Marketaxess Holdings Inc (MKTX) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the MarketAxess third-quarter 2005 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded, Tuesday, November 1, 2005.

I would like to turn the call over to Stephen Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir.

Good morning and welcome to MarketAxess third-quarter 2005 conference call. We issued a press release this morning providing our results for the third quarter of 2005, and the press release is available on our Website.

Rick McVey, Chairman and Chief Executive Officer of MarketAxess, will provide a strategic update for the Company. And then, Jim Rucker, Chief Financial Officer, will review the financial results for the quarter. There will then be a question-and-answer session followed by closing remarks from Rick.

Before I turn the call over to Rick, let me remind you that this presentation may contain forward-looking statements, including statements about the outlook and prospects for Company and industry growth as well as statements about the Company's future, financial and operating performance. These and other statements that relate to future results and events are based on MarketAxess' current expectations. Actual results in future periods may differ materially from those currently expected or desired because of a number of risks and uncertainties, including our dependence on our broker/dealer clients, the level and intensity of competition in the fixed-income electronic trading industry and the pricing pressures that may result; the variability of our growth rate; our limited operating history; the level of trading volume transacted on the MarketAxess platform; the absolute level and direction of interest rates and the corresponding volatility in the corporate fixed-income market; our ability to develop new products and offerings and the market successes of those products; our ability to enter into strategic alliances and to acquire other businesses and successfully integrate them with our business; our future capital needs and our ability to obtain capital when needed and other factors.

The Company's actual results and financial condition may differ perhaps materially from the anticipated results and financial conditions in any such forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise. More information about these and other factors affecting MarketAxess' business and prospects is contained in MarketAxess' periodic filings with the Securities and Exchange Commission and can be accessed at www.MarketAxess.com.

I would now like to turn the call over to Rick McVey.

Thank you, Steve. Good morning, everyone. Before I kick off my strategic update, I would just like to mention a couple of events that we're proud as a company. First, our Emerging Markets Charity Trading Day on September 21st was a tremendous success with over $200,000 raised for charities supported by the Emerging Market Trade Association. We want to thank our dealer and investor customers for their support of this worthwhile cause. This year, we donated our high-grade corporate revenues for the day to the Red Cross for disaster relief following Hurricane Katrina. High-grade trading revenues plus employee contributions totaled over $100,000 to the Red Cross relief effort.

Second, on November 4th, we will celebrate the 1-year anniversary of the pricing of our IPO. During the past year, we have accomplished a tremendous amount and I want to take a moment to thank our employees for their hard work.

On slide 4, we have a quick summary of our third-quarter '05 year-to-date results. Trading volume and revenue were up slightly from the prior year. Expenses are up 13%. The net result is pretax income 19% below the prior-year period. A couple of things to keep in mind here when you look at the period comparisons above -- first, on the revenue side in 2005, we have seen a significant decline in NASD TRACE high-grade corporate bond volume versus the prior year. And on the expense side, a substantial part of our year-on-year increase relates to new expenses associated with being a public company.

In addition, we have invested heavily in 2005 in our newest product, credit default swaps, which we think has great potential in future periods. Despite the lackluster trading volumes currently in the overall corporate bond market, we believe our investments will pay off by expanding our sources of revenue.

On slide 5, we have outlined several select market metrics that illustrate the trends in the market that have an impact on our business. First, credit spreads have been working their way back to pre-April/May levels. In the lower-left corner, you can see that net new issuance of corporate bonds has been light over the last several quarters, as corporations have been able to generate enough cash from operations to meet their funding needs. In the upper-right quadrant, while corporate bond trading has been on the decline recently, total trading of credit including CDS has been growing rapidly. We expect growth in the CDS market to continue; although, it is reasonable to expect some moderation of the recent growth rates. In the lower-right quadrant, you can see that net purchases of corporate and foreign bonds by insurance companies were down significantly from the first quarter of '05, reflecting lower demand for credit from this investment sector. We believe the Company is poised for growth, given the strengthening of our position in corporate bonds and the addition of the CDS product.

Slide 6, as you'll recall from last quarter, describes the competitive advantages of our new U.S. high-grade fee plan. We are especially gratified by the increase in our percentage of TRACE volume in the first full quarter following implementation of this new plan. The plan is designed to achieve increased dealer commitment to electronic trading on the MarketAxess platform. Remember, increased dealer focus and competition results in better prices for our investor clients.

