. We expect to generate cash flows from operations to fund our business operations and growth strategy to meet our short-term liquidity requirements, which we define as the next 12 months. We also expect that proceeds from new debt financing combined with cash flows from operations will be sufficient to fund our operations, growth strategy and dividends and distributions to meet our long-term liquidity requirements.
Prior to the Separation, we received the rights to 10,914,717 million Nasdaq shares, of which 992,247 million were received in 2017 and the remaining 9,922,470 million Nasdaq shares will be received ratably over approximately the next 10 years, provided that Nasdaq, as a whole, produces at least $25.0 million in gross revenues each year.
On June 18, 2018, Newmark's principal operating s
ubsidiary, Newmark OpCo, issued approximately $175 million of EPUs in a private transaction to RBC. Contemporaneously with the issuance of the EPUs, a newly formed SPV consolidated subsidiary of Newmark, entered into two variable postpaid forward contracts with RBC.
The SPV is an indirect subsidiary of Newmark whose sole asset is the Nasdaq share Earn-outs for 2019 and 2020.
The RBC Forward provides
RBC the rights to receive up to 992,247 shares of Nasdaq common stock in each of the fourth quarters of 2019 and 2020
. The RBC Forward is economically similar to at-the-money put options struck at Nasdaq’s June 18, 2018 closing price of $94.21, and provides Newmark with downside protection on the shares while allowing Newmark to retain all appreciation related to the 2019 and 2020 Nasdaq share earn outs.
Net of transaction costs, Newmark received approximately $152.9 million of net proceeds and non-dilutive equity on its balance sheet from
the Newmark OpCo Preferred Investment
in the second quarter of 2018. Newmark used the net proceeds from the
Newmark OpCo Preferred Investment
to repay a portion of the $400.0 million Converted Term Loan maturing September 8, 2019. After this repayment, approximately $247.2 million of the Converted Term Loan remains outstanding. The
Newmark OpCo Preferred Investment
had no impact on the Nasdaq payment expected to be recognized in the third quarter of 2018. Newmark retains the flexibility to monetize some or all of the anticipated more than $650.
0 million worth of remaining seven Nasdaq Earn-Out payments from 2021 through 2027.
By monetizing these expected Nasdaq payments, Newmark has strengthened its balance sheets and improved its financial flexibility and credit metrics. Newmark therefore believes that the monetization transaction moves it closer to completing the planned spin-off of Newmark from BGC. Over time, Newmark expects its stronger balance sheets to enhance our ability to invest and grow our businesses.
As a result of the Nasdaq Earn-out, including the Nasdaq share payment expected to be realized in the third quarter of 2018, Newmark expects to receive approximately $725 million in additional Nasdaq stock over time (stock value based on the August 1, 2018 closing price), which is not reflected on our balance sheet.
On September 8, 2017, BGC completed the Berkeley Point Acquisition. Berkeley Point is a leading commercial real estate finance company focused on the origination and sale of multifamily and other commercial real estate loans through government-sponsored and government-funded loan programs, as well as the servicing of commercial real estate loans, including those it originates. BGC acquired all of the outstanding membership interests of Berkeley Point Financial LLC for an acquisition price of $875 million, with $3.2 million of the acquisition price paid with 247,099 partnership units in BGC Holdings pursuant to a Transaction Agreement, dated as of July 17, 2017, with Cantor and certain Cantor’s affiliates, including CCRE and Cantor Commercial Real Estate Sponsor, L.P., the general partner of CCRE. In accordance with this Transaction Agreement, Berkeley Point made a distribution of $89.1 million to CCRE related to the Berkeley Point Acquisition, for the amount that Berkeley Point’s net assets, inclusive of certain fair value adjustments, exceeded $508.6 million. Contemporaneously with the Berkeley Point Acquisition, on September 8, 2017, the Company invested $100 million in a newly formed commercial real estate-related financial and investment business, Real Estate LP, which is controlled and managed by Cantor. Real Estate LP may conduct activities in any real estate related business or asset backed securities-related business or any extensions thereof and ancillary activities thereto. In addition, Real Estate LP may provide short-term loans to related parties from time to time when funds in excess of amounts needed for investment opportunities are available. The Company’s investment is accounted for under the equity method. In connection with these aforementioned transactions,
64
BGC entered into a $400 million two-year unsecured senior revolving credit facility and a $575 million unsecured senior term loan maturing on the second anniversary of the Berkeley Point Acquisition closing dat
e.
On October 23, 2017, Newmark filed a registration statement on Form S-1 with the SEC relating to the IPO of our Class A common stock. On December 19, 2017 BGC Partners, Inc. and Newmark Group, Inc. announced the closing of the offering of 20 million shares of Newmark’s Class “A” common stock to the public at a price of $14.00 per share less underwriting discounts and commissions. On December 26, 2017, BGC and Newmark announced that the underwriters of Newmark’s IPO exercised in full their overallotment option to purchase an additional 3 million shares of Newmark’s Class A common stock at the initial public offering price of $14.00 per share less underwriting discounts and commissions. As a result, Newmark received aggregate net proceeds of $295.4 million from the IPO after deducting underwriting discounts and commissions and estimated offering expenses. The proceeds of the IPO were used to repay the Term Loan. Following some period after the IPO, BGC may, subject to market and other conditions, distribute the shares that BGC holds of Newmark Group, Inc. pro rata to BGC’s stockholders in a manner intended to qualify as tax-free for U.S. federal income tax purposes.
As of June 30, 2018, our liquidity, which Newmark defines as cash and cash equivalents, and marketable securities, less securities loaned, was approximately $60.3 million. This does not include the (i) $258.7 million of elective excess restricted cash maintained in our restricted liquidity account pledged for the benefit of Fannie Mae and (ii) more than $725.0 million in additional Nasdaq stock, including the payment expected to be realized in the third quarter of 2018 (stock value based on the August 1, 2018 closing price) that Newmark expects to receive over time. Newmark expects to use its considerable financial resources to repay debt, profitably hire, make accretive acquisitions, pay dividends, and/or repurchase shares and units of Newmark, all while maintaining or improving its credit profile.
Term Loan and Converted Term Loan
In connection with the Berkeley Point Acquisition and BGC Partners’ investment in Real Estate LP, on September 8, 2017, BGC Partners entered into a committed unsecured senior term loan credit agreement (which we refer to as the “Term Loan Credit Agreement”) with Bank of America, N.A., as administrative agent (which we refer to as the “Administrative Agent”), and a syndicate of lenders. The Term Loan Credit Agreement provides for a term loan of up to $575.0 million (which we refer to as the “Term Loan”). During the year ended December 31, 2017, in connection with the Term Loan, BGC Partners lent the proceeds of the Term Loan to BGC U.S. OpCo, and BGC U.S. OpCo issued a promissory note with an aggregate principal amount of $575.0 million to BGC Partners (which we refer to as the “Intercompany Term Loan Note”). Pursuant to the terms of the Intercompany Term Loan Note, all of the rights and obligations of BGC Partners under the Intercompany Term Loan Note are the same as the rights and obligations of the lenders with respect to payment under the Term Loan, and all of the rights and obligations of BGC U.S. OpCo under the Intercompany Term Loan Note are the same as the rights and obligations of BGC Partners with respect to payment under the Term Loan. On November 22, 2017, we entered into an amendment to the Term Loan Credit Agreement (which we refer to as the “Term Loan Amendment”), pursuant to which, in connection with the Separation and prior to the closing of the IPO, we assumed the obligations of BGC Partners under the Term Loan. In connection with our assumption of BGC Partners’ rights and obligations under the Term Loan, BGC Partners assigned to us, and we assumed, all of BGC Partners’ rights and obligations under the Intercompany Term Loan Note and, pursuant to the separation, Newmark OpCo assumed all of BGC U.S. OpCo’s rights and obligations under the Intercompany Term Loan Note. During the six months ended June 30, 2018 the Term Loan Credit Agreement was repaid in full.
Also in connection with the Berkeley Point Acquisition and BGC Partners’ investment in Real Estate LP, on September 8, 2017, BGC Partners entered into an unsecured senior revolving credit agreement (which we refer to as the “Revolving Credit Agreement”) with the Administrative Agent and a syndicate of lenders. The Revolving Credit Agreement provides for revolving loans of up to $400.0 million (which we refer to as the “Revolving Credit Facility”). During the three months ended June 30, 2018, Newmark partially repaid $152.9 million of the Converted Term Loan. As of June 30, 2018, there were $247.2 million of borrowings outstanding under the Revolving Credit Facility. Since there were amounts outstanding under the Term Loan facility as of December 31, 2017, the pricing increased by 50 basis points. The Term Loan was paid in full on March 9, 2018. Once the Term Loan was repaid in full, the pricing of the Converted Term Loan returned to the levels previously described. In connection with the $400.0 million borrowings, the proceeds of which BGC Partners lent to BGC U.S. OpCo, BGC U.S. OpCo issued a promissory note with an aggregate principal amount of $400.0 million to BGC Partners (which we refer to as the “Intercompany Revolver Note”). Pursuant to the terms of the Intercompany Revolver Note, all of the rights and obligations of BGC Partners under the Intercompany Revolver Note are the same as the rights and obligations of the lenders with respect to payment under the Revolving Credit Facility, and all of the rights and obligations of BGC U.S. OpCo under the Intercompany Revolver Note are the same as the rights and obligations of BGC Partners with respect to payment under the Revolving Credit Facility. On November 22, 2017, we entered into an amendment to the Revolving Credit Agreement (which we refer to as the “Revolver Amendment”), pursuant to which the then outstanding borrowings of BGC Partners under the Revolving Credit Facility were converted into a term loan (which we refer to as the “Converted Term Loan”) and thereafter, in connection with the Separation and prior to the closing of the IPO, we assumed the obligations of BGC Partners as borrower under the Converted Term Loan. BGC Partners remained the borrower under the Revolving Credit Facility for
65
any future draws and, as long as there is any principal a
mount outstanding under the Converted Term Loan, we guaranteed the obligations of BGC Partners under the Revolving Credit Facility. In connection with our assumption of the Converted Term Loan, BGC Partners assigned to us, and we assumed, all of BGC Partne
rs’ rights and obligations under the Intercompany Revolver Note and, pursuant to the Separation, Newmark OpCo assumed all of BGC U.S. OpCo’s rights and obligations under the Intercompany Revolver Note.
