Marketaxess Holdings Inc (MKTX) 2006 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 2006 Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

As a reminder, this conference is being recorded Wednesday, February 7, 2007.

I would now like to turn the call over to Stephen Davidson, Head of Investor Relations at MarketAxess.

Please go ahead, sir.

Thank you, [Twanda].

Good morning and welcome to the MarketAxess fourth quarter and full-year 2006 conference call.

For the call this morning, Rick McVey, Chairman and Chief Executive Officer of MarketAxess, will provide a strategic update for the Company.

Kelley Millet, President, will provide an update on our North America businesses.

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 me remind you that today's call may include forward-looking statements.

These statements represent the Company's beliefs regarding future events that by their nature are uncertain.

The Company's actual results and financial condition may differ, possibly materially, from what is indicated in those forward-looking statements.

For a discussion of some of the risks and factors that could affect the Company's future results, please see the description of risk factors in our annual report on Form 10-K for the year ended December 31, 2005.

I would also direct you to read the forward-looking disclaimers in our quarterly earnings release that was issued earlier this morning and is available on our Web site.

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

Rick?

Good morning and thank you for joining us.

It is a pleasure to share with you our fourth quarter results, which reflect growing momentum in our business.

For the fourth quarter of 2006, MarketAxess reported record revenues of $22 million, up 17% from the prior year, driving pre-tax income of $3.6 million, an increase of 120%, and diluted earnings per share of $0.06.

These improved results were driven by record U.S. high-grade volume of $57 billion, up 44% on the back of an 18% increase in TRACE volume, resulting in a record estimated 9.5% share of NASD high-grade TRACE volume, strong growth in European high-grade volumes that were up 28%, and record overall trading volume of $92 billion, up 33%.

A quick reminder on estimated share -- estimated market share for our U.S. high grade business can register large short-term swings as it did during the fourth quarter due to the client mix in TRACE and the potential large shifts in the make up of trading activity in the corporate bond market.

New product areas continue to contribute a greater percentage of our volume and revenue.

The already broad network on our inter-dealer platform, DealerAxess, continues to increase with over 90 unique traders from 18 firms, executing trades over the platform by the end of the fourth quarter.

Our high-yield product continues to show steady growth with attractive fees per million.

And during the fourth quarter, we expanded our CDS product with the introduction of new single-name list trading.

On the expense front, we continue to deliver on our first quarter 2006 promise of disciplined expense management and the fourth quarter represents the third consecutive quarterly decline in expenses.

Excluding the impact of non-cash FAS 123R stock compensation expense, our core operating expenses were up less than 1% from the fourth quarter of 2005.

Finally, our financial position continues to be a source of strength for our franchise.

Free cash flow generation continues to surpass net income and we ended 2006 with $131 million in cash and securities compared to $118 million on 12/31/05.

As of February 5th, we have repurchased 1.2 million shares at an average price of $12.94.

To date, we have invested $15.2 million in our own shares versus the maximum authorized buyback amount of $40 million.

In summary, the fourth quarter results show an acceleration of growth rates in our business and we are confident that this renewed earnings momentum will carry over into 2007.

It is important to remember that our results were achieved during what is traditionally a seasonally weak quarter for the bond market.

And while overall market volumes reported to TRACE have rebounded somewhat, we are still 20% below the full-year volume levels of 2004.

An increase in credit spreads and credit spread volatility is likely to bring corporate bond volumes back to prior year levels.

Lastly, there are significant economic pressures at work for our customers that are driving increased demand for e-trading solutions in the credit markets.

Slide 4 presents a clear picture of the operating leverage in our business.

Higher market share in our core client business, combined with new revenue from DealerAxess, drove an improvement in our financial performance.

A relatively small increase in revenue of 6%, combined with slightly lower expenses, drove a 109% increase in pretax income and an 87% increase in net income in the second half of '06 versus the first half of the year.

This is a clear example of the benefits of the competitive position we have attained that allows us to grow volume and revenue without increasing expenses in order to deliver high incremental margins to our shareholders.

We are operating in many sectors of a large and growing global credit market and revenue growth can be generated in a variety of ways.

