Bgc Group Inc (BGC) 2006 Q3 法說會逐字稿

Welcome to the third quarter 2006 eSpeed earnings conference call. At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) Today's conference is being recorded. If you have any objections you may disconnect at this time. I would now like to turn the meeting over to Mr. Jason McGruder, Vice President of Investor Relations.

Good morning this is Jason McGruder of eSpeed. I would like to inform you all that the information provided on this conference call contains forward-looking statements within the meaning of Section 27A of the Security Act of 1933 as amended in Section 21E of the Securities Exchange Act of 1934 as amended. Such amendments are based upon current expectations that involve risks and uncertainties. Any statements contained herein but are not statements of historical fact may be deemed to be forward-looking statement. 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 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 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 achieve, the affects of the attack on the World Trade Center on September 11, 2001, and other factors that are discussed under Risk Factors in eSpeeds annual report on Form 10-K filed with Securities and Exchange Commission.

We believe that all forward looking statements are based upon reasonable assumptions when made. However, we caution that it's impossible to predict actual results or outcomes per the factors of risks, uncertainties or other factors or on anticipated results or outcomes and that accordingly you should not place undue reliance on these statements. Forward-looking statements speak only of -- 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'll actually turn the call over to Howard.

Good morning everyone and thank you for joining us on our third 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. First, Frank will review our third quarter financial results, then Paul will discuss our U.S. treasury business and review our voice assisted business and new products, and then I will conclude by updating our 2006 guidance after which we will be glad to answer your questions. Before we get started I wanted to share with you some good news for eSpeeds futures business with respect to our patent litigation with Trading Technologies. Last week, in a decision interpreting Trading Technologies assertive patent claims, a U.S.

District Court provided several rulings that clearly supported our position that eSpeed and the eSpeeds Echo products fall outside the scope of Trading Technologies patents. In a clee ruling that the court itself acknowledged is the primary dispute in the case the opinion unequivocally supported our view. This decision lifts the cloud of uncertainty surrounding the marketplace for eSpeed and Echo's products and puts us in a much better position to offer customers a broad range of user interfaces for the futures execution. With this matter now materially behind us, our futures business rests on a stronger foundation. So with that I'd like to turn the call over to Frank.

Thanks Howard and good morning. eSpeed reported a GAAP net loss of $500,000 or $0.01 per diluted share in the third quarter. Our non-GAAP net operating income was $1.2 million or $0.02 per diluted share for the quarter in line with our guidance of $0.02 to $0.03.. The difference between non-GAAP net operating income and the GAAP net loss for the quarter occurred primarily due to a $1.3 million expense related to an acquisition we have chosen not to pursue, $500,000 in patent litigation costs, primarily related to the case Howard just mentioned, a $200,000 charitable contribution to the Cantor Fitzgerald Relief Fund from our September 11th charity day and a $100,000 expense related to attack settlement. These expenses were partially offset by a litigation settlement payment to eSpeed of $500,000 from Municipal Partners. All of these differences were net of tax. By comparison, we had GAAP net income of $1.9 million, or $0.04 per diluted share for the third quarter of 2005. For that same period, we reported a non-GAAP net operating income of $3 million, or $0.04 per diluted share. Our GAAP and non-GAAP operating revenues were $38.1 million for the third quarter of 2006 versus the year ago quarters GAAP revenues of $38.8 million. Our non-GAAP operating revenues were up slightly in the third quarter of 2006 compared with the $37.8 million reported in the third quarter of 2005.

Electronic revenues from related and unrelated parties totalled $16.8 million in the quarter which compared to $18.9 million for the third quarter of 2005. Revenues from software solutions were $11.3 million versus $9.9 million in the year ago period. Voice assisted and screen assisted revenues totaled $7.5 million in the quarter compared to $7.3 million in the third quarter of 2005. As we've mentioned in the past, the Wagner patent expires in the middle of the first quarter of 2007. For the third quarter 2006 we recognized approximately $4.4 million in revenue and approximately $2 million in net income related to the patent. Also in the third quarter we continue to control expenses and expect overall operating expenses for the fourth quarter to remain consistent with the first 9 months of the year.