Under the Revolving Credit Agreement, as amended, BGC Partners guaranteed our repayment obligations under the Converted Term Loan. As long as the Converted Term Loan remains unpaid in any portion, we will guarantee any draws by BGC Partners under the Revolving Credit Facility. Once the Converted Term Loan has been paid in full, we will no longer have obligations as a borrower or as a guarantor under the Revolving Credit Agreement. Upon repayment, no portion of the Term Loan or the Converted Term Loan may be reborrowed by us.
Pursuant to the Separation and Distribution Agreement, (a) Newmark Group, Inc. will indemnify, defend and hold harmless the members of the BGC Partners group and each of their respective directors, officers, general partners, managers and employees from and against any and all losses of such persons to the extent relating to, arising out of or resulting from payments made to satisfy any guarantee by a member of the BGC Partners group to a third person in respect of the Term Loan Credit Agreement or the Converted Term Loan and (b) BGC Partners will indemnify, defend and hold harmless the members of the Newmark group and each of their respective directors, officers, general partners, managers and employees from and against any and all losses of such persons to the extent relating to, arising out of or resulting from payments made to satisfy any guarantee by a member of the Newmark group to a third person in respect of borrowings under the Revolving Credit Agreement other than the Converted Term Loans. In addition, (a) Newmark OpCo will indemnify, defend and hold harmless the Cantor group, the BGC Partners group and the Newmark group (other than Newmark OpCo and its subsidiaries) and each of their respective directors, officers, general partners, managers and employees, from and against all liabilities to the extent relating to, arising out of or resulting from any guarantee for the benefit of any member of the Newmark group by any member of the BGC Partners group that survives following the Separation and (b) BGC U.S. OpCo and BGC Global OpCo will indemnify, defend and hold harmless the Cantor group, the Newmark group and the BGC Partners Group (other than BGC U.S. OpCo , BGC Global OpCo and their respective subsidiaries) and each of their respective directors, officers, general partners, managers and employees from and against all liabilities to the extent relating to, arising out of or resulting from any guarantee for the benefit of any member of the BGC Partners group by any member of the Newmark group that survives following the Separation, including, in each case, any guarantee under the Term Loan Credit Agreement or the Revolving Credit Agreement.
The Converted Term Loan will mature on September 8, 2019. The outstanding amounts under the Converted Term Loan will bear interest at a per annum rate equal to, at our option, either (a) LIBOR for interest periods of one, two, three or six months, as selected by us, or upon the consent of all applicable lenders, such other period that is 12 months or less (in each case, subject to availability), as selected by us, plus an applicable margin, or (b) a base rate equal to the greatest of (i) the federal funds rate plus 0.5%, (ii) the prime rate as established by the Administrative Agent, and (iii) one-month LIBOR plus 1.0%, in each case plus an applicable margin. The applicable margin will initially be 2.25% with respect to LIBOR borrowings in (a) above and 1.25% with respect to base rate borrowings in (b) above. The applicable margin with respect to LIBOR borrowings in (a) above will range from 1.5% to 3.25% depending upon BGC Partners’ credit rating, and with respect to base rate borrowings in (b) above will range from 0.5% to 2.25% depending upon BGC Partners’ credit rating. In addition, (x) if there are any amounts outstanding under the Term Loan as of December 31, 2017, the pricing shall increase by 0.50% until the Term Loan is paid in full, and (y) if there are any amounts outstanding under the Term Loan as of June 30, 2018, the pricing shall increase by an additional 0.75% (and 1.25% in the aggregate) until the Term Loan is paid in full. The Converted Term Loan pricing increased by 50 basis points as of December 31, 2017 since there were amounts outstanding under the Term Loan facility as of December 31, 2017. As of March 9, 2018, the Term Loan was paid in full and the pricing of the Converted Term Loan returned to the levels previously described above, as applicable. On June 30, 2018, the interest rate on the Converted Term Loan was one-month LIBOR plus 2.25%, which was approximately 4.3% per annum.
The Revolving Credit Agreement also contain certain other customary affirmative and negative covenants and events of default that apply to us.
Pursuant to the Term Loan Credit Agreement the Converted Term Loan Credit Agreement and the Separation and Distribution Agreement, both the Term Loan and the Converted Term Loan were subject to a mandatory prepayment requirement by an amount equal to 100% of net cash proceeds of our IPO and all other material debt and equity issuances (and certain asset sales), in each case subject to customary exceptions. We contributed all of the net proceeds of the IPO to Newmark OpCo in exchange for a number of units representing Newmark OpCo limited partnership interests equal to the number of shares issued by us in the IPO. Newmark OpCo used all of such net proceeds, plus proceeds from BGC’s investment on March 7, 2018, of $242.0 million in Newmark limited partnership interests and cash on hand to repay in full the Term Loan (which intercompany indebtedness was originally issued by BGC U.S. OpCo and was assumed by Newmark OpCo in connection with the Separation).
66
The Term Loan Credit Agreement and the Converted Term Loan Credit Agreement and the Separation and Distribution Agreement also require us to apply net cash proceeds of m
aterial debt issuances after repayment in full of the Term Loan and Converted Term Loan (and subject to certain exceptions) to repay the BGC Notes.
Berkeley Point Warehouse Facilities
As of June 30, 2018, Berkeley Point had $950 million of committed loan funding available through three commercial banks and an uncommitted $325 million Fannie Mae loan repurchase facility. Consistent with industry practice, Berkeley Point’s existing warehouse facilities are short-term, requiring annual renewal. If any of the committed facilities are terminated or are not renewed or the uncommitted facility is not honored, we would be required to obtain replacement financing.
2042 Promissory Note
On June 26, 2012, BGC issued an aggregate of $112.5 million principal amount of its 8.125% Senior Notes due 2042 (the “8.125% BGC Senior Notes”). In connection with the issuance of the 8.125% BGC Senior Notes, BGC lent the proceeds of the 8.125% BGC Senior Notes to BGC U.S. OpCo, and BGC U.S. OpCo issued an amended and restated promissory note, effective as of June 26, 2012, with an aggregate principal amount of $112.5 million payable to BGC (the “2042 Promissory Note”). In connection with the Separation, on December 13, 2017, Newmark OpCo assumed all of BGC U.S. OpCo’s rights and obligations under the 2042 Promissory Note.
On August 3, 2018, BGC delivered a notice of redemption to the holders of its outstanding 8.125% BGC Senior Notes, which redemption will occur on September 5, 2018. BGC’s redemption of its 8.125% BGC Senior Notes will accelerate Newmark’s obligation to repay the 2042 Promissory Note. Accordingly, on September 4, 2018, Newmark OpCo will borrow $112.5 million from BGC pursuant to the Intercompany Credit Agreement which loan will bear interest at an annual rate equal to 6.5%. Newmark OpCo will use the proceeds of the Intercompany Credit Agreement loan to repay the $112.5 million of the 2042 Promissory Note
.
2019 Promissory Note
On December 9, 2014, BGC issued an aggregate of $300.0 million principal amount of its 5.375% Senior Notes due 2019 (the “5.375% BGC Senior Notes”). In connection with the issuance of the 5.375% BGC Senior Notes, BGC lent the proceeds of the 5.375% BGC Senior Notes to BGC U.S. OpCo, and BGC U.S. OpCo issued an amended and restated promissory note, effective as of December 9, 2014, with an aggregate principal amount of $300.0 million payable to BGC (the “2019 Promissory Note”). In connection with the Separation, on December 13, 2017, Newmark OpCo assumed all of BGC U.S. OpCo’s rights and obligations under the 2019 Promissory Note.
Intercompany Credit Agreement
In connection with the Separation on December 13, 2017, BGC entered into an unsecured senior credit agreement with Newmark (the “Original Credit Agreement”), which was amended and restated, as Intercompany Credit Agreement, on March 19, 2018. The Intercompany Credit Agreement provides for each party to issue revolving loans to the other party in the lender’s discretion.
The Intercompany Credit Agreement eliminates certain provisions from the Original Credit Agreement but the facility maturity date and the interest rate applicable to loans outstanding under the Intercompany Credit Facility remain the same.