When you consider the entire cash and derivative credit space, today's e-share is still in single digits.

We believe that the biggest growth opportunities for e-credit are still in front of us.

Slide 5 turns to the future and outlines the key factors that are driving increased adoption of electronic trading.

We are witnessing an evolution in e-trading from the dealer community from initial resistance to passive acceptance to more active support.

From our perspective, there are a couple of drivers of increased e-trading.

The first driver is the quality of the price of execution for our investor clients.

Both here in the U.S. and Europe, the focus on getting the best price of execution is intense.

Our multi-dealer platform delivers a highly competitive price to investors and we have rolled out a new suite of products that allow compliance officers to assess their firm's adherence with best execution guidelines.

The second primary driver is efficiency, which is a key motivation for client and dealer usage of the trading platform.

Investment managers are actively looking to reduce trading costs, building demand for e-trading solutions.

We currently partner with five of the most widely used fixed income order management systems, further enhancing efficiency for our investor clients.

Lastly, a key driver of adoption is coming from the dealer side, where margin compression in the traditional client flow business continues.

Dealers can no longer support the cost involved with a traditional sales and operations model for low-margin flow business.

Our shift in the U.S. high-grade fee model last year allows dealers to leverage the MarketAxess trading system without seeing an increase in their direct expenses.

We hope to apply this model to additional products in the near future.

Now that our network of dealers and institutional clients is largely built, it is all about increasing penetration to drive shareholder returns.

Slide 6 shows some interesting observations from a Securities Industry and Financial Markets Association survey of European-based investors released yesterday in London.

This survey included participants from both the dealer and investor communities in Europe.

Importantly, 56% of investors surveyed rated e-trading as somewhat or extremely positive for their sell-side relationships versus just 18% one year ago.

Even more striking, 100% of dealers view e-trading as positive for their client relationships.

Clearly, dealer resistance to e-trading with their customers is on the decline.

With respect to trading models, 91% of investors voiced a preference for the multi-dealer inventory and request-for-quote protocols used by MarketAxess for credit trading versus only 3% for an exchange model.

Dealers expect a 38% increase in the percentage of their business conducted electronically in 2007, with investment-grade credit and CDS representing the highest expected growth rates.

This survey validates our strategy to stay focused on the institutional credit space, as market participants are getting much more comfortable with electronic trading.

Now, I would like to turn the call over to Kelley Millet for an update on our North American business.

Thank you, Rick.

In North America, there are three areas that remain key to our success.

We believe a significant growth opportunity remains in our request-for-quote or RFQ high-grade business, which I will discuss shortly in more detail.

Value proposition of our growing DealerAxess, dealer-to-dealer service launched in June is compelling.

It leverages and extends on many of the attributes of the RFQ platform.

Finally, our CDS single-name list beta launch has been well received by both clients and dealers.

Slide 8 shows the growth opportunity that remains in high-grade RFQ.

As discussed last quarter, a key driver of adoption of credit e-trading is pressure on dealer margin and subsequent decline in profitability of their client flow business.

On this slide, we highlight the key components of the client flow business and their contribution to overall TRACE high-grade volumes.

We define flow business as those trades that are fixed rate and less than $5 million in size.

All fixed rate trades under three years to maturity and all trades floating rate and no TRACE.

The corporate bond flow business as defined represented approximately 57% of NASD TRACE in 2006 by volume and 98% of the tickets.

While we are confident that we continue to dominate e-share in the high-grade corporate market, our share of the overall addressable market is only an estimated 15%.

We have a substantial leadership position in a market that has significant upside.

This is business that we feel very confident and should and will go electronic.

Why?

Let's look at two views.

First for dealers, there is a new sense of urgency in the dealer community to reduce the heavy cost associated with the old model of sales coverage that improve margins.

E-solutions are the best way to do this, without risking their client relationships.

This new drive to reduce cost is reducing dealer resistance to e-trading solutions and this important trend is reflected in the new SIFMA survey Rick mentioned earlier.

For investors, investors are keenly focused on reducing cost of trading as evidenced by their continuing drive to connect to our platform via STP.

Client penetration is discussed in more detail in the next slide.

