Bgc Group Inc (BGC) 2006 Q4 法說會逐字稿

Welcome to the fourth 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.

Now I would like to turn today's meeting over to Mr. Jason McGruder, Vice President of Investor Relations. Thank you, you may begin.

Good morning. I would like to read our disclaimer first. The information on this 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 Act of 1934 as amended. Such amendments are based upon current expectations and 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 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 systems, to induce clients to use our marketplaces and services, and to effectively manage any growth we achieve, 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 reasonable assumptions 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 now like to turn the call over to our host, Howard Lutnick, Chairman CEO and President of eSpeed, Inc.

Good morning. And thank you for joining us on our fourth quarter conference call. With me today is our Chief Operating Officer, Paul Saltzman, and our Chief Accounting Officer, Frank Saracino. I am pleased to report that eSpeed's revenues and earnings for the fourth quarter were ahead of both our projections and our prior year fourth quarter results. Our fully electronic business demonstrated an underlying strength in volumes, revenues, and competitive market position. We achieved these positive results while continuing to invest in new products, as well as developing proprietary technology to facilitate our hybrid pipeline.

Before I turn the call over to Frank, I would like to mention an exciting investment for eSpeed. As many of you know, last month we announced the formation of Aqua, which will be a new alternative trading system offering access to hidden blocks of liquidity in the global equity markets. We believe that Aqua's Electronic Trading platform will deliver value to institutional investors, sell-side firms, and hedge funds. Aqua will initially be 51% owned by Cantor Fitzgerald and 49% owned by eSpeed. Both companies collectively are contributing financial, professional and technology assets to the new venture, which will include all of eSpeed's former equities business. We also expect Aqua to offer a small number of strategic partners the opportunity to invest alongside us and be our partners in Aqua. As President of eSpeed, Kevin Foley played a significant role in laying the groundwork for growing our business, and he now serves as President and CEO of Aqua. As many of you know, Kevin is no stranger to innovation in the equities world, having founded and run the Bloomberg Tradebook, ECN, prior to joining us at eSpeed. I would like to acknowledge Kevin for the leadership he brought to the eSpeed team, and we are delighted that he is at the helm of this innovative new venture.

So moving on to our fourth quarter performance, first, Frank will review our financial results, then Paul will discuss our fully electronic business and review our quarterly performance in the hybrid business and new products. And then I will conclude by discussing our outlook for the first quarter and full-year 2007. And after that, we'll be glad to answer your questions. So with that, I would like to turn the call over to Frank.

Thanks, Howard, and good morning. eSpeed reported GAAP net income of $3.3 million or $0.06 per diluted share in the fourth quarter. Our non-GAAP net operating income was $3.1 million or $0.06 per diluted share for the quarter, ahead of our guidance of $0.03 to $0.04. The difference between GAAP net income and non-GAAP net operating income for the quarter was primarily due to a September 11th-related government grant of $1.9 million, partially offset by a $1.2 million charge for the impairment of fixed assets and capitalized software costs, $500,000 in patent litigation costs, and $100,000 charge related to an office relocation. All of these differences were net of tax. By comparison, we reported GAAP net income of $300,000 or $0.01 per diluted share in the fourth quarter of 2005. For that same period, we reported non-GAAP net operating income of $900,000 or $0.02 per diluted share. We reported GAAP revenues of $44.7 million and non-GAAP operating revenues of $41.6 million for the fourth quarter of 2006. The difference between GAAP and non-GAAP revenues for the quarter was the September 11th-related government grant of $3.1 million.

Our GAAP revenues for the year-ago quarter were $37.8 million, while our non-GAAP revenues were $36.1 million. Fully electronic revenues came in at $18.2 million in the fourth quarter of 2006 versus $16.5 million for the fourth quarter of 2005. Revenues from software solutions in the quarter just ended were $13.3 million compared with $10.8 million in the year-ago period. Voice-assisted and screen-assisted revenues totaled $7.4 million in the fourth quarter of 2006 against $7 million in the fourth quarter of 2005. Non-GAAP operating revenues came in $2.6 million above our fourth quarter guidance of $39 million, primarily due to stronger than anticipated revenue from software solutions and fully electronic transactions. Strong revenue performance in these areas was the main driver of our non-GAAP EPS coming in $0.02 ahead of the high end of our guidance.

As we have discussed on past calls, the Wagner patent expires on February 20th, 2007, and after this date, we will no longer receive revenue from this patent. For the fourth quarter of 2006, we recognized approximately $1.9 million in Wagner-related revenue in the fully electronic transactions with unrelated parties line item and just under $4.3 million in Wagner-related revenue in the software solutions and licensing fees from unrelated parties line item. In the same time frame, we recognized $1.2 million in related amortization expense in the software development costs and other intangibles expense line item. This resulted in approximately $3.1 million in income net of tax for the fourth quarter related to the patent.