On March 19, 2018, Newmark borrowed $150.0 million from BGC pursuant to the facilities under the Intercompany Credit Agreement. The interest rate as of June 30, 2018 was 5.31%, which may be adjusted based on the higher of BGC’s or Newmark’s short-term borrowing rate then in effect at such time plus 100 basis points, or such other interest rate as may be mutually agreed between BGC and Newmark. Newmark has transferred these proceeds to its restricted cash account pledged for the benefit of Fannie Mae. As of June 30, 2018, Newmark’s total net borrowings under the Intercompany Credit Agreement are $270.0 million.
Cash Flows for the six months ended June 30, 2018
For the six months ended June 30, 2018, we used $121.0 million of cash in operations. Excluding activity from loan originations and sales, net cash provided by operating activities for the six months ended June 30, 2018 was $64.3 million. We had consolidated net income of $36.8 million, $108.8 million of positive adjustments to reconcile net income to net cash provided by operating activities (excluding activity from loan originations and sales) and $81.3 million of negative changes in operating assets and liabilities. $185.3 million of adjustments to reconcile net income to net cash provided by operating activities was related to loans held for sale. The negative change in operating assets and liabilities included $49.9 million of increases in loans, forgivable loans and other
67
receivables from employees and partners primarily related to continued hiring and expansion of our business
.
We generated $
12.9
million of cash provided by investing activities primarily related to
$51.4 million of
proceeds from the sale of marketable securities
, offset by $22.5 million in cost method investments
. We generated $
309.9
million of cash from financ
ing activities primarily due to net proceeds from warehouse notes payable of $
180.1
million, $242.0 million of proceeds from BGC’s investment in Newmark LPU’s
,
$
233.2
million of new borrowings from BGC under the credit facility
and $152.9 million proceeds
from the
Newmark OpCo Preferred Investment
, partially offset by $
423.6
million repayment of long term debt.
Cash Flows for the six months ended June, 2017
For the six months ended June 30, 2017, we generated $190.8 million of cash from operations. Excluding activity from loan originations and sales, net cash provided by operating activities for the six months ended June 30, 2017 was $52.8 million. We had net income of $92.2 million, $22.7 million of negative adjustments to reconcile net income to net cash provided by operating activities (excluding activity from loan originations and sales) and $16.7 million of negative changes in operating assets and liabilities. The negative change in operating assets and liabilities was driven by a $17.8 million of increases in loans, forgivable loans and other receivables from employees and partners primarily related to continued hiring and expansion of our business. We used $139.9 million of cash for investing activities primarily related to payments to related parties, net of $130.0 million, and used $20.6 million in financing activities primarily due to net payments to related parties of $685.1, offset by net proceeds from warehouse notes payable of $675.9 million and payments on acquisition earn-outs of $10.5 million.
REGULATORY REQUIREMENTS
As a result of the Berkeley Point Acquisition, Newmark is now subject to various capital requirements in connection with seller/servicer agreements that Newmark has entered into with the various GSEs. Failure to maintain minimum capital requirements could result in Newmark’s inability to originate and service loans for the respective GSEs and could have a direct material adverse effect on Newmark’s unaudited condensed consolidated financial statements. As of June 30, 2018, Newmark has met all capital requirements. As of June 30, 2018, the most restrictive capital requirement was Fannie Mae’s net worth requirement. Newmark exceeded the minimum requirement by $456.8 million.
Certain of Newmark’s agreements with Fannie Mae allow Newmark to originate and service loans under Fannie Mae’s DUS Program. These agreements require Newmark to maintain sufficient collateral to meet Fannie Mae’s restricted and operational liquidity requirements based on a pre-established formula. Certain of Newmark’s agreements with Freddie Mac allow Newmark to service loans under Freddie Mac’s Targeted Affordable Housing Program (“TAH”). These agreements require Newmark to pledge sufficient collateral to meet Freddie Mac’s liquidity requirement of 8% of the outstanding principal of TAH loans serviced by Newmark. As of June 30, 2018, Newmark has met all liquidity requirements.
In addition, as a servicer for Fannie Mae, GNMA and FHA, Newmark is required to advance to investors any uncollected principal and interest due from borrowers. As of June 30, 2018 and December 31, 2017 outstanding borrower advances were approximately $192 thousand and $120 thousand, respectively, and are included in “Other assets” in the accompanying unaudited condensed consolidated balance sheets.
See “Regulation” in Part I, Item 1 of our Annual Report on Form 10-K for additional information related to our regulatory environment.
EQUITY
Share Exchange
In relation to the IPO, on December 13, 2017, Newmark entered into an exchange agreement with Cantor, CFGM, BGC and other Cantor affiliates entitled to hold Class B common stock, providing the right to exchange from time to time shares of Class A common stock of Newmark now owned or hereafter acquired, as applicable, on a one-for-one basis for shares of Class B common stock, up to the number of shares of Newmark Class B common stock that are authorized but unissued under Newmark’s certificate of incorporation. The Newmark Audit Committee and Board of Directors have determined that the exchange agreement is in the best interests of Newmark and its stockholders because, among other things, it will help ensure that Cantor retains its exchangeable limited partnership units in Newmark Holdings, which is the same partnership in which Newmark’s partner employees participate, thus continuing to align the interests of Cantor with those of the partner employees.
68
Repurchase Program
On March 12, 2018, our board of directors and audit committee authorized repurchases of shares of our Class A common stock and redemptions or repurchases of limited partnership interests or other equity interests in our subsidiaries up to $200 million. This authorization includes repurchases of stock or units from executive officers, other employees and partners, including of BGC and Cantor, as well as other affiliated persons or entities. From time to time, we may repurchase shares or redeem or repurchase units.
To date, no such shares or units have been repurchased or redeemed.
Fully Diluted Share Count
Our fully diluted weighted-average share count for the three months ended June 30, 2018 was as follows (in thousands)
|
|
Three Months Ended June 30, 2018
|
|
Common stock outstanding
(1)
|
|
|
155,157
|
|
Partnership units
(2)
|
|
|
-
|
|
RSUs (Treasury stock method)
|
|
|
146
|
|
Other
|
|
|
635
|
|
Total
(3)
|
|
$
|
155,938
|
|
(
1
)
|
Common stock consisted of Class A shares, Class B shares and contingent shares for which all necessary conditions have been satisfied except for the passage of time. For the quarter ended June 30, 2018, the weighted-average number of Class A shares was 138.9 million shares, Class B shares was 15.8 million shares and approximately 0.4 million shares of contingent Class A common stock and limited partnership units were included in our fully diluted EPS computation because the conditions for issuance had been met by the end of the period.
|
(
2
)
|
Partnership units collectively include founding/working partner units, limited partnership units, and Cantor units (see Note 2—Limited Partnership Interests), to our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information).
|
(
3
)
|
For the quarter ended June 30, 2018, all potentially dilutive securities were included in the computation of fully diluted earnings per share.
|
CONTINGENT PAYMENTS RELATED TO ACQUISITIONS
Newmark completed acquisitions in 2014, 2015, 2016 and 2017 for which contingent cash consideration may be issued on certain targets being met through 2020 of $12.4 million. The contingent equity instruments are issued by and are recorded as a payable to related party on the unaudited condensed consolidated balance sheet. The contingent cash liability is recorded at fair value as deferred consideration on the unaudited condensed consolidated balance sheet.
EQUITY METHOD INVESTMENTS
Newmark has an investment in Real Estate LP, a joint venture with Cantor in which Newmark has a less than majority ownership and has the ability to exert significant influence over the operating and financial policies. As of June 30, 2018, Newmark had $103.6 million in an equity method investment, which represents a 27% ownership in Real Estate LP.
Contractual Obligations and Commitments
The following table summarizes certain of our contractual obligations at June 30, 2018 (in thousands):
|
|
Total
|
|
|
Less than
1 Year
|
|
|
1-3
Years
|
|
|
3-5
Years
|
|
|
More than
5 Years
|
|
Operating leases
(1)
|
|
$
|
327,688
|
|
|
$
|
27,989
|
|
|
$
|
71,210
|
|
|
$
|
60,194
|
|
|
$
|
168,295
|
|
Warehouse facility
|
|
|
540,571
|
|
|
|
540,571
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Long-term debt
(2)
|
|
|
659,650
|
|
|
|
—
|
|
|
|
547,150
|
|
|
|
—
|
|
|
|
112,500
|
|
Intercompany Credit Agreement
|
|
|
270,000
|
|
|
|
270,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total contractual obligations
|
|
$
|
1,797,909
|
|
|
$
|
838,560
|
|
|
$
|
618,360
|
|
|
$
|
60,194
|
|
|
$
|
280,795
|
|
69
(1)
|
Operating leases are related to rental payments under various non-cancelable leases principally for office space, net of sublease payments to be received. The total amount of sublease payments to be received is approximately $2.9 million over the life of the agreement.
|
(2)
|
Long-term debt reflects long-term borrowings of $247.2 million under Newmark’s Term Loan: the issuance of $112.5 million of the 2042 Promissory Notes due June 26, 2042, and $300.0 million of the 2019 Promissory Notes due December 9, 2019, (see Note 20–Long-Term Debt) for more information regarding these obligations.
|
Critical Accounting Policies and Estimates
The preparation of our unaudited condensed consolidated financial statements in conformity with U.S. GAAP guidance requires management to make estimates and assumptions that affect the reported amounts of the assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities in our unaudited condensed consolidated financial statements. These accounting estimates require the use of assumptions about matters, some which are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our condensed consolidated balance sheets, condensed consolidated statements of operations and condensed consolidated statements of cash flows could be materially affected. We believe that the following policies involve a higher degree of judgment and complexity.
