Marketaxess Holdings Inc (MKTX) 2005 Q4 法說會逐字稿

Ladies and gentlemen thank you for standing by and welcome to the MarketAxess fourth quarter and full year 2005 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. (Operator Instructions). As a reminder, this conference is being recorded Wednesday, February 8, 2006. I would now like to turn the call over to Stephen Davidson, head of investor relations at MarketAxess.

Good morning and welcome to the MarketAxess fourth quarter and full year 2005 conference call. We issued a press release this morning providing our results for the fourth quarter and full year 2005 and our January 2006 monthly volume. Both press releases are available on our website.

For the call this morning, Rick McVey, Chairman and Chief Executive Officer of MarketAxess, will provide a strategic update for the Company and then Jim Rucker, our Chief Financial Officer, will review the financial results for the quarter and full year. We will then go back to Rick for closing comments before the Q&A session.

Before I turn the call over to Rick, let remind you that this presentation may contain forward-looking statements, including statements about the outlook and prospects for the 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 rates; our limited operating history; the level of trading volume and transactions 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's acceptance 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 conditions 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 affecting MarketAxess' business and prospects is contained in MarketAxess' periodic filings with the Securities and Exchange Commission and can be accessed at www.theMarketAxess.com.

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

Thank you Stephen, good morning. 2005 was a challenging year due to the steady decline of overall industry trading volumes in our core market, corporate bonds. We are confident that the conditions that caused this decline are temporary and corporate bond trading will return to a long-term growth pattern.

Given our history of rapid growth, we're disappointed with the results in 2005. However, we took important steps during the year toward our goal to be the leading global electronic trading platform for fixed income. In 2005, we expanded our client franchise and product offerings, most notably through the launch of our Credit Default Swaps product. We have grown through a down cycle in corporate bonds by capturing a greater percentage of NASD high-grade trace volume. We improved our customer value proposition and shareholder earnings stream through our new U.S. high-grade transaction fee plan. We have increased the financial strength of the firm through positive cash flow and a higher base of recurring revenues. And lastly, we have added industry leaders to our management team and our Board of Directors.

We are encouraged by our start to 2006 with January average daily trading volumes setting a new record for the Company. We also see clear evidence that dealers are becoming more focused on reducing their costs for lower margin flow trading, a trend that favors increased acceptance and adoption of electronic trading.

On slide five, we have the financial highlights for the fourth quarter and full year 2005. As I mentioned earlier, top line revenue growth was adversely impacted by corporate bond market conditions during the year. Expense growth is higher than past years due to significant investment in the launch of new products that present substantial opportunities for the Company. Public company expenses were also a significant driver of the expense increased in 2005. Jim will discuss our detailed financial results shortly.

Putting our 2005 results in a broader context, between 2002 and 2005, MarketAxess revenue has increased at a compound annual growth rate of 60% while our expense growth rate over the same period was only 7%. We believe that global fixed income e-trading offers a compelling growth story and we will continue to invest in large and growing markets.

Our product offering continues to expand. We have strong U.S. and European high-grade businesses that are positioned for growth when trading volumes rebound as they did in January. We have an emerging markets business that recorded an annual growth rate of approximately 50% in 2005. Our electronic credit default swaps solution is positioned to lead the e-trading migration in this rapidly growing sector and we have a high yield business that is in greater demand due to the increase in market transparency and the expansion in this sector caused by the downgrades of GM and Ford.

As you can see from slide 6, in 2005, we continued to grow our client franchise across all segments. Total active institutional investor firms on the platform increased a total of 118 firms, or 22%. Active U.S. institutional investor clients grew 19%. Active European institutional clients grew 28%. Our broker-dealer partners on the platform grew from 22 to 25. Dresdner Bank and Royal Bank of Canada joined our European platform during the year. Jeffries & Co. joined the U.S. high-grade trading system. All major global dealers active in credit markets participate on the MarketAxess system today. We experienced strong growth in 2005 in active hedge fund and leveraged accounts utilizing the trading system.