Operating expenses for the quarter came in at $36.8 million compared to $34.9 million we recorded in the year-ago period. This was in line with our expectations and consistent with the expense level that we've seen over the first three quarters of 2006. We anticipate expense levels being at or slightly above this quarter's level over the course of 2007 as we continue to invest in technology to support the growth of our affiliated voice brokers, as well as to support the anticipated future growth in our new products.

We generated cash flow from operations of $6.7 million during the fourth quarter of 2006 compared with $2 million during the comparable period in 2005. Please note that the cash from the September 11th-related grant I mentioned earlier was previously received, although we recognized the income in the fourth quarter of 2006. 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 negative $3.6 million for the fourth quarter of 2006 versus $5.6 million in the year-ago period. Free cash flow for the fourth quarter of 2006, excluding related party receivables and payables was $3.9 million compared with negative $10.7 million in the fourth quarter of 2005.

As we indicated on the last call, we made our annual discretionary bonus payments to employees during the quarter, which is why we experienced a sequential dip in our cash flow. To give you a fuller picture of our free cash flow generation, I would like to mention that for the full year 2006, free cash flow, excluding related party receivables and payables, was $14.7 million, which was a significant improvement compared to the negative $300,000 in 2005. As of December 31st, 2006, our cash and cash equivalents were approximately $187.8 million. Finally, eSpeed's head count was 400 employees as of the end of the quarter. I would now like to turn the call over to Paul.

Good morning, and thank you, Frank. I am pleased to report on our fully electronic business, including our U.S. Treasury business, as well as on our hybrid voice-assisted business and our new products. Fully electronic volume traded on the eSpeed system excluding new products was $9.8 trillion for the fourth quarter of 2006, up 30.8% from the $7.5 trillion reported in the fourth quarter of 2005. There were 62 trading days in the fourth quarter of 2006 compared to 61 in the fourth quarter of 2005. We continued to improve our competitive market position and saw larger than expected trading volumes in the typically seasonally slower fourth quarter. Revenue in the fourth quarter from fully electronic transactions, excluding Wagner-related payments, was $16.1 million, consistent with the $16 million earned in the fourth quarter of 2005, also excluding Wagner-related payments. Moreover, we continued to extend our fixed price arrangements with our larger customers, validating the attractiveness of our business model, while at the same time embracing variable commission arrangements with some of our existing and new customers. Our pipeline of new computer-driven customers and relationships with these new market participants remains strong, assisted by our proprietary technology and customized client-centric approach, as well as by our dedicated sales and technology team. We remain optimistic for 2007, helped by our strong fourth quarter performance, a solid foundation of customer relationships, and our proprietary technology.

Our hybrid screen and voice-assisted volume was a combined $14 trillion in the quarter, up 19.4% from $11.8 trillion in the fourth quarter of 2005. The increase in revenue and volume from our hybrid business came primarily from strong growth at BGC. Regarding the mix of our hybrid volumes and revenues, we want to take a moment to remind you of what we told you in the third quarter of 2005. Specifically, we said that the post-merger integration of Euro Brokers and ETC Pollack by BGC would result in the volumes from certain BGC desks moving from voice-assisted to screen-assisted and voice-only desks. Now that the integration process is complete and we are implementing technology improvements across many of BGC's trading desks, we expect over time for some of the 0% voice-only desks to become 2.5% revenue share screen-assisted desks, and for some of the current 2.5% screen-assisted desks to become 7% revenue share voice-assisted desks. Indeed, some of the growth in screen-assisted revenue over the past several quarters has come from such migration. Eventually, much of this volume is likely to become fully electronic.

As we have discussed in the past, our hybrid pipeline creates potential new fully electronic volume and revenues from existing voice liquidity pools. As volumes grow, benchmarks develop, and the more liquid instruments eventually migrate towards fully electronic trading. As an example, we have recently launched a fully electronic BGC branded European credit default swaps trading platform, and BGC's FX Options business will most likely add a fully electronic component over the next few quarters. Fully electronic trading -- excuse me, fully electronic volume traded on the eSpeed system for new products, which we define as foreign exchange, interest rate swaps, futures, and repos, was up 147.7% to $1.3 trillion in the fourth quarter compared to $539 billion in the fourth quarter of 2005. Beginning in the first quarter of 2007, volumes from credit default swaps will be included in these figures. With that, I would like to turn the call over to Howard who will provide you with our outlook for the first quarter and full-year 2007.