E-trading is a tool to help investor clients demonstrate best execution for the fully-electronic audit trails.

On slide 9, we have some key metrics showing how we are increasing our penetration into client workflows.

In the upper left-hand corner, our share of NASD high-grade TRACE continues to increase.

With a record estimated 9.5% share in the fourth quarter of 2006.

This represents one of the largest year-over-year quarterly increases in our share of TRACE.

While we did see some contribution from our second full quarter of DealerAxess trading, the bulk of the gain is coming from our client-to-dealer business.

In the upper right-hand corner, we have the high-grade TRACE volume by quarter.

This clearly illustrates how far total market volume has decreased beginning in the fourth quarter of 2004.

Again, while our revenue and estimated share are setting records, overall TRACE volume is still 20% below 2004 level.

Straight-through processing solutions increased the value of our platform to investors and raised barriers to entry for our competitors.

We now have 107 STP connections with clients, up from 92 at the end of the third quarter and 45 at the end of 2005.

Most of these connections are with their top-100 revenue generating clients.

Our strategy to increase penetration with institutional investor clients is paying off with higher market share, growing revenues, and increased platform stickiness as evidenced by the chart at the bottom of this page.

On slide 10, I provided update on our DealerAxess business.

The key components of our differentiated value position are a transaction fee structure that is significantly below the traditional voice brokers.

We leverage our superior desktop presence and existing connections to all of those meaningful credit trading desks.

The increasing focus on compliance means that the audit trails that our system provides are in high demand by dealers.

To grow this business and to increase usage, we are delivering technology enhancements that better replicate electronically the trading protocol in the inter-dealer market.

Enhancements have already been made to our high-grade and emerging market products, both are currently being trading on the system.

We have also introduced the Dealer API for DealerAxess, which will only serve to make our desktop presence even stickier, further strengthening our competitive position.

We will expand the number of products traded and in the first quarter, expect to launch CDS trading and we will introduce high yield soon.

The DealerAxess platform is an anonymous, real-time, cross-matching trading model.

This trading model provides attractive future potential to us, as market demand grows in additional product and client segments.

On slide 11, I provide you with an update on our CDS business.

In terms of single-name lists, the beta of our CDS single-name list product is off to a good start and feedback from clients and dealers has been positive.

Corporate bond list trading is a technology that we pioneered in 2002.

So, the introduction of CDS single-name list trading is a natural extension of our core competence.

Investors and hedge funds are attracted to the ability to trade corporate bonds and CDS on the same trading system.

Critical to growing the product in the U.S. will be the further expansion of the dealer pool.

In terms of the CDS index business, we continue to make enhancements to the product.

I would like in the current state to where we were in 2000 with the launch of our core U.S. high-grade RFQ business where many market participants were slow to adopt the electronic solution at first.

We believe there will be increased appetite for electronic CDS trading by investment managers, who are getting more active in the CDS space.

They are the primary users of our corporate bond product today.

This client expansion will go hand in hand with our current focus on hedge fund trading on our CDS system.

Now, I will turn over the call to Jim for a review of our fourth quarter results.

Thank you, Kelley.

On slide 12, we have outlined our volumes from the 2005 and 2006 fourth quarters.

As Rick mentioned earlier, total trading volume in the fourth quarter of 2006 was a record $92 billion.

There are a number of positive aspects to the fourth quarter volumes.

First, we showed strong year-on-year gains with fourth quarter trading volumes up 33% compared to 2005 fourth quarter.

Secondly, the fourth quarter is typically slower due to seasonal factors.

But, despite this, our volumes were up 10% from 2006 third quarter volumes.

Lastly, the gains were broad-based with volume growth in both the U.S. and European regions.

Slide 13 provides you with the revenue detail.

While the full year revenue for 2006 of $83 million was up only 6% from the $79 million we recorded in 2005, the fourth quarter revenue reflects the strong momentum that we experienced in the second half of the year.

Fourth quarter total revenue was a record $22.1 million, up 17% compared to fourth quarter of 2005.

This record result was primarily driven by a 26% increase in U.S. high-grade commissions, which includes fees from both our client-to-dealer as well our dealer-to-dealer business DealerAxess.