Slide 7 is an update on where we are with the launch of the CDS platform. More dealers have completed the technology integration to go live on MarketAxess CDS, bringing our active total to 11 dealers. Important CDS dealers like CSFB, Goldman, Sachs & Co. and Deutsche Bank are just now going live on the system. Clients' derivative documentation remains a key hurdle, but total trading clients have now reached 41 firms. Client documentation with dealers and the DTCC remains largely out of our control.

Total dealer approvals now stand at 170, or approximately four dealers per client. While we continue to move forward with customer documentation, we are simultaneously enhancing our technologies solution. [A fully] electronic is the compliant [Novation] solution was released on schedule in December 2005. Free trade accounts allocations, a key feature for traditional money managers, is on track for early Q2. We are developing functionality to meet client demand in CDS sectors beyond indexed trading.

On slide 8, we have noted both the headwinds and the opportunity in the credit markets for MarketAxess. Full year estimated NASD high-grade trace volume was down 19% versus full year 2004. Overall credit trading continues to grow, reflected by the greater than 100% annual growth occurring in the notional value of credit default swaps outstanding. Net new issuance of corporate bonds has been declining over the last several years as companies have been flush with cash. Greater levels of new issuance tends to drive higher secondary volumes as we observed in January. January was the second strongest month ever for new issuance of corporate bonds and secondary and ASD trace volumes rebounded sharply.

Trading conditions have been generally benign over the last several years due to credit spreads that continue to be at the lower end of historical ranges, generally low levels of credit spread and interest rate volatility with the exception of a brief spike in auto sector spread volatility in the spring and the general trend toward higher short-term rates caused by the sustained period of Fed tightening.

On slide 9, we showed a consistent growth of our U.S. high-grade volume as a percentage of NASD trace volume. A quick note that prior to January 2005, the NASD did not publish complete volume data for the corporate bond market. Our estimates on volume prior to 2005 were implied based on the data the NSAD provided on the percentage of the market they were reporting on TRACE and the average size trade for the $5 million and up reporting bucket.

As a further reminder, TRACE data includes all three segments of the corporate bond market -- interdealer trading, institutional customer trading and retail customers trading. We are currently only involved in institutional customer trading and there can be seismic shifts in the client segment mix of TRACE during some market periods. Over longer periods, we believe our percentage of TRACE volume provides a useful proxy for market share trends. The positive trend in trend in our share of NSAD high-grade trace volume reflects the growing acceptance of electronic trading in the credit sector and positions the Company well for the return to higher overall industry trading volumes.

On slide 10, we are very encouraged by the January volume numbers which we released this morning. In January, we set new monthly records for global average daily trading volume and European credit volumes. We recorded the second-highest monthly total trading volume in the history of the Company. Strength in other trading volume reflected positive traction in some of our newer products. And lastly, U.S. high-grade as a percentage of NASD TRACE volume for January 2006 continues to indicate a positive trend.

Now I would like to turn the call over to Jim, who will walk you through the financials for the fourth quarter and full year 2005.

Thank you, Rick. On slide 11, we outlined our volumes for the fourth quarter of 2005 against the fourth quarter of 2004 and the third quarter of 2005. Total trading volumes in the fourth quarter of 2005 were down 13% when compared to the fourth quarter of 2004 and were up (indiscernible) [the same] versus the third quarter of 2005.

European high-grade volume increased from the third to fourth the quarter of 2005 despite a slow December that reflected a 37% decline then compared to November due to seasonal factors. Other volume in the fourth quarter of 2004 included 4 billion in U.S. Treasury volume, our product which we discontinued in the first quarter of 2005. Adjusted for discontinued Treasury volume, other volume in the fourth quarter of 2005 was 44% above the fourth quarter of 2004.

Slide 12 provides you with revenue detail for the fourth quarter and full year 2005. Full year total revenues for 2005 were $78.6 million. U.S. high-grade revenue benefited from the introduction of our new fee plan in June of 2005 where the combination of higher fixed distribution fees and lower variable fees is positive to high-grade revenue of lower volume levels. U.S. high-grade commissions of 45.6 million in 2005 were in line with the $45.5 million in commissions in 2004 despite the 4% decline in volumes year-over-year.