Thank you, Paul. For the first quarter of 2007, we expect to generate non-GAAP operating revenues in excess of $40 million, and non-GAAP net operating income of $0.03 to $0.04 per diluted share. As for our full-year 2007 outlook, we expect to generate non-GAAP operating revenues of approximately $152 million, and we expect to incur operating expenses in the range of $146 million to $148 million. Therefore, we expect non-GAAP net operating income to be in the range of $0.05 to $0.07 per diluted share. Our outlook reflects the discontinuation of Wagner patent-related revenue and expenses, as well as increased investment to support the growth of our hybrid pipeline and development of eSpeed's futures and foreign exchange products. While the discretionary investments we are making in the futures and foreign exchange area cost us approximately $0.02 per share per quarter, we believe that these businesses will create long-term earnings growth for eSpeed. Operator, I would like to open the call for questions, please.

[OPERATOR INSTRUCTIONS]

Operator, are we having technical problems?

I apologize. One moment, please. Robert Chapman, Chapman Capital.

Howard, there's been a lot of talk amongst the ownership base about the two courses that you could take with this Company from here. The one you've chosen, which is to take the Company's resources and attempt to grow into other lines of business, has not produced any sustainable capital gains over the last couple of years. In fact, it's been more of a capital depreciation. Meanwhile, firms like Archipelago Group and others, are taking their businesses and merging into a larger enterprise, like NYIC Group, and have experienced extraordinary gains, to the tune of 10 to 20 fold previous trading levels. Can you explain why it is that you should expect the owners of eSpeed to continue to support you with the initiatives that you continue to support yourself, when the stock continues to lag almost any indicator or index that one could compare it to?

Well, there -- as you said, there are always multiple directions. There's the direction of the Company building on its own asset base, which it owns. It has the financial strength, which it owns. And any success we have in those new products will [redowned] aggressively to the bottom line of the Company. But you are right, in that the investments we have made up to date have not bourn fruit as of yet. But our marginal cost for building those businesses is comparatively low, and we remain optimistic that we will be able to deliver value and performance going forward. But the Company is open minded, and to the extent there is value out there and other ways to get that value, we remain open minded to any sort of event of the future. So you shouldn't take from us that we are in fact close minded. We continue to operate all the time to try to make this Company more money. And if opportunity develops where we can find a partner or otherwise elsewhere, we are open minded to pursue that.

But open minded is one thing. In essence, talk is cheap. Why not actually take the initiative, retain an investment bank, and actually try to find someone who can deliver immediate value to the owners? And it doesn't have to be a cash transaction. It can be a stock swap. And if the transaction is as accretive as you might fear it to be for the buyer, i.e., that you think you might be selling the Company too cheaply, in theory, and it typically has worked out this way in the past, the acquirer shares that we'll be receiving as eSpeed holders will appreciate and make up for any discount you think we may have gotten in the transaction. Because being open minded and understanding a couple of cents per quarter in cost for growth is one thing.

But the other side of the page is the opportunity cost. Is that, had you years ago, with the benefit of hindsight, obviously, been able to see what could happen with the stock, with ICAP and some of the other competitive initiatives that have hurt the Company, we could be sitting on a $15, $20, $30 value now in another currency instead of eSpeed. So I would encourage you to be more than open minded. I think being much more proactive in this will be to the benefit of the owners. And we want to stay constructive as owners of this Company. But the ownership base, seeing us on the 13F filings has been calling us and asking us to get much more aggressive in pursuing the Company to sell itself, and I hope that you'll see the light before we feel the need to do so.

I hear you, and I appreciate the comment.

Joshua Carter, Goldman Sachs.

Yes, thanks. I wanted to see, Howard, if you could just flush out a little bit more the Aqua business. Certainly understand it from a high level. But would just want to understand, what exactly is this business going to look like? Who are -- what's its differentiated place going to be in the markets? What's the strategy? And then also, how did you come up with the ownership structure of 51% Cantor, 49% eSpeed?

Okay. Well, the model that Aqua is going to, besides having the direct market access business that it received with the contribution of eSpeed's equity business, is that there is the view that the current models of dark liquidity pools, either just inside sell-side firms where they match with each other, or buy-side firms matching with each other, leaves obviously one significant hole, which is the liquidity available at sell-side firms being offered to buy-side firms, and doing so in a way that encourages the sell-side firms liquidity and their business knowledge to be participating in this matching model, which is currently being missed. So Aqua has a plan which will embrace sell-side liquidity and deliver that to the buy-side in a way that protects and defends the sell-side, and gives the benefit to the buy-side. I think it's a very exciting business model. I think it's likely to attract lots of sell-side partners, and delivers value to the buy-side in a way that is completely complementary and noncompetitive to the other markets out there. It really just taps into a new liquidity pool.