Here are the key benefits of the new fee plan. First, for broker-dealers, dealers can now account for their transaction fees on a trade-by-trade basis with the addition of an electronic add-in for the MarketAxess fee. We believe the new fee model provides incentives for dealers to put more volume over our platform due to declining marginal costs at higher volume levels. For institutional clients, it's all about price improvement. For institutional investors in credit, our studies showed that the quality and quantity of dealers competing for their business is the key to finding the best price of execution. We are confident that our new fee plan model is aligned with investors' interests in achieving best execution. For stockholders, we now have a more scalable revenue model with a significant increase in recurring revenues that serves to dampen the volatility of our revenue base. We believe that this fee model creates a competitive advantage for us as we seek to expand our business.

On slide 7, we show the monthly NASD TRACE average daily volume from January through September as well as the percentage of TRACE volume traded on MarketAxess. Keep in mind, we implemented our new fee model on June 1st and we experienced a decline in volume as a percentage of TRACE executed on our platform as our dealer and investor customers worked through the implications of the change. We are pleased to see the return in our share of TRACE during the month that followed.

As you can see from the chart, there has been a substantial decline in overall corporate bond market activity with September high-grade TRACE average daily volumes 30% below January levels. The drop in corporate bond trading during this period has had a dampening effect on our revenue growth. If you look at the NASD TRACE volumes on a quarterly basis, year over year, the outlook is not much better. The key takeaway here is that we're strengthening our position in high-grade corporates during this downturn, reflected by our increase in the percentage of TRACE volume, which should serve us well when trading volumes returned to more robust levels.

On slide 8, while our absolute volume levels are up only 5% on MarketAxess, you can see that on a year-on-year comparison, we continue to grow our share of NASD TRACE volume at a steady pace. A few comments -- prior to January of this year, the NASD did not release full-volume figures for the corporate bond market. As a result, prior to 2005, our percentage of TRACE volume was based on Company estimates for TRACE volume. Also note that the TRACE data includes interdealer, institutional client to dealer and retail client activity. We currently operate only in the institutional client-to-dealer space. Second, it is worth noting that the vast majority of the corporate bond market continues to trade by phone. We expect that to change over the years ahead, presenting a substantial opportunity in the e-trading space.

Please turn to slide 9. Given our focus on growth and the recent launch of our credit default swaps product, we thought it would be useful to walk through the development cycles for new products and business initiatives on the MarketAxess platform and show you how our existing products fit into this paradigm. We have three primary engines of growth. First, organic growth. We are focused on growing the contribution from our existing businesses, in particular the U.S. high-grade, Eurobonds, and emerging markets.

A few words on our emerging markets business. Our EM business has been experiencing consistent growth over the past few years, including growth in excess of 60% over the prior year third quarter. We currently have 18 dealers participating on the EM platform with most dealers having a significant presence in both London and New York. During our recent Charity Trading Day, our EM volume was approximately 10 times the normal daily volume. I think this demonstrates the scalability of our trading system and the potential for future growth.

New products are the second engine of growth. Credit default swaps have been the focus of our efforts over the past 12 months and will continue to be our focus throughout 2006. In addition, we have the client community and the technology we need to benefit from the inevitable increase in electronic trading and the crossover in high-yield sector.

New business initiatives represent the third source of growth. Clearly, we have the cash on-hand to enter new ventures, develop new products and expand into new client segments. For new products and new business initiatives, we look at the product launch process as having four distinct phases that we have outlined above. As a reminder, we have no debt, we are self-funding and we are in fact generating cash in excess of our reported net income again this quarter.

Cash, cash equivalents and securities were 111.9 million as of September 30th, up from 106.8 million at the end of the prior quarter. Our cash balance serves to increase the paths that are available to us to expand our franchise and build shareholder value. The pipeline of potential new products and client segments remains full. We are enthusiastic about our market position and the remaining growth opportunity in fixed-income electronic trading.

On slide 10, we have outlined the developments during the third quarter that highlight the strategic importance of the CDS space. We were the first client-to-multi-dealer electronic platform in the CDS market with our launch on September 12th. The market's sense of urgency for technology solutions grew demonstratably during the quarter due to the Federal Reserve and other key regulators taking a keen interest in operational improvements in the CDS space. Recent credit events, including Delphi, reinforced the importance of the credit derivatives market.

Andy Brindle, former Global Head of CDS at JPMorgan and a true pioneer in the industry, joined MarketAxess as a Senior Adviser to our CDS business. Andy is guiding our CDS strategy, including product design and expansion, as well as utilizing his industry network to further our client goals. Technology enhancements have been made to facilitate - [is the compliant assignments] and novation. New dealers have agreed to join the platform, most recently Deutsche Bank, bringing our CDS dealer group to 14.