For the fourth quarter of 2005, total revenue was $18.9 million. U.S. high-grade commissions were down only 6% versus the fourth quarter of 2005 on volume declines of 13%, again reflecting the benefit for the U.S. high grade fee plan. The average variable fee per million for U.S. high-grade in the fourth quarter was $102.

European high-grade commissions fell by 4% versus the fourth quarter of 2004. The average fee per million declined from $198 to $186 as a result of changes in the product mix on the European platform and a modest change to the European fee schedules in mid-year 2005. Other commissions of $1.8 million benefited from a strong quarter-over-quarter emerging markets growth, but were adversely impacted by lower fees from our new issue business.

Slide 13 outlines our recurring revenue for 2005 compared to 2004. As you can see from this slide, our recurring revenues, which consist of high-grade fixed distribution fees, interest income, license fees and information and user access fees, contribute a meaningful and growing percentage of our revenue stream and are covering a greater percentage of our expense base. These recurring revenues reduced the volatility in our earnings while the variable transaction fees enable us to benefit from higher volumes and increased operating leverage.

Slide 14 provides you with the expense detail for the fourth quarter and full year 2005. Total expenses in 2005 increased by 14.6% from 2004 levels to 67 million. The primary drivers of this increase were investments in new products, the cost of being a public company and investment in our upgraded disaster recovery facilities. Total expenses in the fourth quarter increased by 18.6% to 17.3 million from 14.5 million in the fourth quarter of 2004, primarily driven by an increase in general and administrative expenses.

The most significant variances in the general and administrative lines were an increase in occupancy costs, the classification of Board of Director costs to general and administrative expenses in the 2005 fourth quarter and a onetime benefit in the 2004 fourth quarter when we reversed the UK VAT tax reserve. Headcount as of December 31, 2005 was 182 compared to 172 at year end 2004.

On slide 15, we have laid out our expense guidance for 2006. Beginning in the first quarter of 2006, we will be recording the impact of stock-based compensation in our consolidated financial statements in accordance with FAS 123(R) using the modified prospective method. Excluding the impact if FAS 123(R), we expect full year 2006 expenses to be 8 to 12% above full year 2005 expenses of $67 million. Including the impact of FAS 123(R), we expect full year 2006 expenses to be 10 to 15% above an adjusted 2005 expense level of 69.5 million, which represents full year 2005 reported expenses plus the stock-based compensation impact of FAS 123(R) if it had been adopted in 2005.

This 2006 expense guidance, both excluding and including the impact of FAS 123(R), includes estimated expenses for development of new products and enhancements to existing products in 2006. 2006 projected expenses anticipate the launch of a new marketplace where we would expect full-year expenses of approximately $2 million. We would only enter this marketplace if we had market demand that would create sufficient revenues during the same period to ensure that the launch was not dilutive to earnings.

Our CapEx expenditures for 2006, which include both hardware and software purchases will be between 5 million and $7 million. We expect the diluted shares outstanding for the first quarter of 2006 to be in the range of 36.4 million to 36.6 million shares under the Treasury Stock ,method including the shares of nonworking common stock and shares issuable upon the exercise of options and warrants.

Please turn to slide 16 for our earnings performance. Net income for 2005 was $8.1 million, or $0.23 per share on a diluted basis compared with $57.6 million, or $1.88 per share in 2004. Net income in 2004 included an income tax benefit of $40.3 million related to the recognition of net operating loss carryforwards. Net income for the fourth quarter of 2005 was $2.1 million, or $0.06 per share on a diluted basis compared with 2.6 million, or $0.08 per share in the fourth quarter of 2004. Net income in the fourth quarter of 2005 included an income tax benefit of $1.1 million resulting from a reduction in the deferred tax asset valuation allowance that was partially offset by an adjustment to the tax rate used for recognizing deferred taxes.

On slide 17, we've highlighted the free cash flow generation for the business. After adjusting for non-cash GAAP expenses, CapEx and the changing working capital, our businesses generated $12.1 million in cash. This represented 1.5 times the reported net income for 2005 and highlights the fact that we do not pay cash taxes. The free cash flow is the equivalent of $0.34 a share, well above our reported earnings-per-share for 2005 of $0.23. I would highlight that cash flow in the first quarter will be impacted by annual employee incentive compensation payments that were made in January.