In the time we have spent discussing this business, we've got a lot of support and we are very optimistic that it will do well. Basically, the business combination was Cantor Fitzgerald was always a partner in our eSpeed equities business. It was, from the beginning, it was sort of part of the structure on how we created it in the first place. So that was really a model that our outside directors determined with the right -- from an investment perspective and from a consolidation perspective, was the strategy that they chose was 51/49. And with the outside directors of eSpeed who selected that particular split, and that's how it happened.

Got you. And then, with regards to what this looks like relative to what might be out there already, it sort of sounds like this might be similar to the bids platform that the banks are considering. Is it a competitor to that type of sell-side consortium that will also allow the buy-side to access that liquidity?

I think it will be complementary to that. I think the model that it's selecting actually is different from all of the models that I've read about that are out there. I can't say that I know the deep insides of what's the thinking at [Bids], but I have read the publicly available explanations of its business, and this seems to be complementary to it, not competitive with it. Meaning that Bids can reach its goals and aspirations and so can Aqua, and the market participants would be delighted to participate in both, without one taking anything away from the other.

Got you. Thanks. And then, voice-assisted business, I mean obviously, that's an interesting area of growth. A little bit lower than we had expected in the quarter. Is there anything going on there in particular this quarter, with the IDB business a little bit slower than we might have expected? Or was it sort of in line with your expectations? Just a little more color I guess would be helpful.

Historically in the voice brokerage business, the fourth quarter is seasonally the most difficult, simply because the voice brokerage business really changes in the month of December. And that period starts Thanksgiving. So you lose the last week of November, and then do a little business in December, and then it pretty much disappears. The first quarter tends to be the most important quarter for the voice brokerage business as it reemerges with three quarters in a row -- three months in a row, I should say, of generally noninterrupted business. Obviously, there's always a holiday. But it doesn't have that sustained sort of Christmas, New Year's take to it. So it was in line with our expectations. And we look forward to the first quarter of the year being stronger than the fourth quarter, as it has been consistently over the many years.

Okay. That's helpful. And then related to that, just in terms of fees, it looks like the fully electronic revenue capture, if you would, was better than what we'd expected in the quarter. Is that -- would you say that's new product contribution, or -- ? So this is relative to volumes, what might be going on there to be leaning to that dynamic?

Well, it comes from actually a multiple set of places. We've had -- we are consistently, as Paul mentioned, extending our fixed-price contracts. But as we've said in the past, we don't expect our current fixed-priced contract customers to be paying us additional fees. That's not where additional revenue will come from. Additional revenue will come from new customers coming on, either adding an incremental fixed component to their variable price model, meaning as someone does more business, if they want to reduce their variable fee, they introduce a fixed component to their fee, and then they can reduce their variable. But still transact more variable than they would have done before. And so our average revenue -- our gross revenue goes up, whereas our average per million might decline. So the customer gets a good deal and we get, obviously, more revenue. So that was part of the mix.

And then, obviously, new clients who come on pay a variable fee. And when they're smaller then ready to buy into that fixed component model, and that has also improved. So we had pretty -- we had good business amongst our fixed price largest customers. We had some improvement in our, sort of we'll call them the middle, where they have a fixed component to their mix and they're doing their volume obviously when they put in that fixed component, we make more money, but their average goes down. And then we had new customers coming on line adding to our business. And those three components, plus a little bit of addition from our new products granted the -- while our new products are growing, they are growing from a small base. But we did add some revenue from new products, as well. All that together left us with fully electronic numbers ex the Wagner patent numbers that was holding strong and felt it.

Rich Repetto, Sandler O'Neill.

Howard, first question is, just on the guidance, you didn't put it -- at least in years' past, you put in your outlook for treasury volumes, or at least what the guidance was based off of. It's not in this year's. Is that because the volume is not as relevant, given the sort of the fixed relationships you have or the contracts you have?

Yes, I think what's happened is, it's not as directly aligned as it was three years ago. So you saw this year, volumes were up 30%. And because of the strong fixed component in our pricing, while we do have some variability to it, it's just not as fundamental. If you want to chat with me about what my outlook is, it still remains that, if you remember, I said the volumes would double from -- over the three-year period, and that hasn't changed. So my outlook for overall treasury volumes remains robust and strong. I just didn't put it in my outlook because I thought that the direct connection between volume and revenues for us obviously has gone -- has diminished, and has gone the way pretty much of that we do make, of course, more volume does make us more money. But the materiality of that has greatly diminished. So we do think that the treasury business will remain a huge growth business, and the volumes in treasuries will continue to grow. But our revenue guidance is really based on our business model more than it is the volumes growth. But I have not changed my view that treasury volumes will grow materially over the coming years. And I think you saw this year -- I said that a year ago, and you see the 30% volume growth this year for eSpeed. Obviously, materially outstripping the Fed volume growth is just simply our business model. We're going to add tremendous volumes to treasury business going forward.