Our level of integration with DTCC is leading the industry and promotes T+0 confirmations, a key objective for the CDS industry. The CDS product is more complex than anything we have ever built, and we're confident that we're on the right track with our index solutions with ample growth opportunity in other CDS instruments.

To give you a better idea of our opportunity in CDS, we have included a few points on slide 11 to assist you in modeling out the CDS business. Please keep in mind that CDS volumes and revenue will continue to be reported in the other category. While average daily volume in the U.S. high-grade corporate bond market according to NASD TRACE data is approximately $8 billion, global average daily volume in CDS indices according to market estimates is in the range of 20 to $30 billion. While average trade size in cash is 1 to $1.5 million, the average trade size in CDS indices is approximately 25 to $50 million. The average bid offer spread for corporate bonds is approximately 4 basis points, while the average bid offer in CDS indices is 0.5 basis point.

Our variable fees in U.S. high-grade are running at approximately $109 per million. While this quarter they have been slightly below this level, we feel this continues to be a good benchmark. On the CDS indices side, we will have a blended fee per million of approximately $15 per million. Naturally, index trading is the most liquid and commoditized segment of CDS and therefore carries the lowest fees per million.

As you can see from slide 12, we continue to grow our U.S. institutional client base, which already consists of approximately 80 of the top 100 global holders of U.S. corporate bonds. Total U.S. institutional clients grew from 363 firms at the end of 2004 to 413 firms in Q3 '05, an increase of 14%. On the European side, we have seen an increase in clients on the platform from 175 at the end of 2004 to 214 at the end of Q3 '05, an increase of 22%.

On the broker/dealer front, we added RBC Capital Markets and Dresdner Kleinwort Wasserstein to our European platform and Jefferies & Company to our U.S. high-grade platform, bringing the total dealers on our system to 25 from 22 at the end of 2004.

In terms of hedge fund and leveraged account activity on our system, in September, we had a record month for participation from this important client segment with 9% of our volume derived from hedge fund and leveraged account. Based on our discussions with market participants, the hedge fund and leveraged account community currently represents approximately 25 to 50% of the volume in cash credit products and 70 to 80% of the volume in CDS products. Clearly, the hedge fund client segments represents an important growth opportunity for the Company.

Now, I would like to turn the call over to Jim for a review of our financial results.

Thank you, Rick, and good morning, everyone. Let me first discuss the trading volume results for the quarter. Looking at our results on a year-over-year basis, on slide 13, we reported third-quarter 2005 total volumes of 68.6 billion, which represented an 8% decline when compared to third quarter of 2004. On a sequential basis, we saw total volumes decline 5% from the second quarter of 2005.

As a point of reference, the NASD TRACE data showed that in the market segment in which we're most active, U.S. high-grade corporates, overall market volume declined 21% between the second and third quarters of this year. While both the overall market volumes as well as the volume over the MarketAxess platform during the quarter were disappointing, we are pleased with our percentage of NASD TRACE volume. As you can see from this slide, our total volume for the 9 months ended September 30, 2005 was running 5% above the same period in 2004.

On slide 14, we delve into more detail on our trading volumes by product for the quarter. U.S. high-grade volumes for the quarter were at 39.1 billion, declined 13% when compared to both the third quarter of 2004 and the second quarter of 2005. U.S. high-grade volume was impacted by several factors, including the continued low overall market volumes as well as the slower summer period. However, U.S. high-grade corporate volume measured as a percent of NASD TRACE volume showed strong growth as compared to the second quarter with the month of September at 8.8%, representing the highest percent for the year. This is a gratifying performance following the significant change we made in our U.S. high-grade fee plan on June 1st when we began to electronically include our fees in the dealer bid offer spreads on a trade-by-trade basis.

European high-grade volume declined by 12% when compared to the third quarter of 2004 and 4% when compared to the second quarter of 2005. There is no good source of published volume data for the European markets that would enable us to benchmark our performance against overall market volumes. However, as you can see from this slide, these declines were less than we saw in the U.S. high-grade markets. Other volume increased 16.9% to 13.3 billion compared to 11.4 billion in the 2004 third quarter led by strength in the emerging markets area.

Slide 15 provides you with revenue detail for the quarter. Total revenue for the quarter was 19.1 million, up 2% from the 2004 third quarter but down slightly compared to the second quarter of 2005. When compared to the 2004 third quarter, buyer information service fees, increased licenses fees and higher interest income were offset by a decline in variable transaction commissions resulting from lower volumes. Transaction commission revenue for the quarter was $15.8 million, down 6% from the 2004 third quarter and down 6% compared to second quarter of 2005.