What's particularly compelling for us is that this positive result was achieved in spite of the fact that fourth quarter 2006 NASD high-grade TRACE volumes are still low below the levels we saw in 2004.

The U.S. high-grade fixed distribution fees and DealerAxess monthly minimum fees for the fourth quarter were $9.2 million.

Slide 14 provides you with the expense detail.

Total expenses in the fourth quarter of 2006 were $18.5 million.

When you exclude the incremental non-cash FAS 123R related stock compensation costs, total expenses in the 2006 fourth quarter were up less than 1% when compared to fourth quarter of 2005.

Full year 2006 total expenses, if you exclude the $3.2 million in FAS 123R related stock compensation expenses, increased 7% from full year 2005.

We continue to deliver against our first quarter commitment of expense discipline.

On slide 15, you can see that we are reducing expenses in 2006 at the same time that we continue to enhance our products, including both CDS and DealerAxess.

Total expenses in the fourth quarter were down for the third consecutive quarter.

Headcount as of December 31, 2006 was 176 compared to 182 as of December 31, 2005, a 3% decrease.

A decline of 50% in professional and consulting expenses for the fourth quarter of 2006 when compared to 2005 fourth quarter was primarily driven by a reduction in technology and non-technology consultancy costs.

This also contributed to this positive expense development.

The increase in stock option costs for the 2006 fourth quarter was primarily the result of our success in recruiting new senior hires to the firm.

Let me sum up our expense guidance for 2007.

As you can see from slide 16, we expect the full year 2007 expenses to be in a range of 4% to 8% above the full year 2006 expenses of $74.7 million.

While the high end of the guidance includes estimated expenses for product enhancements and developments, in the near term, we will continue to exercise expense discipline.

Our CapEx expenditures for 2007, which include capitalized software development expenses, will be between $6 million and $9 million.

Please turn now to slide 17 for our earnings performance.

The combination of record fourth quarter revenues as well as expense discipline has driven much improved operating margins, highlighting the operating leverage that we have in our business.

As you can see from this slide, a 17% increase in revenue when compared to fourth quarter of 2005, with expense growth contained to 7%, has driven a 120% increase in pre-tax income.

Operating margin for the fourth quarter increased to 16%, up from 9% in 4Q '05.

We reported diluted earnings per share for the fourth quarter of 2006 of $0.06.

Excluding the impact of the FAS 123R stock compensation costs, diluted earnings per share would have been $0.08 in the fourth quarter of 2006.

Fourth quarter 2005 diluted earnings per share of $0.06 included an adjustment for deferred tax assets, resulting in tax benefit of $500,000.

If you exclude this tax adjustment, earnings per share in the fourth quarter of 2005 would have been $0.03.

The effective tax rate for the fourth quarter of 2006 was 38%.

Our diluted number of shares for the fourth quarter of 2006 was 35.2 million.

On slide 18, we have summary balance sheet data.

Cash, cash equivalents and securities totaled $131 million as of December 31, 2006, up 11% from $118 million at the end of 2005 and representing $3.74 per share on a diluted basis.

We continue to have no debt and total stockholders' equity was $185 million, representing book value on a diluted basis of $5.26 per share.

As we announced on the third quarter call in November, our Board approved a $40 million share buyback program that became effective in December.

As of February 5, we have purchased 1.2 million shares at an average price of $12.94, and at a total cost of $15.2 million.

That leaves $24.8 million remaining in the current authorized program.

Our cash balances give us plenty of flexibility to pursue new initiatives throughout the buyback.

On slide 19, we have highlighted the free cash flow generation for the business.

Free cash flow, defined as net cash provided by operating activities less CapEx, was $10.3 million in 2006, or the equivalent of $0.29 per share, well above our reported earnings per share for 2006 of $0.15.

This represented 1.9 times reported net income for 2006 and highlights the fact that we do not pay cash taxes and adjusts for the non-cash impact of stock compensation costs.

As a reminder, cash flow in the first quarter of 2007 will be impacted by annual employee incentive compensation payments that were made in January.

And with that, let me turn the call back to Rick for some closing comments before the Q&A.