On slide 18 we have summary balance sheet data. Cash, cash equivalents and securities totaled $118.1 million as of December 31, 2005. The deferred tax asset was $39.8 million. The deferred tax asset benefits the Company's cash flow but we do not expect to pay cash taxes except for certain state and local taxes until the deferred tax asset is fully utilized.

Total stockholder's equity was 170.9 million, representing local book value on a fully diluted basis of $4.86 a share. With that, let me turn the call back to Rick for some closing comments.

In closing, we remain optimistic about the growth opportunity ahead for market access. Our growth will come from three main areas. First, increased penetration of existing products. While we are approaching 8% of NSAD high-grade TRACE volume, the vast majority of the other 92% is still trading by phone.

Second, expansion into new product sectors where we can leverage our technology and liquidity. And third, extension into new client segments that are currently underserved by existing each trading solutions. Those segments may include hedge funds, interdealer and retail trading.

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

(Operator Instructions). Daniel Goldberg, Bear Stearns.

Can you talk a little bit about -- obviously volumes in January were very strong, you did mention a little bit more. But any other color there obviously approaching or at a new record on a monthly basis? And if you could maybe address also Europe, it seemed like it was much stronger than some of the other products?

I think the year did get off to a great start and there are a couple of factors behind that. One, for the first month of the quarter, we are pleased with the market share trends that we are seeing as a percentage of TRACE high-grade volume. Secondly as I mentioned earlier, it was a very active month for new issuance. So we do believe that that is one of the drivers of higher secondary volumes, and it certainly was a very good month for new issuance.

Third, we are starting this year in a different place versus early 2005 with respect to the outlook for interest rates. It's widely believed that the Fed is coming to the completion of their tightening phase and as a result, the fear of higher rates is not in the market today that was there a year ago. So in my opinion, all of those factors contributed to what was a very strong month for MarketAxess.

Okay. In terms of the expense guidance, I guess 12 to 15% including the options, what are your assumptions regarding volumes as it relates to that? Is that at all a variable if volumes were higher than expected, or on the other hand, lower than expected?

I think then that our expenses don't vary too much according to volume in our existing products. Really what drives the expenses and has driven our expense guidance are the products and the market segments that we're in. We are not that sensitive on a monthly -- on a quarter basis. The changes in the volume of products, that's (indiscernible) volumes in existing products.

Okay, so we should assume that under really any circumstances, we should see those increases in expenses?

That's right; those expenses will not vary significantly, depending on the volumes that we've seen through the year.

I think it's more dependent, Daniel, on the markets and products that we enter into during the year. And as Jim mentioned, we have put room in that for new markets during the course of 2006. We are very pleased by the market demand that is coming our way to extend our technology into new sectors and client segments and we have left room to expand the trading system throughout 2006 in the expense guidance that Jim provided. I think the key point is, we are confident that if we do move into those sectors, we will have offsetting revenue for the services that we are providing.

And you mentioned specifically, Jim, $2 million for a potential launch of a new marketplace -- any more detail there?

Not a lot more to say, Dan, other than Rick's comments. We do believe that there is demand in other sectors. And as Rick mentioned, if we can crystallize that demand, we will enter them, but only on the basis it would not be dilutive to earnings during the year.

Okay. And lastly in terms of CDS, I think you did give us some update there. Any update there on the competitive landscape? Have you seen anything from Trade Web trade-up that substantial?

We're not aware of anything. We certainly have not seen anything from Trade Web and the anecdotal evidence that we have from the dealer community suggests that our competitive advantages are coming through early in the CDS product. We believe that we are uniquely positioned to offer the combination of corporate bond and CDS trading side-by-side and to integrate the two sectors. We have a broader group of dealers participating and we are highly confident in the technology solution that we have built for that market. So we think we're in the right place competitively. There's nothing that surprises us in the first four months of trading in CDS. We clearly would have liked to have had an even faster start, but we are seeing all of the signs of success that we've had in other markets. We are getting through documentation, we're getting through technology integration and we think we are building toward a point of critical mass in the trading community. And clearly, the technology improves efficiency and operational control in a fast-growing market. So we think all of the elements of success are there in the early stages very similar to what we've as seen in previous successful products.