As you will recall, the U.S. high-grade commissions of 10.8 million reflect the full quarter's impact from the introduction of the new fee plan in June. Remember, the new fee plan calls for higher fixed fees, which were 7.1 million for the quarter and lower variable fees. The variable fee per million was a bit lower than the $109 per million that we had previously forecasted and will be impacted by the yield maturity and size of TRACE. Overall, we see the benefit from the new fee plan with its higher fixed fees and lower volume quarters, such as the quarter we've just experienced.

European high-grade commissions fell by 14%, primarily as a result of the lower volumes that I talked about on the previous slide. Other commissions of 1.8 million benefited when compared to the prior year quarter from higher emerging market volumes but were adversely impacted by lower fees from our new issue business as a result of fee incentives we have provided to our broker/dealer clients. All other revenues which consist of information user access fees, license fees and interest income increased to 3.3 million in the third quarter of 2005 from 1.9 million in the prior year's same period. The increase was due to higher fees from our Corporate Bond Ticker service, increased dealer license fees and higher interest income.

Last quarter, we provided detail in our recurring revenues and have given an update on recurring revenues for the third quarter on slide 16. As you can see from this slide, our recurring revenues which consist of high-grade fixed distribution fees, interest income, license fees and information user access fees continues to contribute a larger percentage of our revenue stream. The third quarter of 2005 is the first quarter in which the full impact of the new U.S. high-grade corporate fee plan with its higher fixed distribution fees is clearly evident.

As I stated on our last call, a greater percentage of recurring revenues serves us well in down markets like the one we've been experiencing over recent quarters. These recurring revenues serve as a nice cushion to more volatile commission revenue, reducing our sensitivity to volumes. If you look at our recurring fees relative to our expenses that we'll discuss in more detail in a moment, you will see that over 58% of our expense base was covered by these recurring fees in the third quarter.

On slide 17, we have provided more detail around our expenses for the quarter. Total expenses for the third quarter of 2005 of 17.3 million were 26% above the third quarter of 2004. The primary drivers of this increase were increased audit and tax expenses that are reflected in the professional and consulting line; increased depreciation and amortization that's included in all other expenses and is a result of our upgraded disaster recovery capabilities; as well as increased capitalized software development costs, primarily to the CDS product. The charitable contributions we made during the quarter following our successful Charity Day on September 21st are included in the other expense category.

The number of employees increased from 171 as of September 30, 2004 to 178 as of September 30, 2005. Salary costs for the third quarter of 2005 were up just 4% from the third quarter of 2004. In terms of our operating expense guidance for 2005, we stated on prior calls that we expected operating expenses to increase 11% to 16% over full year 2004 expenses of 58.5 million. With three-quarters of the year behind us, we expect to report total operating expenses towards the top end of our previously-stated guidance.

At the same time, capital expenditures are running below the guidance that we gave at the beginning of the year. Capital expenditure for the third quarter was $1.3 million. The anticipated CapEx for the full year will be at the low end of our most recent guidance of 4 to $6 million.

On slide 18, we've overlaid our total expenses for the third quarter of 2004, second quarter of 2005 and third quarter of 2005 with our recurring revenue for each quarter to illustrate the increase in coverage of our expense base by recurring revenues, primarily generated by our U.S. high-grade fixed distribution fees. As shown, in the third quarter of 2005, recurring revenues covered 58% of our expense base, up from 48% and 46% in 2Q '05 and Q3 '04 respectively. Taking this analysis one step further to illustrate the inherent leverage in our platform, we have shown the trading volume required in Q3 '05 to meet the remaining 7.2 million of the expense base over and above that covered by our recurring revenues. For Q3 2005, that trading volume was 54 billion. Revenue from the remaining 11 billion of volume on the platform drops right to the bottom line.

Our longer-term objective is to both increase the percentage of our expense base that is covered by recurring revenues and expand our operating margins. We want to be less vulnerable to overall market volume swings, while still being able to benefit from the upside that higher adoption of electronic trading in the credit markets and higher volume across our platform can bring.

Turning now to our third-quarter 2005 results on slide 19, pretax earnings for the third quarter were 1.7 million. Net income was $1.2 million or $0.03 per share on a fully diluted basis compared to 1.8 million or $0.05 a share in the second quarter of 2005. The lower net income when compared to Q3 2004 is a result of revenue that was up slightly from the prior year, offset by expenses that increased 13%, reflecting the realities of operating as a public company as well as our expansion into credit derivatives. In addition, Q3 2004 included an extraordinary income tax benefit of $4.2 million related to the recognition of prior year net operating loss carry-forwards.