Aaron Braun, Willow Creek.

Thank you for the update. I wanted to follow-up on my line of questioning from the last call, as well as the comments from the first caller. In reviewing the year, it's clear that there's been some very solid progress that's been made, and solid operating cash generation, particularly if you strip out the investments in the new lines of businesses. Looking at the $187 million in cash on the balance sheet, it just emphasizes the point that this Company is being valued at an unusually low level. And I guess my question is I saw the Company repurchase 52,000 shares during the quarter. I'm wondering why that approach wasn't pursued more aggressively, given that that may be an attractive use of cash at this discounted level? And secondly, wanted to pursue the line of questioning from last quarter about whether the value of this Company may be significantly higher to either management as an MBO, which given the cash resources of the Company, certainly would not be prohibitive. Or to some other industry participants, such as was mentioned by the first caller? Thanks.

So to the first part of your question, the Company has a strong cash position, was a positive cash generator for the year, and it adds to its cash position. The uses of that cash is a consistent question of our Board, and what is the best use of it. You may remember during the summer we sought an acquisition that we thought would be an excellent addition to us, would leverage our technology, and would make us more money. We were unsuccessful in that acquisition because it was an auction. But that was at least an expression of showing you it's not as if the Board and the management of the Company just don't have ideas of what to do that we think would make us more money. It was just an auction process that we were not successful at.

With respect to buy back stock, we obviously consider that. There are times when, if we were -- as an example, if we were considering a transaction, that window is closed for us. So there are times where, if management might want to buy stock, but that is not an opportunity that is available to us, we keep that open, and that is part of our Board discussions all the time. We have an authorized stock buyback. And while I don't comment on when and why we buy our stock, that is definitely a topic that is available to us and we are keenly aware of.

And to really address both your question and the first caller's comment, eSpeed is -- eSpeed was a spin-off from Cantor Fitzgerald in a very particular way. Meaning it earns 65% of the fully electronic revenues, and then the Cantor businesses clear and settle that business, and they are paid 35% of the revenues for taking all of that risk, settlement risk, the clearing risk. So as a concept of someone else wanting to buy the Company, which is what the first caller and yourself have asked, it is a more complex transaction than otherwise would be the case, were eSpeed to own 100% of its own revenues and be standing alone. It does have a perpetual joint services agreement with the Company we're spun off from. It has always had that from the day of its birth and from its IPO. That was always public and it was always part of the Company. The market data, the results, if you're thinking about Archipelago and the New York Stock Exchange, the market data component of the data is a part of a business currently called Cantor Market Data, and is owned by Cantor Fitzgerald. So those two components were in -- are not a part of eSpeed, and therefore they make a transaction with eSpeed more complex, in that it would have to include the Cantor Fitzgerald components, or in case the BGC components. So that -- I'm just pointing out that as a fact, it would be a more complex transaction, than is obvious. So please keep in mind.

Rich Repetto, Sandler O'Neil.

Howard, just wanted to follow-up. First, on this Aqua, is the rates there, are they -- is it more on a subscription basis? Or is it more on a per share, like, normal -- the alternative trading systems you see in equities? In other words, will it scale with -- will revenue scale with volume?

We do expect revenue to scale with volume, so we expect it to have a variable component to it.

But there's also a fixed component, too? Is that what you mean?

Well, there may well be a fixed component. That is really part of the model of working it out with everybody, what is the most likely way to build success. But certainly, having a variable component to the business making it a more attractive model.

Okay. And the very last, just sort of an accounting. The revenues from Wagner that went into fully electronic, or even in the quarter, you said the breakouts were between fully electronic from unrelated parties and software from unrelated. I'm just trying to get that breakout. I missed it when you went through that earlier.

Sure. For fully electronic, it was 1.9 million and from software solutions it was 4.2 million.

Okay. Thanks, guys.

Okay. Thank you all for joining me this morning. And we appreciate your support, and we look forward to speaking to you again in the future. Thanks, and have a great day today, everyone.

Okay. And once again, thank for participating on today's call. The replay will be available within 24 hours on the Investor Relations section of eSpeed.com for 90 days. Once again, thank you for participating. You may disconnect.