Bgc Group Inc (BGC) 2006 Q2 法說會逐字稿

Welcome to the second quarter 2006 eSpeed earnings conference call. [OPERATOR INSTRUCTIONS] Now I'd like to turn the meeting over to Mr. Jason McGruder, Vice President of Investor Relations. Sir, you may begin.

Good morning. This is Jason McGruder, VP of Investor Relations for eSpeed. I would like to remind you all that the information provided on this conference call contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities and Exchange act of 1934 as amended. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein, that are not statements of historical fact may be deemed to be forward-looking statements.

Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, our relationship with Cantor Fitzgerald and its affiliates, the costs and expenses of developing, maintaining, and protecting our intellectual property, including judgments or settlements paid or received, and the related costs, the possibility of future losses and negative cash flow from operations, the effect of market conditions, including trading volume and volatility, our pricing strategy and that of our competitors, our ability to develop new products and services, to enter new markets, to secure and maintain market position, to enter into marketing and strategic alliances, to hire new personnel, to expand the use of our electronic system, to induce clients to use our marketplaces and services to effectively manage any growth we achieved, the effects of the attacks on the World Trade Center on September 11th, 2001, and other factors that are discussed under "Risk Factors" in eSpeed's annual report on Form 10-K filed with the Securities and Exchange Commission.

We believe that all forward-looking statements are based upon a reasonable assumption when made. However, we caution that it is impossible to predict actual results or outcomes or the effects of risks, uncertainties or other factors on anticipated results or outcomes, and that accordingly, you should not place undue reliance on these statements. Forward-looking statements speak only as of the date when made, and we undertake no obligation to update these statements in light of subsequent events or developments. Actual results and outcomes may differ materially from anticipated results or outcomes discussed in forward-looking statements.

I would like to now turn the call over to our host, Howard Lutnick, CEO and Chairman of eSpeed.

Good morning and thank you for joining us for eSpeed's second quarter conference call. With me today are our President, Kevin Foley; our Chief Operating Officer, Paul Saltzman; and our Interim Chief Accounting Officer, Frank Saracino. As some of you may know, Frank has been eSpeed's Global Controller since 2004, and we are pleased to welcome him on this call.

But first, Frank will review our second quarter financial results, then Paul will discuss our US Treasury business, Kevin will then review our voice-assisted business and new products, and I will conclude by updating our 2006 guidance, after which we will be glad to answer your questions.

And now, I'd like to introduce Frank Saracino.

Thanks, Howard, and good morning. We reported a GAAP net loss of $400,000 or $0.01 per diluted share in the second quarter. Our non-GAAP net operating income was $1.8 million or $0.04 per diluted share for the quarter, ahead of our guidance to $0.02 to $0.03. This was due to slightly higher than anticipated revenue, coupled with operating expenses in line with our expectations.

The difference between non-GAAP net operating income and the GAAP net loss was due to a $2 million expense related to the relocation of our London office to Bank Street in Canary Wharf and $500,000 in patent litigation costs, partially offset by the positive settlement of a tax related matter of $300,000. All these differences are net of tax.

By comparison, in the second quarter of 2005, we had a GAAP net loss of $1.5 million or $0.03 per diluted share, and a non-GAAP net operating income $1.9 million or $0.04 per diluted share. Our revenues were $39 million for the second quarter of 2006. Fully electronic revenues from related and unrelated parties totaled $17.3 million in the quarter which compared to $18.8 million for the year ago period.

As many of you know, most of our fully electronic revenues come from unrelated banks, investment banks and trading firms, but are deemed related party revenue because these transactions are cleared by Cantor Fitzgerald. Going forward, we will break out fully electronic transaction revenue on our income statement for those transactions that are not cleared by our affiliates.

Revenues from Software Solutions were $11.5 million versus $10.4 million in the year-ago period. Voice assisted and screen assisted revenues totaled $8.1 million in the quarter versus $6.8 million in the second quarter of 2005. This increase reflects continued growth at BGC. With respect to the Wagner Patent we earned approximately $1.8 million in the quarter net of tax.

We continue to control expense levels even as we invest in our business. We expect overall operating expense levels for the remainder of the year to remain consistent with those in the first half of the year. eSpeed generated cash flow from operations of $4.3 million during the second quarter of 2006 compared with $8.6 million during the comparable period in 2005. We also report free cash flow defined as cash from operations less net cash used in investing activities including capital expenditures.

Our free cash flow was $800,000 for the second quarter of 2006 versus $200,000 in the year earlier period. Excluding related party receivables and payables, free cash flow for the second quarter of 2006 was $6.1 million compared with $4.1 million in the year-ago quarter. As of June 30, 2006, our cash and cash equivalents were approximately $178.2 million.