We generated cash flow from operations of $20.8 million during the third quarter of 2006 compared with $16 million during the comparable period in 2005. During the fourth quarter, we will make our annual bonus payments to employees which will impact our fourth quarter cash flow. Last year we paid approximately $9 million in bonus payments. 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 $12.9 million for the third quarter of 2006 versus $11.5 million in the year earlier period. Free cash flow for the third quarter of 2006 excluding related party receivables and payables was $7.6 million compared with $11.7 million in the year ago period. As of September 30, 2006, our cash and cash equivalents were approximately $191.1 million. Finally, eSpeeds head count was 393 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 U.S. treasuries business as well as our hybrid voice assisted businesses and our and our new products. Fully electronic volume on the eSpeed system, excluding new products, was $9.4 trillion for the third quarter of 2006, up 17.1% from the $8 trillion reported in the third quarter of 2005. There were 63 trading days in the third quarter of 2006 compared to 64 in the third quarter of 2005. In the third quarter we maintained our competitive market position and held on to our previous gains. Our performance for the first 3 quarters of the year compared to the year earlier period continued the long term positive trends in our market position, demonstrating tangible support from our clients, for our customer focused philosophy on our fixed pricing model. Moreover, we have seen this positive trend continuing so far in the fourth quarter and we believe that our competitive market position will improve over the remainder of the quarter both sequentially and year-over-year. Our combined screen and voice assisted volume was $14.1 trillion in the quarter up 12.8% from $12.5 trillion in the third quarter of 2005. Looking forward to 2007 we expect volume and revenue for these products to grow as they have through 2006.

Fully electronic volume on the eSpeed system for new products, which we define as foreign exchange, interest rate swaps, futures and repos, was up 213% to $1.2 trillion in the third quarter compared to $376 billion in the third quarter of 2005. While we're pleased with the friends in our volume growth in new products, as we have said before, we're still growing these businesses 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 into the profitability of the Company. We are particularly optimistic about our futures business in light of the Trading Technologies decision, which Howard briefly discussed at the outset of this call.

As you know, we purchased Echo in October of 2004 for approximately $14 million. Our investment was based in large part on the strategic synergies we saw between cash and futures along with Echo's cutting edge spreading tools in proprietary technology. We felt that Echo had a great product but a limited customer base. We continue to invest in protecting the eSpeed and Echo futures business and have spent an additional approximately $14 million for direct operating expenses and patent litigation over the past 2 years. Prior to last weeks claims construction decision, TT had argued that our futures products infringed their patents, when in fact the courts opinion supports our belief that none of our products infringed their patents. With the overhang of litigation no longer putting a chill on our sales efforts we feel that our decision to buy Echo and to expand eSpeeds futures business will turn out to be an extraordinarily exciting investment. We will immediately redouble our sales efforts for these products and we expect not only to recoup our investment, but to eventually grow our futures business into a strong competitor in the global marketplace and a meaningful contributor to eSpeeds bottom line. With that I'd like to turn the call to Howard who'll update our outlook for the fourth quarter and the full year.

Thank you Paul. For the fourth quarter we expect to generate non-GAAP operating revenues in excess of $39 million and non-GAAP net operating income of $0.03 to $0.04 per diluted share. We are also raising our full year 2006 outlook. We expect to generate non-GAAP revenues of approximately $155 million compared to our previous guidance or $154 million. We are lowering our expense outlook and expect to incur operating expenses in the range of $144 to $145 million which is an improvement from our previously stated guidance range of $144 million to $147 million. Consequently, we expect non-GAAP net operating income to end the year in the range of $0.12 to $0.13 per diluted share, which is up from our previous range of $0.10 to $0.12 per diluted share. So with that, operator, we would like to open the call for questions please.

(OPERATOR INSTRUCTIONS) Thank you. Our first question comes from Josh Carter with Goldman Sachs.

Thank you. I wanted to just touch briefly upon the new products it's nice to see the growth there. Wondering if you can talk a little bit about the pricing model there. Is it completely consistent with your core products or are there are some variations in the new products?

Clearly variation across the product categories. I would say interest rates swaps would be consistent with the model. Foreign exchange, because of its commodity type product would be consistent with a kind of model like early U.S. treasuries meaning it will eventually end up with a fixed price model but initially while we may have some deals early on that are lower cost, it will effectively become a per million model leading to eventually some sort of top line limit of that. Futures can be a combination of those two. And repos more akin to U.S. treasury. So each of them is slightly different but they still are generally in line with one of the the other sets of products that we have they just fall into different categories.

On average would you say the new products have more attractive pricing than the core business or just on par from your perspective obviously?

They have certainly the same potential as all of our other products. I would not categorize any of them as less. I would say other than futures products have probably less because it is in the routing business it's probably slightly less upside in terms of a per million or per transaction fee. Other than that certainly the balance of them have at least the same pricing value to the Company and at least the same upside. And I point out since these -- none of these products really come with a substantial marginal cost for us. In fact, they come with very little marginal cost. Any revenues we receive from them have the same marginal benefits of 70 -- probably incremental revenues of 75% to the bottom line. So, even futures which has a relatively smaller price per contract let's say than we would get from interest rate swaps or even foreign exchange because of our marginal costs are so low making money as long as you're making -- you're doing it consistently, it's just non-marginal cost money to your bottom line.