Revenue Recognition
We derive our revenues primarily through commissions from brokerage services, gains from mortgage banking activities/originations, net, revenues from real estate management services, servicing fees and other revenues. Revenue from contracts with customers is recognized when, or as, the Company satisfies its performance obligations by transferring the promised goods or services to the customers as determined by when, or as, the customer obtains control of that good or service. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized by measuring the Company’s progress in satisfying the performance obligation as evidenced by the transfer of the goods or services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time when the customer obtains control over the promised good or service. The amount of revenue recognized reflects the consideration we expect to be entitled to in exchange for those promised goods or services (i.e., the “transaction price”). In determining the transaction price, we consider consideration promised in a contract that includes a variable amount, referred to as variable consideration, and estimate the amount of consideration due the Company. Additionally, variable consideration is included in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. In determining when to include variable consideration in the transaction price, the Company considers all information (historical, current and forecast) that is available, including the range of possible outcomes, the predictive value of past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of the Company’s influence.
We also use third-party service providers in the provision of its services to customers. In instances where a third-party service provider is used, the Company performs an analysis to determine whether the Company is acting as a principal or an agent with respect to the services provided. To the extent that the Company determines that it is acting as a principal, the revenue and the expenses incurred are recorded on a gross basis. In instances where the Company has determined that it is acting as an agent, the revenue and expenses are presented on a net basis within the revenue line item.
In some instances, the Company performs services for customers and incurs out-of-pocket expenses as part of delivering those services. The Company’s customers agree to reimburse the Company for those expenses, and those reimbursements are part of the contract’s transaction price. Consequently, these expenses and the reimbursements of such expenses from the customer are presented on a gross basis because the services giving rise to the out-of-pocket expenses do not transfer a good or service. The reimbursements are included in the transaction price when the costs are incurred and the reimbursements are due from the customer.
Equity-Based and Other Compensation
Discretionary Bonus: A portion of our compensation and employee benefits expense comprises discretionary bonuses, which may be paid in cash, equity, partnership awards or a combination thereof. We accrue expense in a period based on revenues in that period and on the expected combination of cash, equity and partnership units. Given the assumptions used in estimating discretionary bonuses, actual results may differ.
Restricted Stock Units: We account for equity-based compensation under the fair value recognition provisions of U.S. GAAP guidance. Restricted stock units (which we refer to as “RSUs”) provided to certain employees are accounted for as equity awards, and in accordance with U.S. GAAP guidance, we are required to record an expense for the portion of the RSUs that is ultimately expected to vest. Further, U.S. GAAP guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent
70
periods if actual forfeitures differ from those estimates. Because signif
icant assumptions are used in estimating employee turnover and associated forfeiture rates, actual results may differ from our estimates under different assumptions or conditions.
The fair value of RSU awards to employees is determined on the date of grant, based on the fair value of BGC Partners’ Class A common stock. Generally, RSUs granted by us as employee compensation do not receive dividend equivalents; as such, we adjust the fair value of the RSUs for the present value of expected forgone dividends, which requires us to include an estimate of expected dividends as a valuation input. This grant-date fair value is amortized to expense ratably over the awards’ vesting periods. For RSUs with graded vesting features, we have made an accounting policy election to recognize compensation cost on a straight line basis. The amortization is reflected as non-cash equity-based compensation expense in our unaudited condensed consolidated statements of operations.
Restricted Stock: Restricted stock provided to certain employees is accounted for as an equity award, and as per U.S. GAAP guidance, we are required to record an expense for the portion of the restricted stock that is ultimately expected to vest. We have granted restricted stock that is not subject to continued employment or service; however, transferability is subject to compliance with our and our affiliates’ customary non-compete obligations. Such shares of restricted stock are generally saleable by partners in 5 to 10 years. Because the restricted stock is not subject to continued employment or service, the grant-date fair value of the restricted stock is expensed on the date of grant. The expense is reflected as non-cash equity-based compensation expense in our unaudited condensed consolidated statements of operations.
Limited Partnership Units: Limited partnership units in BGC Holdings and Newmark Holdings are generally held by employees. Generally such units receive quarterly allocations of net income, which are cash distributed on a quarterly basis and generally contingent upon services being provided by the unit holders. As discussed above, preferred units in BGC Holdings and Newmark Holdings are not entitled to participate in partnership distributions other than with respect to a distribution at a rate of either 0.6875% (which is 2.75% per calendar year) or such other amount as set forth in the award documentation. The quarterly allocations of net income to such limited partnership units are reflected as a component of compensation expense under “Allocations of net income and grants of exchangeability to limited partnership units” in our unaudited condensed consolidated statements of operations.
Certain of these limited partnership units entitle the holders to receive post-termination payments equal to the notional amount in four equal yearly installments after the holder’s termination. These limited partnership units are accounted for as post-termination liability awards under U.S. GAAP guidance. Accordingly, we recognize a liability for these units on our unaudited condensed consolidated balance sheets as part of “Accrued compensation” for the amortized portion of the post-termination payment amount, based on the current fair value of the expected future cash payout. We amortize the post-termination payment amount, less an expected forfeiture rate, over the vesting period, and record an expense for such awards based on the change in value at each reporting period in our unaudited condensed consolidated statements of operations as part of “Compensation and employee benefits.”
Certain limited partnership units in BGC Holdings and Newmark Holdings are granted exchangeability into BGC Partners Class A common stock on a one-for-one basis (subject to adjustments and other requirements as set forth in the BGC Holdings and Newmark Holdings limited partnership agreement). At the time exchangeability is granted, we recognize an expense based on the fair value of the award on that date, which is included in “Allocations of net income and grants of exchangeability to limited partnership units” in our unaudited condensed consolidated statements of operations.
Employee Loans: We have entered into various agreements with certain employees and partners whereby these individuals receive loans that may be either wholly or in part repaid from distributions that the individuals receive on some or all of their limited partnership interests or may be forgiven over a period of time. Cash advance distribution loans are documented in formal agreements and are repayable in timeframes outlined in the underlying agreements. We intend for these advances to be repaid in full from the future distributions on existing and future awards granted. The distributions are treated as compensation expense when made and the proceeds are used to repay the loan. The forgivable portion of any loans is recognized as compensation expense in our unaudited condensed consolidated statements of operations over the life of the loan. We review the loan balances each reporting period for collectability. If we determine that the collectability of a portion of the loan balances is not expected, we recognize a reserve against the loan balances. Actual collectability of loan balances may differ from our estimates. As of June 30, 2018 and December 31, 2017, the aggregate balance of employee loans, net of reserve, was $248.0 million and $209.6 million, respectively, and is included as “Loans, forgivable loans and other receivables from employees and partners, net” in our unaudited condensed consolidated balance sheets. Compensation expense for the above-mentioned employee loans for the three and six months ended June 30, 2018 was $5.2 million and $11.2 million, respectively and $2.4 million and $4.4 million for the three and six months ended June 30, 2017, respectively. The compensation expense related to these loans was included as part of “Compensation and employee benefits” in our unaudited condensed consolidated statements of operations.
71
Goodwill
Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in a business combination. As prescribed in U.S. GAAP guidance, Intangibles - Goodwill and Other Intangible Assets, goodwill is not amortized, but instead is periodically tested for impairment. We review goodwill for impairment on an annual basis during the fourth quarter of each fiscal year or whenever an event occurs or circumstances change that could reduce the fair value of a reporting unit below its carrying amount.
When reviewing goodwill for impairment, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. If the results of the qualitative assessment are not conclusive, or if we choose to bypass the qualitative assessment, we perform a goodwill impairment analysis using a two-step process. Newmark had goodwill balances as of June 30, 2018 and December 31, 2017 of $481.7 million and $477.0 million, respectively.
The first step of the process involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. To estimate the fair value of the reporting units, we use a discounted cash flow model and data regarding market comparables. The valuation process requires significant judgment and involves the use of significant estimates and assumptions. These assumptions include cash flow projections, estimated cost of capital and the selection of peer companies and relevant multiples. Because significant assumptions and estimates are used in projecting future cash flows, choosing peer companies and selecting relevant multiples, actual results may differ from our estimates under different assumptions or conditions. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is deemed not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of potential impairment.
The second step of the process involves the calculation of an implied fair value of goodwill for each reporting unit for which step one indicated a potential impairment may exist. The implied fair value of goodwill is determined by measuring the excess of the estimated fair value of the reporting unit as calculated in step one, over the estimated fair values of the individual assets, liabilities and identified intangibles. Events such as economic weakness, significant declines in operating results of reporting units, or significant changes to critical inputs of the goodwill impairment test (e.g., estimates of cash flows or cost of capital) could cause the estimated fair value of our reporting units to decline, which could result in an impairment of goodwill in the future.
Income Taxes
Newmark accounts for income taxes using the asset and liability method as prescribed in U.S. GAAP guidance,
Income Taxes
. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to basis differences between the unaudited condensed consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Certain of Newmark’s entities are taxed as U.S. partnerships and are subject to the Unincorporated Business Tax (“UBT”) in New York City. Therefore, the tax liability or benefit related to the partnership income or loss except for UBT rests with the partners, rather than the partnership entity. As such, the partners’ tax liability or benefit is not reflected in Newmark’s unaudited condensed consolidated financial statements. The tax-related assets, liabilities, provisions or benefits included in Newmark’s unaudited condensed consolidated financial statements also reflect the results of the entities that are taxed as corporations, either in the U.S. or in foreign jurisdictions.