Finally, eSpeed's headcount was 379 employees as of quarter end. I would now like to turn the call over to Paul.

Thank you, Frank. I'm happy to report on our fully electronic business, including our US Treasuries business. Fully electronic volume on the eSpeed system excluding new products was $10.2 trillion for the second quarter of 2006, up 43.9% from the $7.1 trillion reported in second quarter of 2005. There were 63 trading days in the second quarter of 2006 compared to 64 in the second quarter of 2005.

In the second quarter, we experienced robust volume growth across all benchmark classes, consistent with our previously articulated prediction that Treasury volumes would double by 2008 from 2005 levels. We continued to improve our competitive market position both sequentially and year-over-year. The resulting improvement in the depth and quality of our markets combined with our persistent focus on improving customer service at all levels of the user experience and the customized nature of our proprietary technology has created a very strong foundation for the future.

Our fixed fee model continues to be embraced by our largest customers who have renewed long-term commission arrangements, as well as by newer market participants who enjoy the marginal cost benefits and predictability of a fixed commission arrangement. In sum, we remain confident in our basic strategy and believe we are uniquely well positioned to grow our benchmark Treasury business.

I would now like to turn the call over to Kevin. Kevin?

Thanks, Paul. I'd like to review our hybrid voice assisted businesses and our new products. Our voice assisted volume was $8.6 trillion in the quarter, up 16.4% from the $7.4 trillion reported in the second quarter of 2005. We continue to see strong growth at BGC.

Our competitive advantage stems from our ability to create electronic markets with inherited liquidity as a result of our relationship as the global technology provider to BGC, to Freedom and to other affiliates. As more markets reach the point where they have the benchmarks and liquidity necessary to migrate towards fully electronic trading, we will earn a greater percentage of revenue and a higher margin from our hybrid business.

Fully electronic volume on the eSpeed system for new products, which we define as foreign exchange, interest rate swaps, futures and repos, was $744 billion in the second quarter compared to $506 billion in the second quarter of 2005. This represented a year-over-year increase of 47%, which was driven largely by foreign exchange, and by futures.

While we're pleased with our volume growth in new products, we're still growing these areas from a small base. As we continue to invest, we are seeing more participants, more market activity, tighter spreads and other encouraging signs, which lead us to believe that we're moving in the right direction in terms of making our portfolio of new products meaningful contributors to sales and to the profitability of the company.

Now I'd like to return the call to Howard who will update our outlook for the remainder of 2006.

Thank you Kevin. In the seasonally slower third quarter, we expect to generate non-GAAP operating revenues in excess of $38 million and non-GAAP net operating income in the range of $0.02 to $0.03 per diluted share. We're also raising our full year 2006 outlook.

We expect to generate non-GAAP operating revenues in excess of $154 million compared to our previous guidance of $152 million. And we expect to incur operating expenses at the lower end of our range of $144 to $147 million. Therefore we expect non-GAAP net operating income to be in the range of $0.10 to $0.12 per diluted share, up from the previous range of $0.07 to $0.10 per diluted share.

Operator, I would now like to open up the call for questions.

[OPERATOR INSTRUCTIONS] Rich Repetto, you may ask your question.

Hi Howard. Can you hear me?

I can hear you fine, Rich.

First question - first, good quarter, beat the consensus. Just looking at the transaction revenues, the fully electronic went up a bit, as your volume, despite the industry volume dropped and went up. But it was offset by the decrease on the voice assisted. And I was just wondering, it looked like the commission in the voice assisted went down more than say the fully electronic. Any color on the dynamics going on there? Because overall transaction revenues were pretty flat quarter-to-quarter.

With respect to the voice business, we have not seen BGC modify in any material degree, its commission schedules up or down. What does happen, given the strength of BGC's business is as the business grows and changes, some quarters there are different volume mixes and revenues mixes as some desks grow more quickly than others or some desks like we saw last quarter they had extraordinarily good quarter and then they went back to being more in the levels of which the goals and objectives of BGC were set.

So BGC remains a very fast-growing business and very successful. But it’s -- because we get a percentage of their revenue, the kind of mix of their business that we get will be shown to you.

I think one of the interesting things for you to do in order to understand our pipeline is just take the inverse of the numbers of the screen assisted business, which we get 2.5%, and the voice assisted business where we get 7% -- if you did the inverse, you'd get a clear sense of the kind of gross revenues that BGC is doing that we participate in and you'd see those numbers being -- and remaining very strong.

Understood. And then, Howard, you increased the guidance for the back half of the year or for the full year. And I'm just wondering -- you usually put in sort of your outlook for volumes at least for the next quarter, but I didn't see it in this guidance. I was just wondering, was there -- was that a purpose intentional or what your outlook is for Treasury trading here in the near-term?