That's great. Thank you. With regards to the competitive landscape you're comments mention that you feel like you're gaining traction there. Could you point to two or three things that you think are the key drivers of the improved competitive position now and especially in your forecast going forward?

You're talking about our foundation business or the new products?

Sorry, the foundation business now.

Sure. I think as we indicated our competitive market position certainly sequentially and year-over-year has followed a long term consistent positive trend. That is the driver behind our strategy to attract new customers and different customers, which we have talked all along which will be an important source of incremental revenue. Our competitive market position has improved again because of our pricing model, because of our customer focus in delivering service to our customers and generally, as you know, liquidity begets liquidity and the the quality of our markets are strong and continue to attract a broad and deep customer base. Another factor in our view the more sophisticated the customer, the more they appreciate the capacity of and the technical capacity of eSpeed system. eSpeed system in our view is technically superior. And so the more complex the trading algorithms of our clients the more they ask eSpeed to do interesting and exciting types of transactions. The more they appreciate the differentiation between our systems capacity and those of our competitors and therefore we garner a larger share of those type of trades and so we think the future bodes very well for us because as people get to the second and third phases of algorithmic and electronic trading they then really see the benefits of all that we have invested. We are consistently seeing people step into those kinds of categories and really come to appreciate the technological prowess of the system.

Sure, this is Paul again, I'd also like to say that one differentiating factor obviously is our proprietary technology, unlike our competition which allows us to customize service to our customers.

That's great. thank you. Howard I'm wondering if you have any update on BGC, I know the press has been talking a little bit about it, is there anything new on that front?

I can't say anymore than BGC is an excellent customer of ours, they generate our voice pipeline. We are great rooters of theirs because the better they do, clearly the better we do. As you know, we get 2.5% of their screen assisted business and 7% of voice and then when they go fully electronic, obviously 65%. So we are great fans of theirs and they are our pipeline. But other than that I can't really comment.

Okay, that sounds good. And then just a few housekeeping items on the financials. The cash cash flow is obviously very strong this quarter, 21 million, just in terms of operating not free cash flow but the free cash flow was also strong, and there was a very large increase in the change in operating asset from liabilities, receivables came down quite a bit s did other assets in terms of the the balance sheet items providing additional cash. I'm just wondering if you could walk through what the drivers are. what the reasons were for the large change there, is that just anticipation of paying out bonuses or is there something else that was going on there in those operating asset line items?

Hi, no, it's Frank, in particularly with working capital a lot of it is just timing of when we pay down receivables, nothing really in particularly to note. In the past some of our Wagner patent payments were prepaid and so we had other assets related to that but nothing of particular note.

Thank you. Our next question comes from Chris [Tinet] with Sandler O'Neill.

Thanks for taking my call. One follow-up question on the new products, can you give us any color on where the strength was or was it across the board in terms of the individual products?

We can because they are from a small base I tend to not break them out. I can say that we are -- we have -- we are very optimistic with respect to our foreign exchange product and growing more so. I think the quality of our products, the kinds of participants, the commitments we're getting from market makers not yet on the system but committing to participate in our marketplaces has led us to have a very optimistic view of foreign exchange. Our futures business I think feels both better and growing stronger. I think the opportunities that were -- are presented to us now with respect to getting that chill out of the air with Trading Technologies I think will improve our routing business in futures. And so we are very excited about that. And then of course, the other markets of interest rate swaps and repos, parts of those businesses it's not the entire repo market and it's not the entire interest rate swap market but certainly the plain vanilla interest rate swap market and parts of the repo market are really not in our view and if they'll go electronic view but a when they'll go electronic. And so those opportunities remain in front of us and feel pretty good. So that category of new products is something that we're very excited about beginning to make a material contribution to the Company. Granted, we always point out it is from a small base, but better it should be a small base that's three times the size of what it was, so certainly feels better.

Okay. Then in terms of buybacks, can you update on how much buyback authority you have, if that expires and if the, I think Frank mentioned some expenses related to a merger that didn't go through, an acquisition that didn't go through, if any lack of buyback was related to that?

We have $58.7 million left in authorized stock buyback by the the board of directors. And I don't comment with respect to stock buyback. We'll tell you when we have bought stock and we tell you we do have the authorization to buy stock, but outside of those parameters I just don't find -- feel it's appropriate to comment one way or the other. For reasons or not for reasons we'll buy back stock when we do and we'll let you know when we do.

Just thought I'd try to ask. Just one more on the balance sheet. It looked like you had shifted money out of, in terms your assets, out of repos and into cash? Any comment on that?

It's just a timing of the last day of the year.

Okay. That's it for me. thanks guys.

Thank you. Aaron Bron with Pequot Capital. You may ask your question.