Newmark’s income taxes as presented are calculated on a separate return basis, although Newmark’s operations have historically been included in BGC’s U.S. federal and state tax returns or separate non-U.S. jurisdictions tax returns. As Newmark operations in many jurisdictions are unincorporated commercial units of BGC and its subsidiaries, stand-alone tax returns have not been filed for the operations in these jurisdictions. Accordingly, Newmark’s tax results as presented are not necessarily reflective of the results that Newmark would have generated on a stand-alone basis.
Newmark provides for uncertain tax positions based upon management’s assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. Management is required to determine whether a tax position is more likely than not to be sustained upon examination by tax authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Because significant assumptions are used in determining whether a tax benefit is more likely than not to be sustained upon examination by tax authorities, actual results may differ from Newmark’s estimates under different assumptions or conditions. Newmark recognizes interest and penalties related to uncertain tax positions in “Provision for income taxes” in Newmark’s unaudited condensed consolidated statements of operations.
A valuation allowance is recorded against deferred tax assets if it is deemed more likely than not that those assets will not be realized. In assessing the need for a valuation allowance, Newmark considers all available evidence, including past operating results, the existence of cumulative losses in the most recent fiscal years, estimates of future taxable income and the feasibility of tax planning strategies.
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The measurement of current and deferred income tax assets and liabilitie
s is based on provisions of enacted tax laws and involves uncertainties in the application of tax regulations in the U.S. and other tax jurisdictions. Because Newmark’s interpretation of complex tax law may impact the measurement of current and deferred in
come taxes, actual results may differ from these estimates under different assumptions regarding the application of tax law.
On December 22, 2017, the SEC issued Staff Accounting Bulletin (“SAB 118”), which provides guidance on accounting for tax effects of the 2017 Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the 2017 Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the 2017 Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the 2017 Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate to be included in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provision of the tax laws that were in effect immediately before the enactment of the 2017 Tax Act. While Newmark is able to make reasonable estimates of the impact of the reduction in corporate rate and the deemed repatriation transition tax, the final impact of the 2017 Tax Act may differ from these estimates, due to, among other things, changes in interpretations, additional guidance that may be issued, unexpected negative changes in business and market conditions that could reduce certain tax benefits, and actions taken by Newmark as a result of the 2017 Tax Act.
Derivative Financial Instruments
We have loan commitments to extend credit to third parties. The commitments to extend credit are for mortgage loans at a specific rate (rate lock commitments). These commitments generally have fixed expiration dates or other termination clauses and may require a fee. We are committed to extend credit to the counterparty as long as there is no violation of any condition established in the commitment contracts.
We simultaneously enter into an agreement to deliver such mortgages to third-party investors at a fixed price (forward sale contracts).
Both the commitment to extend credit and the forward sale commitment qualify as derivative financial instruments. We recognize all derivatives on the unaudited condensed consolidated balance sheets as assets or liabilities measured at fair value. The change in the derivatives fair value is recognized in current period earnings.
Recent Accounting Pronouncements
See Note 1—Organization and Basis of Presentation, to our unaudited condensed consolidated financial statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q for information regarding recent accounting pronouncements.
Dividend Policy
Our board of directors has authorized a dividend policy that reflects our intention to pay a quarterly dividend, starting with the first quarter of 2018. Any dividends to our common stockholders will be calculated based on our expected post-tax Adjusted Earnings per fully diluted share, as a measure of net income for the year. See below for a definition of “post-tax Adjusted Earnings” per fully diluted share.
We currently expect that, in any year, our aggregate quarterly dividends will be equal to or less than our estimate at the end of the first quarter of such year of 25% of our post-tax Adjusted Earnings per fully diluted share to our common stockholders for such year. The declaration, payment, timing and amount of any future dividends payable by us will be at the discretion of our board of directors; provided that any dividend to our common stockholders that would result in the dividends for a year exceeding 25% of our post-tax Adjusted Earnings per fully diluted share for such year shall require the consent of the holder of a majority of the Newmark Holdings exchangeable limited partnership interests, which is currently Cantor.
For the second quarter of 2018, our board of directors declared a dividend of 9 cents per share based on management’s current expectation of our post-tax Adjusted Earning per fully diluted share for the year, and has indicated that it expects such dividend to remain consistent for the full year. To the extent that 25% of our post-tax Adjusted Earnings per fully diluted share for the year exceeds this dividend on an annualized basis (i.e. an expected aggregate of $0.36 for four quarters), we do not expect that our board of directors will increase the amount of the quarterly dividend payment during the year, or make downward adjustments in the event of a shortfall, although no assurance can be given that adjustments will not be made during the year. We have indicated that we expect to announce the annual expected dividend rate in the first quarter of each year. On August 1, 2018, Newmark’s Board of Directors increased Newmark’s authorization of repurchases of shares of Newmark’s Class A common stock by $100 million to $200 million.
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The declaration, payment, timing and amount of any future dividends payable by us will be at the sole discretion of our board of directors. We are a holding company, with no direct operations, and therefore we are able t
o pay dividends only from our available cash on hand and funds received from distributions from Newmark OpCo. Our ability to pay dividends may also be limited by regulatory or other considerations as well as by covenants contained in financing or other agr
eements. In addition, under Delaware law our, dividends may be payable only out of surplus, which is our net assets minus our capital (as defined under Delaware law), or, if we have no surplus, out of our net profits for the fiscal year in which the divide
nd is declared and/or the preceding fiscal year. Accordingly, any unanticipated accounting, tax, regulatory or other charges may adversely affect our ability to declare and pay dividends. While we intend to declare and pay dividends quarterly, there can be
no assurance that our board of directors will declare dividends at all or on a regular basis or that the amount of our dividends will not change.
Adjusted Earnings Defined
Newmark uses non-GAAP financial measures including, but not limited to, “pre-tax Adjusted Earnings” and “post-tax Adjusted Earnings,” which are supplemental measures of operating results that are used by management to evaluate the financial performance of the Company and its consolidated subsidiaries. Newmark believes that Adjusted Earnings best reflect the operating earnings generated by the Company on a consolidated basis and are the earnings which management considers available for, among other things, dividends and/or distributions to Newmark’s common stockholders and holders of Newmark Holdings partnership units during any period.
As compared with items such as “Income (loss) before income taxes and noncontrolling interests” and “Net income (loss) for fully diluted shares” all prepared in accordance with U.S. GAAP, Adjusted Earnings calculations primarily exclude certain non-cash compensation and other expenses that generally do not involve the receipt or outlay of cash by the Company and/or which do not dilute existing stockholders, as described below. In addition, Adjusted Earnings calculations exclude certain gains and charges that management believes do not best reflect the ordinary operating results of Newmark
Adjustments Made to Calculate Pre-Tax Adjusted Earnings
Newmark defines pre-tax Adjusted Earnings as GAAP income (loss) from operations before income taxes and noncontrolling interest in subsidiaries, excluding certain items such as:
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The impact of any unrealized non-cash mark-to-market gains or losses on “other income (loss)” related to the variable share forward agreement with respect to Newmark’s expected receipt of the Nasdaq payments in 2019 and 2020;
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Non-cash asset impairment charges, if any;
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Allocations of net income to limited partnership units;
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Non-cash charges related to the amortization of intangibles with respect to acquisitions;
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Non-cash charges relating to grants of exchangeability to limited partnership units.
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Virtually all of the Company’s key executives and producers have partnership or equity stakes in the Company and receive deferred equity or limited partnership units as part of their compensation. A significant percentage of Newmark’s fully diluted shares are owned by the Company’s executives, partners and employees. The Company issues limited partnership units and grants exchangeability to unit holders to provide liquidity to Newmark’s employees, to align the interests of the Company’s employees and management with those of common stockholders, to help motivate and retain key employees, and to encourage a collaborative culture that drives cross-selling and revenue growth.
When the Company issues limited partnership units, the shares of common stock into which the units can be ultimately exchanged are included in Newmark’s fully diluted share count for Adjusted Earnings at the beginning of the subsequent quarter after the date of grant. Newmark includes such shares in the Company’s fully diluted share count when the unit is granted because the unit holder is expected to be paid a pro-rata distribution based on Newmark’s calculation of Adjusted Earnings per fully diluted share and because the holder could be granted the ability to exchange their units into shares of common stock in the future. Non-cash charges with respect to grants of exchangeability reflect the value of the shares of common stock into which the unit is exchangeable when the unit holder is granted exchangeability not previously expensed in accordance with U.S. GAAP. The amount of non-cash charges relating to grants of exchangeability the Company uses to calculate pre-tax Adjusted Earnings on a quarterly basis is based upon the Company’s estimate of expected grants of exchangeability to limited partnership units during the annual period, as described further below under “Adjustments Made to Calculate Post-Tax Adjusted Earnings.”
Adjusted Earnings also excludes non-cash GAAP gains attributable to originated mortgage servicing rights (which Newmark refer to as “OMSRs”) and non-cash GAAP amortization of mortgage servicing rights (which the Company refers to as “MSRs”).
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Under
U.S.