Well, if you look at our comparative statistics you would find that the primary dealer volumes - what's happened is there's been a dislocation in that the US Treasury, Federal Reserve announced primary dealer volumes and the overall volumes that we're experiencing from our client base are not as traditionally consistent as they have been in the past. That correlation has been declining and sometimes precipitously declining over the past year.

So I didn't think it became as relevant if our volumes -- you know if our fully electronic volumes excluding new products quarter-over-quarter are going to be up 14% and the primary dealer volumes are going to be down 3%. I'd stopped really focusing on what the projection was of the primary dealer volumes because it's not really reflecting our overall business.

The year-on-year growth that we had comes from an overall set of market participants, which include electronic arbitrage and statistical arbitrage computer-based models that have played a significant role in the equity markets, which are not moving into the fixed income market. And that is where we expect to have additional clients going forward. That volume won't be included in the primary dealer volume category. But, of course, it'll be part of our doubling of the business.

We do expect over the next two years for that trend to reverse itself as the primary dealer community starts bringing on their electronic trading models and their volumes will start to grow. But as we pointed out to you in the past, because of our fixed fee models we have stable revenues and predictable revenues. But from our current client base, we don't expect to be earning more money from our largest current clients.

We do expect our revenue growth to come from as our volumes grow, new clients coming online, both the client I talked about coming from the equity markets and others who decide to play the professional Treasury market. And then, as those clients grow with the growing size of the Treasury business, they will also qualify for our fixed fee models. And they -- we will then add them to our subscription base, thereby growing our revenue stream.

I get it. Thanks. And last question, Howard, is on the Wagner patent, I think it was mentioned in the prepared remarks. I think it was a net income number of 1.9 for the quarter --

$1.8 million.

1.8. I guess the question is, I know a good portion of that rolls -- I guess expires in February of '07. And I'm just trying to see what is the impact you see and how you -- if you could give me the impact EPS wise and then how you see filling that hole, that gap?

Well you are correct that the Wagner patent revenues do roll off in February of '07 and that's why I thought that it was important to start breaking that out for you, so you could clearly see it. 100% of the Wagner Patent revenues do roll off in February of '07.

The way -- there are a number of ways that we expect to increase our business in order to make up for that. One, the clearest example is the growth rate that BGC is experiencing and driving in its business and the related revenues that we receive from them for that business.

So as BGC continues to grow, we will benefit from that and I expect the growth to come with respect to our sales in two directions. One, just a gross size of the pipeline is growing quickly and substantially, so that will raise the numbers themselves, and number two, you can see we now have a very healthy pipeline of screen assisted business where we only get 2.5%. Any evolutionary move on those businesses to 7% will also assist us in almost trebling that revenue stream. Now I don't think the entire revenue stream of course will convert in that period of time but any small movement of any of those businesses to the 7% line will, of course, mitigate this. So BGC is sort of absolutely the top line item on how we expect to make up that revenue change.

And number two is we continue to invest in our new products and continue to work on them and we do have expectations for those businesses to start to add revenues to our model. When trying to add $1.8 million three quarters from now, we do not feel that that is a very high bar that we need to achieve. So the combination of those two factors, we feel pretty good about the opportunity for us to grow our business to make up for that and that, of course, sets aside the strong patent portfolio that the company also has. And the Wagner patent was just an excellent example of how even one patent in our portfolio can be harvested to create substantial economic value for us going forward.

Okay. Thanks very much Howard.

Raj Sharma, you may ask your question.

Hi Howard. Hi guys, how are you?

We're fine. Thanks.

The volumes seem to have picked up across the board and that's always a very good sign, an increase in market share. Howard, where does the -- in the longer-term from a year, two years out, where does the profitability start to increase? Is that new clients from the Treasury business and/or new revenue generation on new products while you keep your expense levels sort of distant and stable? Can you talk a little bit about the new clients that - are you seeing traction in the Treasury business?

Sure. I can take that from a number of sources. Let's just talk about the US Treasury business. Obviously, the market-share improvements that we have seen over the past year strengthens our competitive position and therefore means that as new clients come in, they're more likely to come to us first. They tend to operate obviously with us and our competitor, but it's always nice when you have an ever-growing market position and strengthening position that the clients tends to come to you first, train on your system and then grow with your system.

So new clients and the type of clients we are most likely to see who would pay us our fixed fee model, which will be the ones that are most important to all of our shareholders, would be the kind of clients who are programmed trading clients in the equity markets would be an excellent example.

So if you go down the list of who the large volume training firms are who trade equity, arbitrage, and index arbitrage and high volume trading in the equity markets, as they look for additional opportunities to grow their businesses, because many of these firms are extraordinarily well funded, they will then come to the Treasury markets which are now very, very large, growing very quickly, very deep and very liquid.