Hi, yes, good morning gentlemen. Congratulations on the progress this year so far. Howard, I'd like to go back to a question I posed to you three or four calls ago about some of the strategic alternatives that the Company may have some of which have been discussed in the press. Specifically I mentioned three potential avenues for value creation for the public shareholders, one would be some alliance or affiliation or acquisition by one of the other exchanges, and I guess there's been some recent press reports as to conversations that may have occurred over time. Secondly, which the last questioner touched on is a recapitalization of the balance sheet and use of cash on the balance sheet through debts tender, special dividend or more aggressive share repurchase. And thirdly would be taking the Company private given the strong operating cash flow you've experienced this year and we talked about some of the embedded intellectual property that the market really isn't giving you credit for. So why continue to be a public entity when the marketplace isn't giving you credit for some of those hidden assets so to speak? Hope you could just maybe give us an update on your thought process about those issues.

Sure. We continuously analyze and consider the opportunities in front of the Company. The Company has a strong cash position, it has proprietary technology and it has exciting intellectual property. We think those assets would make the Company an attractive partner and participant in exchange consolidation. For that to happen the Company is in if a great position to go it alone given its partnership with BGC that as BGC grows and adds to our pipeline, you can see that pipeline grow. And so we are -- that's why I said we are a great rooting fans of BGC because their growth really gives us a pipeline to our future and that becomes very much a when not if category because those 2.5%s will become 7%s and eventually much of the 7% will become 65% and that just feeds our bottom line without significant marginal cost. We are open minded. We are always interested in what are the best movers for the Company and that is going to be a part of our life going forward. You saw that we had a transaction that we chose not to pursue and that is going to happen. We are going to consider things all the time. We'll consider strategic alternatives all the time and value creation for our shareholders is a very key point for us. So we think we are in a good position and getting -- and that position is only getting better and more attractive and I think we will be able to produce shareholder value over the short, intermediate or long term and that is our bounce. Which do we select? But clearly we are becoming a much more popular person at the party.

Thanks for that commentary. Can I just drill down onto the two areas haven't been -- you did touch on the buyback issue with the last caller, but in terms of the conversations with the exchanges that were reported in the press can you characterize those at all for us? And on the other end of the spectrum given the private equity environment or and as well as the activist shareholder environment growing which we are neither, can you tell us whether you've been in contact with any of those types of investors?

I wouldn't want to comment on any particular sets of conversations or particular types of conversations. I would say however these concepts are not foreign either to the Company or to people who meet with the Company or talk to the Company or call the the Company. So we are open minded. We are interested and we are as I said becoming ever more popular. And by being -- by saying we're ever more popular it means our phone rings more often. It's hard to be popular if no one's calling. I think the point is we have an excellent position in the capital markets. Our technology is capable of much, much more than it is currently being asked to do. That's part of the whole pipeline process is that we've built our pipeline to handle much, much more depth and breadth of products. I think we will do things that produce long term shareholder value and the question is are there things to do that we think are valuable in either the short or the intermediate period that will give us that long term value. And we are always open minded and always willing to consider any of those alternatives but, obviously, as of today, there's nothing that we see that's better than our current pipeline. If we see something better, we'll surely let you know.

Cool. Thanks for the update.

(OPERATOR INSTRUCTIONS) Our next question comes from Scott Appleby with Deutsche Bank.

Thank you. Hi guys, Just curious, I want to get back to the organic growth going on there and most specifically with FX, and I wanted to try to understand how that product completes with or will compete with CME and Reuters new joint venture?

Directly?

If so.

What. I'm sorry, what's the question. I thought, yes or directly is sort of the easiest way to answer. I didn't see -- I didn't hear the follow-up. Sorry.

Oh. Okay. How will you then compete with them and why will the eSpeed platform be a better one to use?

Rather than comment on what they're planning on doing or thinking about doing or considering doing how about we talk about what we are doing, which is we have a model that embraces CLS which is a central clearer of 189 banks of the world. So what we embrace is a model where the banks can act as prime broker for clients to do business. And maybe the exchanges are trying to work outside the bank in prime brokerage model. We are embracing the bank in prime brokerage model and we think having 189 banks as structured partners is a great way to be successful. I don't know if that means that the other guys can't be. But we certainly think that we have designed our products having listened to the marketplace, banks and clients, and I think we have a model that is certainly improving in volume and improving in all of the characteristics that lead one to be optimistic about a business. However we are still from a small base but certainly it feels better here.

Thanks.

Thank you. At this time there are no further question.

Well, I would like to thank everyone for joining me this morning and for joining eSpeed and our management team and we look forward to updating you again next quarter. So thanks everyone and have a great day today.

Thank you for participating on today's call. You may listen to a replay of the conference by dialing toll free, 1-800-944-3640. International participants may dial 1-203-369-3429.