In summary, the results for the fourth quarter are very encouraging and we are optimistic that this momentum will carry us into what is traditionally our strongest quarter for the year in the first quarter.

Our results give you a taste of the inherent operating leverage in the model, where a relatively small 6% increase in revenue in the second half of 2006 can drive a nearly twofold increase in pre-tax income, net income, and EPS over the first half.

We are in the early stages of e-trading in the credit markets and any one of the six sectors where we are currently active represents a large growth opportunity for us.

Positive industry trends continue to move in our favor, as investors increasingly view electronic solutions as additive to their sell-side relationships.

Investors are increasingly focused on best execution, price transparency and reducing their manual costs of trade processing.

And dealer resistance to electronic solutions is waning, as they look to reduce costs related to the old way of doing business.

We will continue to provide meaningful industry leadership to foster these trends for investors and dealers.

With the first-mover advantage in most of our chosen markets, we are well positioned to capture e-share and reinforce the already high barriers to entry that we have built over the past several years.

With that, I would be happy to open up the call for your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Daniel Goldberg with Bear Stearns.

Please proceed.

Yes, good morning.

Hi, Daniel.

Hi.

Can you just talk a little bit about future, I guess, capital management?

I guess by your remarks it appears you have been much more aggressive in the first couple of months of 2007 in terms of -- I calculate about 1 million shares or so bought back so far this year and it appears at a much lower price.

How should we think about the pace of your buybacks and maybe a level buybacks going forward?

Daniel, I think you know the buyback program was authorized by the Board in November, as I said in the prepared remarks, started in December and is ongoing.

As you know, there have been purchases and I gave the number in the prepared remarks.

What I can't do at this point is give any indication of the purchases going forward.

I think, just expanding on that, Daniel, I think it's fair to say that the Board will look each quarter at their view on the value in our current share price and the cash balances to determine whether it's appropriate to continue to purchase shares.

And as you say, we have picked up the pace in the program in the first quarter that's primarily a result of the fact that it started so late in the fourth quarter.

Okay.

And as you continue to buy back the stock, I mean, does that change your appetite for any type of acquisition?

It really does not.

I think we are continually on the lookout for acquisitions that will diversify our sources of revenue and have attractive synergies where we can expand the operating margins.

So, our interest in potential acquisitions is as strong as it ever has been.

Okay.

On the pricing, it looks as if the commission per million traded declined, I guess, in two out of three revenue categories.

Maybe give us a sense what -- some color there and maybe what your outlook is going forward?

Yes, Daniel, as you mentioned, in both U.S. high-grade and in Europe, the average fees per million were down slightly from the third quarter.

In U.S. high-grade, most of this is a function of the fee plan where you have the fixed distribution fees as a spread of a higher volume for the quarter.

The variable fee in U.S. high-grade was very similar to the variable fee that we saw in the third quarter.

In Europe, it was down.

It was down from about 176 in the third quarter to 165 in the fourth quarter, and that was really due to a higher percentage of trading in FRNs and shorter maturity bonds that we saw in Europe.

Okay.

And anything that would change your outlook going forward, I mean, are the trends continuing or should we see these fees numbers maybe reverse themselves?

My personal view, Daniel, is that what we are saying in terms of short maturities is a function of the current environment.

And at some point, that will turn around and we'll start to see more longer-maturity trades traded across the platform.

And with our fee plan, that will increase the fee per million.

Okay.

And then, just lastly, any sense for I guess January volumes?

We haven't yet put out the January volumes.

We should be doing that within the next few days.

So, I can't give any detail.

But, suffice it to say that, I think when you see the volumes, what you'll find is that overall volumes are broadly in line with the fourth quarter.

Thanks.

Great.

[OPERATOR INSTRUCTIONS] Your next question comes from Joshua Carter with Goldman Sachs.

Please proceed.

Hi, thank you.

I wanted to just touch a little bit on the industry volumes and just the environment in general for -- for the products that you are trading on your platform.

What -- the growth rate has been really impressive both on a TRACE level and also obviously for your business given you are taking share for U.S. high-grades over the last six months, five months, although the trend has declined for several months, several years.