Our effective tax rate for the quarter was 33% due to tax treatment of employee stock options. The effective tax rate for the 9 months ending September 30, 2005 was 39%. As a reminder, we will begin expensing stock options in January. Had we been expensing stock options in this past quarter, diluted earnings per share would have been reduced by $0.01. We will be providing more detail with regards to the impact of stock option expenses in 2006 on our Q4 earnings call.

On slide 20, we have summary balance sheet data. Cash, cash equivalents and securities totaled $111.9 million as of September 30th, reflecting an increase of $5.2 million when compared to June 30th. Deferred tax asset was $36.8 million. Deferred tax asset benefits the Company's cash flow, as we do not expect to pay cash taxes except for certain state and local taxes until the deferred tax asset is fully utilized. Total stockholders' equity was $167.4 million, representing book value on a fully diluted basis of $4.72 per share.

With that, Rick and I would be happy to take your questions.

(Operator Instructions). Daniel Goldberg, Bear Stearns.

Can you give us a little bit of an update October volumes to date and you know your core product that also as well on the CDS side, what you've seen so far I guess now that we are into it November for October?

No, I am afraid I can't give any detail yet on October volumes because we haven't yet published those volumes. We do expect that we'll be putting out the volume shortly, in fact next week. So at that point, we can obviously -- you can take out the full October volumes.

Okay how about on the CDS side? Can you give us any trend? Obviously, you started that mid-September with a pilot. Now, you are I guess at the 14, 15 dealers in that program. What other trends are you seeing there? Are you seeing that business pick up a bit now that it's been I guess you could say live for a 1.5 month or so?

For competitive reasons, we are not specifically releasing CDS volumes. As you mentioned, we think the key part of the early adoption is to expand the group of dealers and clients that have access to the platform. And, we are doing that successfully and we are working through all the documentation issues that go with electronic trading in the derivative space that are different from the cash corporate bond space. So, we think we are building a larger foundation. At this point, we are not releasing volumes as I mentioned earlier because of competitive reasons.

Okay. On the commissions per million dollars treated obviously impacted by the new fee plan, the high-grade I think was the highest according to our data since the third quarter of '03, up about 7% quarter over quarter. And other was actually down, as you talked about briefly. Can you just talk about any other trends or run rates that you see in those numbers as we model out '06?

No. As you say, if you look at the old [lamens] fee per million in U.S. high-grade, we obviously do benefit in lower volume quarters from the higher fixed fees. So you say that blended rate is up. If you look at the marginal rate, either variable transaction fee rate in U.S. high-grade, it is slightly below the rate that we previously put out of 109; it's running at about 105. And, it is impacted by the mix of business across the platform, including maturities and the size of trades. On the European business, I think you see that we've had pretty consistent average fees per million. They go up and down a little bit by quarter, but I think you'll see this recent quarter is pretty much in line with previous quarters.

Okay and then on the other -- presumably the CDS should bring that down trend-wise?

Yes, because you have a higher volume product that carries lower fees like a CDS index product that obviously will bring the blended fee per million down in future quarters.

Then on the hedge fund, you mentioned 9% of your volume in September was from the hedge fund customer. Where can you see that going and what things are you doing to get them more involved in using the MarketAxess platform?

It's a great question. First of all, I think the launch of the CDS product is the most important thing we can do to make the trading system relevant to the hedge fund community. That is the place where most of them expressed their views in the credit space. We're seeing a significant increase in hedge fund interest and logins in the platform with the launch of the CDS product. The second thing we are doing is expanding our marketing resources so that we have more salespeople in both New York and London, specifically focused on hedge funds, so they are aware not only of the CDS product but the benefits that we think we can deliver to them in the core corporate bond market as well as our data product.

Patra Chakshuvej, JPMorgan.

I know you guys said that you didn't want to quantify the impact of the CDS platform, but can you discuss how many clients are now signed onto the platform and when you expect to roll it out to your entire client base?

We started with a select group of clients that are active in the CDS space, and we are working through the additional documentation process for a large group of other clients that we believe are attracted to the CDS product. So, it's again for competitive reasons. It's not a statistic that we are giving out, but we're confident in the growth of clients that have access to the system and the developments that we've seen week on week over the last 6 weeks.

Okay, I guess do you know when you expect to complete the documentation process?

Well, it's an ongoing effort. There are three or four layers of documentation between ourselves and dealers and customers. I think it will be several quarters of working through the documentation and importantly getting more clients set up with Deriv/SERV at DTCC, which is a key prerequisite to being able to take advantage of the CDS product on MarketAxess.

