Foolish Forecast: Timing eSpeed

Next up this earning season: dishonorably discharged ex-Motley Fool Hidden Gems recommendation eSpeed (Nasdaq: ESPD  ) . The bond-trading enabler reports its Q1 2006 numbers tomorrow after close of market.

What analysts say:

  • Buy, sell, or waffle? Only two analysts follow eSpeed. When asked, both agreed that they would rather be doing anything else, up to and including shampooing feral cats. It's all sell ratings, all the time at eSpeed, folks.
  • Revenues. Analysts predict that eSpeed will report a 7% slide in revenues to $36 million.
  • Earnings. It's also predicted that profits will crater, falling to just $0.01 per share.

What management says:
Think that decline in profits would be bad? Last year, eSpeed earned a whopping $0.03 per share in profits -- marking a year-over-year decline of 83% -- this, despite its revenues slipping only 14%. Part of the problem appears to be in the kind of revenues the company did collect. Specifically, eSpeed's high-margin, fully electronic trading revenues declined 33% versus 2004 levels, while its lower margin voice- and screen-assisted trading revenues increased 22%.

The most recent news out of eSpeed was that its CFO has resigned to become CFO of an unnamed hedge fund. Which begs the question: Although this is almost certainly bad news, is it worse news for investors in eSpeed, or for the investors in the hedge fund?

What management does:
There's no good way to sugarcoat this, and I won't even try: eSpeed's margins are in freefall. The gross margin is down 770 basis points over the last 18 months, and with operating costs climbing even as revenues fall, the operating margins have taken an outsized hit. As for the one notable anomaly shown below, where rolling net margins exceeded rolling operating margins last quarter, chalk that one up to the fact that eSpeed recorded an operating loss in Q4 2005 -- but interest earned on its cash pile was enough to yield a small profit on the bottom line.

Margins %

9/04

12/04

3/05

6/05

9/05

12/05

Gross

80.7

80.6

79

76.9

75.4

73

Op.

27.6

28.2

18.9

10.6

4.9

0.2

Net

20.8

15.9

10.5

4

1.4

1.4

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ending in the named months.

The Fool says:
The one bright light still twinkling among eSpeed's numbers also dimmed last year, as the company's free cash flow turned negative. For the year, eSpeed experienced net free cash outflows of $8.6 million. The flow of cash out eSpeed's door accelerated in Q4, when negative free cash flow totaled $5.8 million.

True, eSpeed still has a substantial cash hoard to tide it over as it attempts to right its ship. Also true, the levels of free cash flow negativity we saw last year, even if they continue, will hardly make a dent in the cash hoard for years to come. Finally, and sadly true: Given our druthers, we'd still prefer to see eSpeed adding to its cash pile than subtracting from it.

Customers and Competitors:

  • GFI Group (NYSE: GFI  )
  • Reuters (Nasdaq: RTRSY  )
  • ICAP
  • CBOT Holdings (NYSE: BOT  )
  • Intercontinental Exchange (NYSE: ICE  )

eSpeed is a discharged Hidden Gems pick, no longer recommended. If you'd like to see what small caps Tom Gardner does recommend currently, take the newsletter for a 30-day free spin.

Fool contributor Rich Smith does not own shares of any company named above.


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