What do you think is driving this right now and how should we think about it going forward and even if you were to try to make some sort of estimates for -- more of a secular growth rate over the next five years, how would you encourage us to think about it?

Couple of things on that, Josh.

I think if you look at the last four or five months of 2006, one of the drivers was clearly a very active new issue calendar.

And I think that that typically, all else equal, will drive greater secondary volumes, partly reflected in TRACE.

I think broadly speaking, there are other trends in the credit market that are very positive for corporate bond trading volumes.

Transparency has clearly increased, which typically increases market activity and participation.

Transaction fees are coming down through efficiency in electronic trading platforms.

As a result, over time, we continue to believe that trading turnover and velocity will increase in corporate bonds.

The last point is we believe that the rapid increase in the credit derivative trading volumes will ultimately prove to be positive for corporate bond trading as well as, as the market is now more complete and efficient and the CDS market has brought in additional sources of capital into the credit trading markets.

So, our medium to longer term view continues to be very constructive on credit trading volumes in general and corporate bond trading volumes specifically.

That's great.

And then specifically on your market share, I mean clearly there is a big addressable opportunity for you and the slide was very helpful to that point in the presentation.

How would you -- how would you guide us to think about market share increases?

I mean, clearly, the trend has been very positive in the U.S. business.

Would you expect this to be gradual over the next few years or do you think there will be a waterfall effect, and at some point when it sort of turns, I mean, how should we think about it as we are trying to model the business out by years?

Josh, certainly, there is a lot of discussion around tipping points in the adoption of e-trading.

I think over the next quarters and perhaps over the next year or so, we will look for more of the same in terms of continued adoption rate that we have seen.

Keep in mind that month to month, those share numbers can vary based on a number of different factors.

I think also the kind of dealer pressures and the compliance issues that the buyside are currently facing, I think are going to do nothing but accelerate.

If you look at our European business for example, I was in London on a conference yesterday, the emergence of [method] in terms of a compliance issue with the buy side in London, we think also could be a positive impact in the growth of that business as well as share.

Thanks.

And then final question just on the competitive environment for CDS.

Clearly, the brokers, both the inter-dealer brokers and I guess the dealers have made some or increased their investments or made new investments in the Clearing Corp in Chicago and there is a lot of talk about that being specifically at least initially targeted at CDS.

The exchanges as well are trying to be more aggressive in rolling out products or trying to roll out products in the CDS as well.

Just give us sort of an update on your perspective of CDS and more specifically with regards to what's happening with the Clearing Corp and that would be very helpful.

Thanks.

We, as you know, Josh, we continue to stay primarily focused on the transaction and our core belief is that more efficiency at the back-end of the CDS business will serve as a catalyst for more electronic trading at the front-end.

So, we are very open to new processing and clearing solutions that are developing in the market and have proven successfully that we can connect to any clearing entities that our clients choose.

Our core competence continues to be at the front-end in the electronic trade itself and we do believe we have natural advantages there for CDS.

As our institutional customer-to-dealer network is already built, and we have the leading position in corporate bonds and ultimately the marketplace is looking for a unified solution where corporate bonds and CDS can trade on the same platform.

So, we -- we see great upside there and we are encouraged by the feedback that we are getting from both investors and dealers.

Josh, I think the other point of your question was the exchange or exchange type model versus the RFQ model -- certainly in cash, as you are aware, there's limited liquidity.

It's somewhat fragmented across the marketplace.

Clearly, there is incremental liquidity in CDS especially in single names, but again, that's relatively narrow in terms of continuous liquidity.

And finally, as we saw the SIFMA survey, the overwhelming view of the buy side is that RFQ will remain at least in the short-term the preferred means of e-trading.

So, although we monitor obviously the impact of exchanges in all elements of the business, it will be an evolving business and we continue to believe that the RFQ model will have a significant part in that.

Thanks very much.

At this time, there are no further questions.

I would now like to turn the call over to Mr. Rick McVey for closing remarks.

Thank you very much for joining us this morning and we look forward to talking to you next quarter.

Ladies and gentlemen, this concludes the presentation.

You may now disconnect and have a great day.