GAAP, the Company recognizes OMSRs gains equal to the fair value of servicing rights retained on mortgage loans originated and sold. Subsequent to the initial recognition at fair value, MSRs are carri
ed at the lower of amortized cost or fair value and amortized in proportion to the net servicing revenue expected to be earned. However, it is expected that any cash received with respect to these servicing rights, net of associated expenses, will increase
Adjusted Earnings (and Adjusted EBITDA) in future periods.
Additionally, Adjusted Earnings calculations exclude certain unusual, one-time or non-recurring items, if any. These items are excluded from Adjusted Earnings because the Company views excluding such items as a better reflection of the ongoing, ordinary operations of Newmark. Newmark’s definition of Adjusted Earnings also excludes certain gains and charges with respect to acquisitions, dispositions, or resolutions of litigation. Management believes that excluding such gains and charges also best reflects the ongoing operating performance of Newmark.
Adjustments Made to Calculate Post-Tax Adjusted Earnings
Because Adjusted Earnings are calculated on a pre-tax basis, Newmark also intends to report post-tax Adjusted Earnings to fully diluted stockholders. Newmark defines post-tax Adjusted Earnings to fully diluted stockholders as pre-tax Adjusted Earnings reduced by the non-GAAP tax provision described below.
The Company calculates its tax provision for post-tax Adjusted Earnings using an annual estimate similar to how it accounts for its income tax provision under GAAP. To calculate the quarterly tax provision under GAAP, Newmark estimates its full fiscal year GAAP income (loss) from operations before income taxes and noncontrolling interests in subsidiaries and the expected inclusions and deductions for income tax purposes, including expected grants of exchangeability to limited partnership units during the annual period. The resulting annualized tax rate is applied to Newmark’s quarterly GAAP income (loss) from operations before income taxes and noncontrolling interests in subsidiaries. At the end of the annual period, the Company updates its estimate to reflect the actual tax amounts owed for the period.
To determine the non-GAAP tax provision, Newmark first adjusts pre-tax Adjusted Earnings by recognizing any, and only, amounts for which a tax deduction applies under applicable law. The amounts include non-cash charges with respect to grants of exchangeability, certain charges related to employee loan forgiveness, certain net operating loss carryforwards when taken for statutory purposes, and certain charges related to tax goodwill amortization. These adjustments may also reflect timing and measurement differences, including treatment of employee loans, changes in the value of units between the dates of grants of exchangeability and the date of actual unit exchange, variations in the value of certain deferred tax assets and liabilities and the different timing of permitted deductions for tax under GAAP and statutory tax requirements.
After application of these previously described adjustments, the result is the Company’s taxable income for Newmark’s pre-tax Adjusted Earnings, to which the Company then applies the statutory tax rates. This amount is the Company’s non-GAAP tax provision. Newmark views the effective tax rate on pre-tax Adjusted Earnings as equal to the amount of Newmark’s non-GAAP tax provision divided by the amount of pre-tax Adjusted Earnings.
Generally, the most significant factor affecting this non-GAAP tax provision is the amount of non-cash charges relating to the grants of exchangeability to limited partnership units. Because the non-cash charges relating to the grants of exchangeability are deductible in accordance with applicable tax laws, increases in exchangeability have the effect of lowering the Company’s non-GAAP effective tax rate and thereby increasing Newmark’s post-tax Adjusted Earnings.
Management uses post-tax Adjusted Earnings in part to help it evaluate, among other things, the overall performance of the business, to make decisions with respect to the Company’s operations, and to determine the amount of dividends payable to common stockholders and distributions payable to holders of limited partnership units.
Newmark incurs income tax expenses based on the location, legal structure and jurisdictional taxing authorities of each of its subsidiaries. Certain of the Company’s entities are taxed as U.S. partnerships and are subject to the Unincorporated Business Tax (“UBT”) in New York City. Any U.S. federal and state income tax liability or benefit related to the partnership income or loss, with the exception of UBT, rests with the unit holders rather than with the partnership entity. The Company’s consolidated financial statements include U.S. federal, state and local income taxes on the Company’s allocable share of the U.S. results of operations. Outside of the U.S., Newmark is expected to operate principally through subsidiary corporations subject to local income taxes. For these reasons, taxes for Adjusted Earnings are expected to be presented to show the tax provision the consolidated Company would expect to pay if 100 percent of earnings were taxed at global corporate rates.
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Ca
lculations of Pre-Tax and Post-Tax Adjusted Earnings per Share
Newmark’s Adjusted Earnings per share calculations assume either that:
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The fully diluted share count includes the shares related to any dilutive instruments, but excludes the associated interest expense, net of tax, when the impact would be dilutive; or
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The fully diluted share count excludes the shares related to these instruments, but includes the associated interest expense, net of tax.
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The share count for Adjusted Earnings excludes certain shares expected to be issued in future periods but not yet eligible to receive dividends and/or distributions. Each quarter, the dividend payable to Newmark’s common stockholders, if any, is expected to be determined by the Company’s board of directors with reference to a number of factors, including post-tax Adjusted Earnings per fully diluted share. Newmark may also pay a pro rata distribution of net income to limited partnership units, as well as to Cantor for its noncontrolling interest. The amount of this net income, and therefore of these payments per unit, would be determined using the above definition of pre-tax Adjusted Earnings using the fully diluted share count. The declaration, payment, timing and amount of any future dividends payable by the Company will be at the discretion of its board of directors using the fully diluted share count.
OUR ORGANIZATIONAL STRUCTURE
Our Restructuring
We are Newmark Group, Inc., a Delaware corporation. We were formed as NRE Delaware, Inc. on November 18, 2016 and changed our name to Newmark Group, Inc. on October 18, 2017. We were formed for the purpose of becoming a public company conducting the operations of BGC Partners’ Real Estate Services segment, including Newmark and Berkeley Point.
Through the following series of transactions prior to and following the completion of the Separation and our IPO, we became a separate publicly traded company. A majority of our issued and outstanding shares of common stock are held by BGC Partners. If BGC Partners completes the spin-off, a majority of our issued and outstanding shares of common stock will be held by the stockholders of BGC Partners as of the date of the spin-off.
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Prior to the completion of our IPO, the separation and contribution pursuant to which members of the BGC Group transferred to us substantially all of the assets and liabilities of the BGC Partners’ Real Estate Services segment, including Newmark, Berkeley Point and the right to receive the remainder of the Nasdaq payment (the “Contribution”), various types of interests of Newmark Holdings were issued to holders of interests of BGC Holdings in proportion to such interests of BGC Holdings held by such holders immediately prior thereto.
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Concurrently with the Separation and Contribution, we entered into the transactions described under “Assumption and Repayment of Indebtedness” below.
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In March 2018, BGC Partners made an additional investment in us as described under “BGC Partners March 2018 Investment” below.
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BGC Partners may distribute the shares of our common stock held thereby to its stockholders as described under “The Distribution” below.
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The types of interests in Newmark, Newmark Holdings and Newmark OpCo outstanding following the completion of these transactions are described under “Current Structure of Newmark” below.
The Separation and Contribution
Prior to the completion of the IPO, pursuant to the Separation and Distribution Agreement, members of the BGC Group transferred to us substantially all of the assets and liabilities of the BGC group relating to BGC Partners’ Real Estate Services segment, including Newmark, Berkeley Point and the right to receive the remainder of the Nasdaq Earn-out. For a description of the Nasdaq Earn-out, see “Nasdaq Transaction.” Prior to the separation, the BGC Group held all of the historical assets and liabilities related to our business.
In connection with the Separation, Newmark Holdings limited partnership interests, Newmark Holdings founding partner interests, Newmark Holdings working partner interests and Newmark Holdings limited partnership units were distributed to holders of BGC Holdings limited partnership interests, BGC Holdings founding partner interests, BGC Holdings working partner interests and BGC Holdings limited partnership units in proportion to such interests of BGC Holdings held by such holders immediately prior to the Separation.
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We also entered into a tax matters agreement with BGC Partners that governs the parties’ respective rights, responsibilities and obligations after the
Separat
ion
with respect to taxes, tax attributes, the preparation and filing of tax returns, the control of audits and other tax proceedings, tax elections, assistance and cooperation in respect of tax matters, procedures and restrictions relating to the
Distribu
tion
, if any, and certain other tax matters. We also entered into an administrative services agreement with Cantor, which governs the provision by Cantor of various administrative services to us, and our provision of various administrative services to Cant
or, at a cost equal to (1) the direct cost that the providing party incurs in performing those services, including third-party charges incurred in providing services, plus (2) a reasonable allocation of other costs determined in a consistent and fair manne
r so as to cover the providing party’s appropriate costs or in such other manner as the parties agree. We also entered into a transition services agreement with BGC Partners, which governs the provision by BGC Partners of various administrative services to
us, and our provision of various administrative services to BGC Partners, on a transitional basis (with a term of up to two years following the
Distribution
) and at a cost equal to (1) the direct cost that the providing party incurs in performing those se
rvices, including third-party charges incurred in providing services, plus (2) a reasonable allocation of other costs determined in a consistent and fair manner so as to cover the providing party’s appropriate costs or in such other manner as the parties a
gree.