Also, could you talk about the competition in the U.S. high-grade market? I know you said that your market share for U.S. high-grade had improved quarter over quarter, but we saw your overall volumes actually decline. I know that TradeWeb had actually announced a 177% quarter-over-quarter increase in corporate bond trading volumes, so I was just wondering what your thoughts were on the competitive landscape.

Well, this space continues to be competitive, which we think is a good thing and keeps us sharp. It's very difficult to know exactly what's going on at TradeWeb in particular because they do present growth figures but they don't give absolute volume or revenue numbers. What I can tell you based on all of our work with the institutional dealer and client community is that we are very confident that we continue to have the vast majority of the institutional electronic corporate bond market. And by that, I mean we occupy more than 95% of the revenues in this space even during the quarter that was just completed.

Howard Chen, Credit Suisse First Boston.

Could you provide a little bit more granularity around the product yield, the average duration and trade size that drove the U.S. high-grade product pricing a bit lower than you forecasted? Jim, you mentioned it like twice on the call I think.

If you look at the average maturity of trades on the platform, it was down slightly in the third quarter. You know it was in fact down from an average maturity of 6.2 million -- sorry 6.2 years down to 5.8. So we've had a slight decline in the average yield's maturity, and that's really what's responsible mostly for the slight decline that we've had in average fees per million in U.S. high-grade from the 109, down to about 105.

But when you budget out and you think about the environment with rising interest rates, is it safe to assume that your mix should stretch out on duration rather than shrink over time?

Well what is true to say is if you look back, that's the lowest years of maturity we've had for a few quarters. Certainly looking back historically, it's generally been longer than that.

Great, that's helpful. Then on slide 16, you break out the recurring revenue stream, which I think is really helpful. But, if I'm looking at this quarter and what you define as recurring revenue, does that mean -- does that imply that the 1.2 million of information in user access fees and the 1 million of licensing fees have found a new kind of base level and shouldn't be declining going forward? Because I was under the impression that the licensing fees were somewhat lumpy quarter to quarter.

The license fees are impacted when we bring new dealers onto the platform, but there's also an element of that that is amortized over 3 years and so it's relatively constant. So they will go up-and-down a bit, but they say there is that constant element to it. If you look at the trend in information user access fees, that's been on an upward path over the past few quarters.

What could drive that number down like next quarter or it really shouldn't?

Information user access, we say, you see the trend over past quarters has been outwards, as we've added new users to the Bond Ticker product.

Rick, thanks for detailing out the pricing dynamics on the CDS product. When you start thinking about next year, can you share your thoughts on what you think would be a reasonable market share role for the Company? I.e., how much of that 20 to 30 billion of average daily volume, assuming it doesn't grow, do you think it's reasonable for you to capture?

A couple of things, one, I think we -- our thoughts are to plan conservatively and build a scalable platform for higher scenario outcomes. But, the one thing that is clear that is different in the CDS base is there is a calling out for technology solutions to improve operational control. So, this is the first product we've launched, where actually dealers and customers are completely aligned and wanting more electronic trading, especially with the real-time link to DTCC that will allow us to deliver T+0 confirmations and help the industry to clear up that backlog.

So the dynamics here are different, which I think gives rise to the possibility that the adoption rate in CDS will be faster than what we have historically observed in cash products.

Then do you think there is any unique barriers to this marketplace that would hamper you from getting to 9% market share faster than how you got there in the core U.S. high-grade market? You spoke to some of the things in your favor.

I think we're working through all of the early obstacles and longer-term. No, we don't think that there are any barriers, and we think it is possible that the market share traded electronically especially in the index area will end up being greater than what trades electronically in the cash products.

Then one last one -- you spoke a lot about investment and clearly you guys have a lot of cash on balance sheet that you could deploy. What else would you kind of fit within that pre-launch groundwork/investment phase that we can think about a year or two from now?

For competitive reasons, we are not prepared to give a lot of detail on things in that stage of development internally. But, I think when you look at the overall space, there are still major sectors of fixed income that are not trading electronically at all. There are major client segments that are very early stages in moving toward electronic trading, and there are additional regions that we think are attractive. So, we really have a very full whiteboard in terms of new expansion ideas. Each quarter, we're trying to identify the two or three ideas that make the most sense for our shareholders to invest in and move forward.

Aaron [Cadell], [Hogdy] Capital.

I just wanted to go back to your comments on the competitive landscape. And I guess I obviously saw that Archipelago I guess in concert with NYSE announced that they are planning to enter the corporate bond market. How would you view them as a potential competitor? And more broadly I guess they're the first sort of multi-security or multi-product exchange or quasi-exchange entering this market and how do you view I guess yourselves as a specialist versus the NYSE/Archi or somebody else that would be doing equities, fixed income, options, possibly other stuff?