And when do you think you will be able to give us kind of a breakout in terms of the volumes or month over month growth or quarter over quarter growth related to CDS?

I think at this early stage, Dan, we (indiscernible) for competitive reasons that want to include it in other. And I think as we have said in the past, when any new product gets to the point where it is significant in terms of either volume or revenue, we will look at breaking it out from the other category.

Great, thanks a lot.

Ken Worthington, J.P. Morgan.

Hi, this is actually [Petra] on the line. In terms of your expense guidance of 8 to 12% year-over-year, I was wondering how much of that incorporates any further enhancements in the CDS market and where you guys stand on the expense buildout of that.

The expense guidance that we have given for 2006 does include all of the expenses for further buildout of the CDS product. There certainly will be continued enhancements to that during the course of 2006, and all of those expenses are built into the guidance.

I guess I was wondering if you guys could give a little bit more color as to how much of that expense increase was dedicated to the further enhancements to the CDS market.

We don't split out the numbers between the specific new product initiatives, but the expense guidance includes both expansion of our existing products as well as the development in new product areas.

Great. Rick, you had mentioned that 92% of corporate bond trading market still is done over the phone. What factors do you think would need to come into play for you guys to dramatically increase your market share above 8%?

That is a great question, and we spend a lot of time thinking about that one. But I think it's very interesting to note the change in view around the dealer communities, starting in 2006 in particular. Margins in secondary corporate bond trading have clearly been impacted by the increase in transparency and TRACE. And as a result, most dealers are focusing on ways that they can reduce their costs throughout this year and beyond.

So I think as the dealer community gets more fully behind the economic benefits of greater electronic trading with their clients, that will be a client catalysts for greater market share taking place on the MarketAxess system. So I really believe that we're in a different place starting this year and we have the opportunity to see an acceleration of share gains.

Okay, great. Thanks.

(Operator Instructions). Aaron (indiscernible).

Good morning. First, I know that you're not breaking out CDS currently, but could you even give a rough idea of how much of other is represented by CDS at this point?

We really are not breaking out the other category. I think we are giving more disclosure on our volumes and financials than any of our competitors. And at early stage products, I think we, as Jim mentioned, expect to continue to report them in the aggregate in the other category at the time where we believe that they have become relevant and material to the Company financials; at that point, we would consider breaking them out.

And then, Jim, on your comments on the cash flow impacted in the first quarter by employee incentive compensation, what amount are we talking about there broadly?

We don't put out the exact amount there, Aaron, but I think it's fair to say that cash flow in the first quarter are generally negative, but we make it up in the remaining three quarters of the year.

Last question, I think at this time last year, you gave revenue guidance as well as expense guidance, and obviously it's tough to a lot of moving parts. But just broadly as I just do a back of the envelope, if I say 78 million of expenses and 36.5 million shares, the midpoint of your guidance, to just get to $0.22, $0.23, thereabouts, you need to kind of growth revenue by about in the mid double-digits, so 13, 15%, something like that. And then obviously to get growth, you would have to something above that from the base of the 78 million. Can you give any idea -- you must have some thoughts on some plan of what your revenue growth rate could be in 2006?

We don't put out revenue guidance. In fact, we did that last year. Obviously, our revenues are dependent not only on our marketshare, but also our market volumes, which as we all know are difficult to predict. But clearly, we are planning on the basis and belief that we have the opportunity here to expand our operating margins in the Company as we move forward.

Okay, thank you very much.

(Operator Instructions). And with no further questions, I would like to turn the call over for any closing remarks.

Thank you very much for joining us this morning. We are excited by our prospects and we look forward to talking to you next quarter.

Ladies and gentlemen, we thank you for your participation in today's conferences. This concludes the presentation and you may now disconnect. Have a great day.