And those are the kinds of clients who are testing with us. And that leaves us with a level of confidence that we will be adding new clients going forward and that will be just incremental revenue at very high margins. So we expect our expenses, as Frank said to stay consistent with where they've been in the first six months, so any additional clients that would come on really would hit, really clearly to our bottom line.

So those are -- Treasury will not come from higher prices from current clients because they have fixed fee models, but rather additional clients paying that subscription fixed fee. The second area longer-term is really product evolution across the BGC cycle. That we have -- BGC has businesses that currently are just voice, where we do really no technology work for them, and we receive no money as they would like to add a screen -- we then get to add 2.5% to our revenues and that goes into the screen assisted line.

Many of those screen assisted line businesses are contemplating considering developing or working on moving their businesses to voice assisted, meaning letting your computer do much more of the work for them. That tends to happen as they get busier and busier and they need the computer to help them, manage their markets, manage liquidity, manage benchmarks better and move the markets more quickly, then we'll get 7%.

So just that evolution from the 2.5% to the 7% will add of substantially because it doesn't really add to our expenses. Our expenses are -- we're already developing those products, we've already built them, we already are investing in them, those are already in our numbers, so therefore when we get to deliver that revenue uptick, we get to really book that revenue uptick to our bottom line.

And then lastly, some businesses over time will go electronic. It is not a matter of if, it is simply a matter of when. And the benefit eSpeed has - I think that's why Kevin used the word inherited liquidity, which is those businesses already have liquidity. And when they move electronic, we're not are trying to recreate them from whole cloth, but rather taking that $600 million or so pipeline that we talked about the inverse of the revenues that we see. And looking at that pipeline, driving that pipeline eventually through a 65%, we get the money model, really fits us in an excellent position. So our view is with our proprietary technology and our fixed cost base, time is our friend because these businesses will eventually go electronic, and we will eventually get those margins.

That part of the story is not really a "what's the difference between the second quarter and the third quarter?" Those are the things we focus on about new clients and treasuries and new products. But the overall business model of having evolutionary markets come to us and us receiving the 65% of the revenues is really the fundamental foundation and underlying strength of the future of the Company and why the company will eventually make substantial profits.

Thanks. One other question on foreign exchange. Could you please give us an update on -- Kevin said that the increase of new products was mostly foreign exchange. Is that -- so can you talk a little bit more about the market makers and liquidity? And also, do you have a profitability goal now? You used to have $0.01 a quarter. Have you reinstated that? Are you looking at the business in that way?

Well, two things, Raj. I said it came from both foreign exchange and from futures business -- we're routing futures from our platform that [indiscernible] is already using. And foreign exchange, we're not talking about a specific milestone or a specific goal, but we're very excited about -- and we think the Street has renewed excitement about our model and our efforts and foreign exchange.

We now have on board providing leadership in foreign exchange, Peter Bartko, who is the founder and builder of EDS and brings substantial credibility to the bank community to our efforts. And you can really see the interest and the activities start to gel and coalesce. So we feel very good about that, although it will take the time that it takes.

And futures is a matter of methodically working out and harvesting the opportunity that we have from -- the eyeballs of -- and fingertips of trading cash electronically, also increasingly trading their futures electronically. And we're working to get a piece of that business. As our spot foreign exchange business grows, that actually increases our futures opportunities from spot foreign exchange traders as well further down the line.

And just one last question. Cantor's got -- is now a primary dealer. How does that affect eSpeed's business? How does that figure into the mix?

Cantor's primary dealership doesn't really have any impact on our business or BGC's business even, for that matter. It was an existing business of the Company. It's been well known. Everyone sort of knows about the business. And just getting a status from the government doesn't change the business I think day over day. So I think business of Cantor Fitzgerald won't really have any impact for us one way or the other.

Got it. Thank you so much.

I show no further questions. [OPERATOR INSTRUCTIONS] Steve Duff, you may ask your question.

Hi, guys. Did you guys buy any stock back in the quarter?

We did not.

Were you prohibited from doing so?

I think it's the policy of the Company that we do not respond to timing issues with respect to the --

No, no. It's not a timing question. It's just -- are you for any reason, legal or regulatory, prohibited from buying stock back here?

I don't comment one way or the other. Sorry.

But as a shareholder, that will be, that's something we would like to know. I know there's an approval. I just want to understand if you were prohibited from doing that?

I think the standing policy of the Company is that I cannot comment on that, and we do not comment on it. I'm sorry, but I cannot comment.

Okay. Thanks.

I show no further questions.

Well, thank you all for joining us this morning. And we continue to make progress. And we remain, as you can hear, optimistic about our long-term prospects. So we look forward to updating you all again in November. So thank you very much, and we look forward to speaking to you soon.