That is a great and timely question. First, let me say that we think it's a great thing to see the increase in interest in the electronic corporate bond space. It is kind of interesting to see the Archipelago plan developing because a little bit different than what you outlined. The New York Stock Exchange is already operating across asset class and has had a corporate bond product for many years on their automated bond system. I think it's indicative of the obstacles that have existed in moving the corporate bond market to a true exchange format.

We certainly promoted Exchange-style trading earlier on in our existence as did others; the New York Stock Exchange continues to do so. Now, Archipelago intends to expand their product offering to include corporate bonds. One thing is very clear, Exchange-style trading has been very slow to take hold in corporate bonds. It is we think primarily because most securities in the corporate bond market lack continuous markets that lend themselves to real-time anonymous Exchange-style trading. We do think that Archipelago and the New York Stock Exchange could add value in the retail space, which lacks the level of price competition in corporate bonds that is available today for institutional customers. From what we've seen, the early focus coming from both of them is on the retail client segment.

We think more participation and more efficiency in the retail space would actually provide a positive foundation for our platform in terms of the added interest for odd-lot trading that would help with institutions trying to transact in those sorts of sizes with daily cash flows. So, in general, we don't view this as competing directly with what we do or overlapping with our business. We think the overall developments in electronic trading are a big positive for our business.

Then shifting to just a couple of knits, your GAAP tax rate bounces around. Can you give any guidance for the GAAP tax rate for '06?

I think really on the tax rate as you say, it will vary quarter by quarter. But if you look at the year-to-date tax rate, we're running at 39% year to date. I think on a previous call, I've given a number of where I expect that to get to a 40%. So the 39% obviously is right in that zip code.

But, for this quarter, it looked like it was about 33. So that would just be the mix of European revenues versus U.S. or what determines that?

It's also we did benefit during this quarter from employee stock options that were exercised and sold during the quarter. We get some tax benefit from that. So that's also impacted this quarter's rate.

Then last one -- can you just go back to -- I guess a couple of people asked about it before but the commissions per million, particularly on the other? Basically, that's due to the CDS -- the big drop there is due to CDS?

Really, if you look at the comparison in the other category you know from the same period last year, we're running this quarter at about $141 per million in average compared to it was 182 in the prior year quarter, so, we are down. And the key reason for it being down is what I mentioned in the prepared remarks with regards to our new issue business, where we have been offering fee incentives to dealers, and that has brought the average fee per million in the other product area down.

How long will those fee incentives be? How long do you plan to continue them?

At this point, I don't know where actually, but we're trying some things in the new issue products and some fee incentives. We're going to wait and see how those go.

(Operator Instructions). Casey Ambrich, Millennium.

Just a couple more follow-ups on competition in the CDS market and estimates. On the competition, can you remind us how many actual participants are in this space?

In the client-to-dealer space, as we mentioned earlier, we were the first client-to-multi-dealer platform to launch in September. The primary source of competition in the client-to-multi-dealer space is likely to come from TradeWeb. You may also be familiar with electronic offerings in the interdealer space, which do not directly compete with what we do in the customer-to-dealer space. But, companies like Creditex and GFI are involved in the interdealer trading of credit derivatives.

If I remember though, I thought there was like 35 participants though from the IPO -- if I remember from the IPO, there was like 35 participants who were somehow involved in bond trading. Is that not correct?

I think it might be in overall bond trading. But, I thought your question was specific just to the CDS space.

No, no, no, not to CDS. I'm talking about the whole market, and then I was going to talk about the CDS space.

I think if you look at all sectors and all electronic offerings, including single dealer offerings, retail offerings, various regions, then yes, you can come up with a number of somewhere around 35. I think when you look at institutional trading activity, the vast majority of it is taking place today on multi-dealer platforms. And there really are just a couple of those.

Okay and then just -- okay and I am a little confused about the Act; you guys commented for a while. You are excited that Act is coming into the bond trading space?

We think it reflects the growth potential in this space. So we think it is a great sign to see increasing interest. Just to put things specifically, the New York Stock Exchange has had an electronic corporate bond offering for many years. And to put this in context, during 2004, MarketAxess in the U.S. corporate bond space traded approximately 200 billion in trading volume. While at the same time, the New York Stock Exchange traded approximate approximately 3.5 million billion. So, this is a very different offering, and we think institutions are best served by trading on a disclosed platform where they can command liquidity due to their sheer size from their dealer counterparties.

So, we do believe that the Exchange offering is going to have appeal in a very different client segment than we operate today. More efficiency and activity in the retail space we think would be a good thing for the institutional electronic market.