Assumption and Repayment of Indebtedness
In connection with the Separation and prior to the closing of our IPO, we assumed from BGC Partners the Term Loan and the Converted Term Loan. Newmark OpCo also assumed from BGC U.S. OpCo the BGC Notes. We contributed all of the net proceeds of our IPO to Newmark OpCo in exchange for a number of units representing Newmark OpCo limited partnership interests equal to the number of shares issued by us in the IPO. Newmark OpCo used all of such net proceeds to partially repay intercompany indebtedness owed by Newmark OpCo to us in respect of the Term Loan (which intercompany indebtedness was originally issued by BGC U.S. OpCo and was assumed by Newmark OpCo in connection with the separation). We used all of such repayment from Newmark OpCo to partially repay the Term Loan. The Term Loan had a maturity date of September 8, 2019, and was repaid in full on March 9, 2018. Pursuant to the Term Loan, in the event that any member of the Newmark Group received net proceeds from the incurrence of indebtedness for borrowed money or an equity issuance (in each case subject to certain exceptions), Newmark OpCo was obligated to use such net proceeds to repay the remaining intercompany indebtedness owed by Newmark OpCo to us in respect of the Term Loan (which in turn we were obligated to the remaining amount outstanding on the Term Loan), and thereafter, to repay the remaining intercompany indebtedness owed by Newmark OpCo to us in respect of the Converted Term Loan (which in turn we will use to repay the remaining amount outstanding on the Converted Term Loan). On June 19, 2018, Newmark OpCo repaid approximately $152.9 million of the outstanding principal amount under the Converted Term Loan. As of June 30, 2018, approximately $247.2 million of the Converted Term Loan remains outstanding. Following full repayment of the Term Loan and the Converted Term Loan, in the event that any member of the Newmark Group receives net proceeds from the incurrence of indebtedness for borrowed money (subject to certain exceptions), Newmark OpCo will be obligated to use such net proceeds to repay the BGC Notes. In addition, we will be obligated to repay any remaining amounts under the BGC Notes prior to the Distribution.
On
March 19
, 2018, Newmark and BGC Partners entered into an Intercompany Credit Agreement and on the same date Newmark borrowed $150.0 million from BGC pursuant to the facilities under the Intercompany Credit Agreement. The interest rate as of June 30, 2018 was LIBOR plus
3.25
%, or
5.31
%, which may be adjusted based on the higher of BGC’s or Newmark’s short-term borrowing rate then in effect at such time plus 100 basis points, or such other interest rate as may be mutually agreed between BGC and Newmark. Newmark has transferred these proceeds to its restricted cash account pledged for the benefit of Fannie Mae. As of June 30, 2018, Newmark’s total net borrowings under the Intercompany Credit Agreement are $
270.0
million.
BGC Partners March 2018 Investment
On March 7, 2018, BGC Partners and its operating subsidiaries purchased 16,606,726 newly issued exchangeable limited partnership units of Newmark Holdings for an aggregate investment of approximately $242.0 million. The price per unit was based on the $14.57 closing price of our Class A common stock on March 6, 2018 as reported on the NASDAQ Global Select Market. These units are exchangeable, at BGC Partners’ discretion, into either shares of our Class common stock or our Class B common stock, par value $0.01 per share. Following such issuance, BGC Partners owned 83.4% of our 138.6 million shares of Class A common issued and outstanding on March 7, 2018 and 100% of our 15.8 million issued and outstanding shares of Class B common stock. Including the newly issued exchangeable limited partnership units of Newmark Holdings, BGC Group owned 59.2% of the 253.0 million fully diluted shares of Newmark outstanding on March 7, 2018. The balance of our fully diluted share count was owned by the public, Cantor, partners of Newmark Holdings, and employees. Because Newmark limited partnership units are not entitled to a vote until they are exchanged for Newmark common stock, BGC Group’s voting power with respect to Newmark did not change as a result of the March 2018 investment. If the BGC Group were to exchange such units into shares of our Class B common stock, the BGC Group would have 95.0% of our total voting power as of June 30, 2018 (92.7% if the BGC Group were to exchange such units into shares of our Class A common stock).
Immediately after giving effect to the March 7, 2018 investment, the BGC Group owned an aggregate 19.2% of the economic interest in Newmark Holdings and an aggregate 59.8% indirect economic interest in Newmark OpCo. Immediately after giving effect
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o the March 7, 2018 investment, Cantor owns 24.8% of the economic interest in Newmark Holdings and a 9.5% indirect economic interest in Newmark OpCo, and the other limited partners of Newmark Holdings (including Newmark employees) owned 56.0% of the econom
ics of Newmark Holdings and an aggregate 21.4% indirect economic interest in Newmark OpCo.
The Distribution (Spin-off)
BGC Partners has advised us that it currently expects to pursue a Distribution, or spin-off, to its stockholders of all of the shares of our common stock that it then owns in a manner that is intended to qualify as generally tax-free for U.S. federal income tax purposes. As currently contemplated, shares of our Class A common stock held by BGC Partners would be distributed to the holders of shares of Class A common stock of BGC Partners and shares of our Class B common stock held by BGC Partners would be distributed to the holders of shares of Class B common stock of BGC Partners (which are currently Cantor and another entity controlled by Mr. Lutnick). The determination of whether, when and how to proceed with any such spin-off is entirely within the discretion of BGC Partners.
Current Structure of Newmark
As of June 30, 2018, there were 138,921,533 shares of Class A common stock issued and outstanding. BGC Partners held 115,593,786 shares of our Class A common stock representing approximately 83.2% of our outstanding Class A common stock. Each share of Class A common stock is generally entitled to one vote on matters submitted to a vote of our stockholders. In addition, as of June 30, 2018, BGC Partners held 15,840,049 shares of our Class B common stock representing all of the outstanding shares of our Class B common stock. Together, the shares of Class A common stock and Class B common stock held by BGC Partners as of June 30, 2018, represented approximately 92.2% of our total voting power. Each share of Class B common stock is generally entitled to the same rights as a share of Class A common stock, except that, on matters submitted to a vote of our stockholders, each share of Class B common stock is entitled to 10 votes. The Class B common stock generally votes together with the Class A common stock on all matters submitted to a vote of our stockholders. We expect to retain our dual class structure, and there are no circumstances under which the holders of Class B common stock would be required to convert their shares of Class B common stock into shares of Class A common stock. Our amended and restated certificate of incorporation referred to herein as our certificate of incorporation does not provide for automatic conversion of shares of Class B common stock into shares of Class A common stock upon the occurrence of any event.
We hold the Newmark Holdings general partnership interest and the Newmark Holdings special voting limited partnership interest, which entitle us to remove and appoint the general partner of Newmark Holdings and serve as the general partner of Newmark Holdings, which entitles us to control Newmark Holdings. Newmark Holdings, in turn, holds the Newmark OpCo general partnership interest and the Newmark OpCo special voting limited partnership interest, which entitle Newmark Holdings to remove and appoint the general partner of Newmark OpCo, and serve as the general partner of Newmark OpCo, which entitles Newmark Holdings (and thereby us) to control Newmark OpCo. In addition, as of June 30, 2018, we directly held Newmark OpCo limited partnership interests consisting of approximately 154,761,581 units representing approximately 61.1% of the outstanding Newmark OpCo limited partnership interests
(not including
EPUs
)
. We are a holding company that will hold these interests, serve as the general partner of Newmark Holdings and, through Newmark Holdings, act as the general partner of Newmark OpCo. As a result of our ownership of the general partnership interest in Newmark Holdings and Newmark Holdings’ general partnership interest in Newmark OpCo, we will consolidate Newmark OpCo’s results for financial reporting purposes.
Cantor, BGC Partners (including through its operating subsidiaries), founding partners, working partners and limited partnership unit holders directly hold Newmark Holdings limited partnership interests. Newmark Holdings, in turn, holds Newmark OpCo limited partnership interests and, as a result, Cantor, BGC Partners (including through its operating subsidiaries), founding partners, working partners and limited partnership unit holders indirectly have interests in Newmark OpCo limited partnership interests. In accordance with the Separation and Distribution Agreement, BGC owns limited partnership interests in Newmark OpCo as a result of issuances of BGC Class A common stock, primarily related to the redemption of limited partnership interests in BGC Holdings and Newmark Holdings. Prior to the Newmark spin-off, these limited partnership interests held by BGC in the Newmark OpCo will be exchanged into Newmark Class A or Class B common stock, and will be included as part of the Newmark Distribution to BGC shareholders. In addition, RBC holds approximately $175 million of EPUs issued by Newmark OpCo in connection with the Newmark OpCo Preferred Investment.
As a result of the Distribution of limited partnership interests of Newmark Holdings to partners of BGC Holdings in connection with the separation, each holder of BGC Holdings limited partnership interests held a BGC Holdings limited partnership interest and a corresponding 0.454545 of a Newmark Holdings limited partnership interest for each BGC Holdings limited partnership interest held thereby immediately prior to the Separation. The BGC Holdings limited partnership interests and Newmark Holdings limited partnership interests are each entitled to receive cash distributions from BGC Holdings and Newmark Holdings, respectively, in accordance with the terms of such partnership’s respective limited partnership agreement.
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The Newmark Holdings limited partnership interests held by Cantor
and
BGC Partners (including through
its operating subsidiaries
)
are designated as Newmark Holdings exchangeable limited partnership interests. The Newmark Holdings limited partnership interests held by the founding partners are designated as Newmark Holdings f
ounding partner interests. The Newmark Holdings limited partnership interests held by the working partners are designated as Newmark Holdings working partner interests. The Newmark Holdings limited partnership interests held by the limited partnership unit
holders are designated as limited partnership units.
Each unit of Newmark Holdings limited partnership interests held by Cantor and BGC Partners (including through its operating subsidiaries) is generally exchangeable with us for a number of shares of Class B common stock (or, at Cantor’s option or if there are no additional authorized but unissued shares of Class B common stock, a number of shares of Class A common stock) equal to the exchange ratio (which was initially one, but is subject to adjustment as set forth in the Separation and Distribution Agreement). Prior to the spin-off, however, such exchanges are subject to the limitation as described in our 2017 Annual Report on Form 10-K (the “10-K”) under “Item 13—Certain Relationships and Related-Party Transactions—Amended and Restated Newmark Holdings Limited Partnership Agreement—Exchanges.”
As of June 30, 2018, 5,676,703 founding/working partner interests were outstanding. These founding/working partner were issued in the Separation to holders of BGC Holdings founding/working partner interests, who received such founding/working partner interests in connection with BGC Partners’ acquisition of the BGC Partners business from Cantor in 2008. The Newmark Holdings limited partnership interests held by founding/working partners are not exchangeable with us unless (1) Cantor acquires such interests from Newmark Holdings upon termination or bankruptcy of the founding/working partners or redemption of their units by Newmark Holdings (which it has the right to do under certain circumstances), in which case such interests will be exchangeable with us for our Class A common stock or Class B common stock as described above, or (2) Cantor determines that such interests can be exchanged by such founding/working partners with us for our Class A common stock, with each Newmark Holdings unit exchangeable for a number of shares of our Class A common stock equal to the exchange ratio (which was initially one, but is subject to adjustment as set forth in the Separation and Distribution Agreement), on terms and conditions to be determined by Cantor (which exchange of certain interests Cantor expects to permit from time to time). Cantor has provided that certain founding/working partner interests are exchangeable with us for Class A common stock, with each Newmark Holdings unit exchangeable for a number of shares of our Class A common stock equal to the exchange ratio (which was initially one, but is subject to adjustment as set forth in the Separation and Distribution Agreement), in accordance with the terms of the Newmark Holdings limited partnership agreement. Once a Newmark Holdings founding/working partner interest becomes exchangeable, such founding/working partner interest is automatically exchanged upon a termination or bankruptcy (x) with BGC Partners for Class A common stock of BGC Partners (after also providing the requisite portion of BGC Holdings founding/working partner interests) if the termination or bankruptcy occurs prior to the Distribution and (y) in all other cases, with us for our Class A common stock.
Further, we provide exchangeability for partnership units under other circumstances in connection with (1) our partnership redemption, compensation and restructuring programs, (2) other incentive compensation arrangements and (3) business combination transactions.
As of June 30, 2018, 74,062,985 limited partnership units were outstanding (including founding/working partner interests and working partner interests, and units held by BGC Partners (including through its operating subsidiaries)). Limited partnership units will be only exchangeable with us in accordance with the terms and conditions of the grant of such units, which terms and conditions are determined in our sole discretion, as the Newmark Holdings general partner, with the consent of the Newmark Holdings exchangeable limited partnership interest majority in interest, in accordance with the terms of the Newmark Holdings limited partnership agreement.
Notwithstanding the foregoing, prior to the Distribution, without the prior consent of BGC Partners, no Newmark Holdings limited partnership interests shall be exchangeable into shares of our Class A common stock or Class B common stock. Prior to the Distribution, unless otherwise agreed by BGC Partners, in order for a partner to exchange an exchangeable limited partnership interest in BGC Holdings or Newmark Holdings into a share of BGC common stock, such partner must exchange both one BGC Holdings exchange right unit and a certain number of Newmark Holdings exchangeable units as set forth in the BGC Holdings limited partnership agreement, in order to receive one share of BGC Partners common stock. Prior to the Distribution, to the extent that BGC Partners receives any Newmark OpCo units as a result of any exchange of Newmark Holdings exchangeable units as described in the immediately preceding sentence or as a result of any contribution by BGC Partners to Newmark OpCo or purchase by BGC Partners of Newmark OpCo units (see “Item 13—Certain Relationships and Related-Party Transactions—Reinvestments in Newmark OpCo by BGC Partners” in our Annual Report on Form 10-K/A (“10-K/A”), then, in each case, prior to the Distribution BGC Partners will contribute such Newmark OpCo units to Newmark in exchange for a number of shares of Newmark common stock equal to the number of such Newmark OpCo units multiplied by the then current exchange ratio (with the class of shares of our common stock corresponding to the class of shares of common stock that BGC Partners issued upon such exchange).
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The exchange ratio between Newmark Holdings limited partnership interests and our common stock
was initially
one
. However, this exchange ratio will be adjusted in accordance with the terms of the
Separation
and
Distribution Agree
ment
if our dividend policy and the distribution policy of Newmark Holdings are different.
See “Item 5—Market for the Registrant’s Common Equity, Rela
t
ed Stockholder Matters and Purchased of Equity Securities—Dividend Policy” and “Item 13—Certain Relations
hip and Related-Party Transactions-Adjustments to Exchange Ratio
”
in ou
r
10-K
/A
.
With each exchange, our direct and indirect (and, prior to the Distribution and as described above, BGC Partners’ indirect) interest in Newmark OpCo will proportionately increase because, immediately following an exchange, Newmark Holdings will redeem the Newmark Holdings unit so acquired for the Newmark OpCo limited partnership interest underlying such Newmark Holdings unit.
The profit and loss of Newmark OpCo and Newmark Holdings, as the case may be, are allocated based on the total number of Newmark OpCo units
(not including
EPUs
)
and Newmark Holdings units, as the case may be, outstanding.
The following diagram illustrates our ownership structure as of June 30, 2018. The diagram does not reflect the various subsidiaries of Newmark, Newmark Holdings, Newmark OpCo, BGC Partners, BGC U.S. OpCo, BGC Global OpCo or Cantor, the results of any exchange of Newmark Holdings exchangeable limited partnership interests or, to the extent applicable, Newmark Holdings founding partner interests, Newmark Holdings working partner interests or Newmark Holdings limited partnership units. In addition, the diagram does not reflect the EPUs in Newmark OpCo held by RBC. Holders of the EPUs are not allocated any gains or losses for tax purposes and are not entitled to regular distributions. For additional information regarding the EPUs, please see the section titled “Exchangeable Preferred Partnership Units and Forward Contract” in Note 1 – Organization and Basis of Presentation and the section titled “Exchangeable preferred Limited Partnership Units” in Note 2 – Limited Partnership Interests in our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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OUR OWNERSHIP STRUCTURE
Shares of our Class B common stock are convertible into shares of our Class A common stock at any time in the discretion of the holder on a one-for-one basis. Accordingly, if BGC Partners converted all of its common stock held in our Class B common stock into
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our Class A common stock, BGC
Partners
would hold approximately
84.9
% of the voting power and the public stockholders would hold approximately
15.1
% of the voting power (and the indirect economic interests in Newmark OpCo would remain unchanged).
The diagram above does not show (a) certain operating subsidiaries that are organized as corporations whose equity are either wholly owned by us or whose equity are majority-owned by us with the remainder owned by Newmark OpCo or (b) EPUs issued by Newmark OpCo held by RBC.
Structure of Newmark Following the Distribution (Spin-off)
BGC Partners has advised us that it currently expects to pursue a Distribution, or spin-off, to its stockholders of all of the shares of our common stock that it then owns in a manner that is intended to qualify as generally tax-free for U.S. federal income tax purposes. As currently contemplated, shares of our Class A common stock held by BGC Partners would be distributed to the holders of shares of Class A common stock of BGC Partners and shares of our Class B common stock held by BGC Partners would be distributed to the holders of shares of Class B common stock of BGC Partners (which are currently Cantor and another entity controlled by Mr. Lutnick). The determination of whether, when and how to proceed with any such spin-off is entirely within the discretion of BGC Partners.
To account for potential changes in the number of shares of Class A common stock and Class B common stock of BGC Partners and Newmark between the IPO and the spin-off, and to ensure that the spin-off (if it occurs) is pro rata to the stockholders of BGC Partners, immediately prior to the spin-off, BGC Partners will convert any shares of Class B common stock of Newmark beneficially owned by BGC Partners into shares of Class A common stock of Newmark, or exchange any shares of Class A common stock of Newmark beneficially owned by BGC Partners for shares of Class B common stock of Newmark, so that the ratio of shares of Class B common stock of Newmark held by BGC Partners to the shares of Class A common stock of Newmark held by BGC Partners, in each case as of immediately prior to the spin-off, equals the ratio of shares of outstanding Class B common stock of BGC Partners to the shares of outstanding Class A common stock of BGC Partners, in each case as of the record date of the spin-off.
Had the spin-off occurred immediately following the close of th
e second quarter of 2018, the ratio of Newmark common shares to be distributed in respect of each BGC common share would have been
approximately 0.4647. However
, the exact ratio of Newmark common shares to be distributed in respect of each BGC common share in the spin-off will depend on, among other things, the number of BGC common shares outstanding and the number of Newmark common shares (including Newmark common shares underlying units of Newmark OpCo) owned by BGC as of the record date of the spin-off. The spin-off is subject to a number of conditions, and BGC may determine not to proceed with the spin-off if the BGC board of directors determines, in its sole discretion, that the spin-off is not in the best interest of BGC and its stockholders. Accordingly, the spin-off may not occur on the expected timeframe, or at all.
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