Because as I looked going back since the IPO, volumes in the trades have gone down monthly and margins from the new pricing structure have put -- pricing from the -- margins driven by the new pricing structure seem to be putting some pressure on the margins. So, I'm just trying to understand how a new [depocketed] participant is going to help volumes and margins for the space.

I will comment on the first and then let Jim comment on the margins. Because I think actually on a fully loaded basis, the margins in our business have actually improved in the most recent quarter for corporate bonds. But, it has been a difficult year for institutions active in the corporate bond market. We've seen several significant downgrades and a series of defaults specially related to the auto sector. So, it's been a very difficult year for institutions and corporate bond trading, which we think is the reason that the overall market has been declining. Obviously, the credit business goes through various cycles and we are confident that it will turn around and we will see the growth in corporate bond trading return. The most important growth area right now is actually the credit derivatives market, and that is why we think it has been so important for us to make the investment to enter that sector.

Then, just on the CDS market, I know you guys are being a little cautious about talking about the flows and the volumes for competition -- for competitive reasons. But can you just kind of give us some color about how this deal is going to be priced and what type of expectations at a minimum you might expect for next year on your bottom line?

I think Rick gave some information in his prepared remarks about the CDS pricing, at least the CDS index product. You know, Rick gave out a number of $15 per million I think in terms of the variable revenue that we will earn on CDS index trades. You know, it is too early at this point for us to be talking about volumes. Again, it's an early-stage sort of product. We're still building the dealer and client base, and we certainly got to talk more about volumes in future quarters.

Right. I think the economics of the business are pretty straightforward. There are three or four key variables to help you think about the revenue potential next year and beyond. The first is the average fee per million, and we've given some insight on that today. The second is the total average daily volume, and we've given an estimate of that today for the CDS business. The third piece is the growth rate in those average daily volumes, and the CDS business is growing very rapidly. Then, the last variable is the estimated market share that will trade electronically on MarketAxess.

So, those are the four variables that we work with. We do not give forward-looking revenue or volume forecasts. But we're trying to give you all the information we can to understand the size of the market opportunity.

Justin Hughes, Philadelphia Financial.

Just a question on your expenses. I think the previous quarter, you guided a 16% expense growth for the year. And on your prepared remarks, you said -- excuse me, it was 11 to 16% was the range you gave. And on your prepared comments, you said it will still be at the high end of that towards the 16%. So I get to -- your expenses have to increase about $1 million in the fourth quarter from the third-quarter level. Is that correct?

Yes. I think what I gave out at the beginning of the year was the 11 to 16% range over the full year '05 expenses (multiple speakers)

Then you said -- I'm sorry go ahead.

Sorry?

Then you said in the prepared remarks that it will still be towards the high end of that range, correct?

That's right. For the full year, we expect to be within the range but towards the high end of that.

So it looks like there is going to be another step-up in the fourth quarter, and I'm just curious why because I know you were building out the CDS product in the third quarter and I kind of thought that we would plateau at that third-quarter level. So I'm just surprised that you're guiding towards increased expenses again in the fourth quarter.

We continue to build out the CDS product. As with most products, it happens in phases, where you know we continue to add a new functionality and to build out the product.

I thought maybe you would be done with parts of that and moving onto other parts. But, then you are talking about a lot of other products you can go into for next year, should we expect to see this continued type of growth rate?

I think what you have to remember is that the expense growth this year is really impacted by two things. First, the cost of being a public company, and then second is the spend that we've made on new products and particularly the CDS product. You know what you clearly won't have next year is another increase in respect of the public company expenses. For those, we would expect to be very similar next year in terms of what we've incurred this year.

So maybe half of the growth rate in expenses for next year, something like that?

Yes. You know, I think on the last quarterly call when we spoke about expenses, I said that if you take out the public company expenses, we thought that the underlying growth of expenses this year versus last year was in the 10% range.

Ladies and gentlemen, this does conclude the question-and-answer portion of your conference. I would like to turn the presentation back to Mr. Rick McVey for any closing remarks.

Thank you and thank you all for joining us this morning. Just in closing, we continue to be the leader in electronic trading in the institutional client-to-dealer credit market. MarketAxess is well-positioned to recapture growth when favorable market conditions return. We have the first mover advantage and a strong CDS product and our ability to generate cash even during quiet markets gives us the flexibility to continue investing organically as well as pursuing new business initiatives. Thank you again for joining us for the call, and we look forward to talking to you next quarter.

Once again, ladies and gentlemen, we do appreciate your participation in today's conference. This does conclude the presentation. You may now disconnect. Have a great day.