Marketaxess Holdings Inc (MKTX) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the MarketAxess First Quarter 2007 Earnings Conference Call

(OPERATOR INSTRUCTIONS)

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

Please go ahead, sir.

Good morning and welcome to the MarketAxess First Quarter 2007 Conference Call.

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

Kelly Millet, President of MarketAxess, 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.

We will then go back to Rick for closing comments before the Q&A session.

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

These statements represent the company's belief 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 risk 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, 2006.

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 website.

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

Rick?

Good morning and thank you for joining us.

We are very pleased with our results for the first quarter of 2007 and the clear revenue and earnings momentum we have generated over the last three quarters.

For the first quarter of 2007, MarketAxess reported net income of $2.5 million or $0.07 per share on record revenues of $23.8 million.

This compares to $0.03 per share on $20.3 million in revenue in the prior year period.

Our pre-tax margin expanded to 19%, an increase of 12 percentage points above the prior year period, reflecting the strong operating leverage in our business.

These results were driven by commission generation in our core high-grade corporate bond business.

We achieved record U.S.

high-grade volume of $61 billion, up 32% over the prior year period, driven primarily by year-on-year market share gains and further bolstered by an 8% increase in overall trace volumes.

For the month of March, we achieved a record 11% share of trace and preliminary estimates for April show U.S.

high-grade market share at similar levels.

European high-grade volumes were up 18% over the prior year period and also reached a new quarterly record, helping to drive record overall trading volume of $104 billion, up 24% over the prior year period.

On the expense front, first quarter 2007 expenses were up 1.9% compared to the first quarter of 2006.

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

We ended the first quarter with $113 million in cash and securities compared to $131 million on 12/31/06.

The decline in cash on hand reflects our stock repurchases during the quarter and the payment of annual cash bonuses to employees in January.

During the first quarter, we repurchased $18.5 million in stock and paid out accrued employee compensation of approximately $11 million.

In summary, the first quarter results showed continued revenue momentum, disciplined expense management, and accelerating earnings.

Slide Four more clearly shows the earnings momentum we have experienced over the past three quarters.

Since the first half of 2006, we have experienced three consecutive quarters of revenue, pre-tax income, and net income growth, with pre-tax margins expanding consecutively to 19% in the first quarter of '07, up from 7% in the first quarter of 2006.

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

Looking at the first quarter versus one year ago, a revenue increase of 17% combined with slightly higher expenses drove a 219% increase in pre-tax income and a 126% increase in net income.

For every $1 in incremental revenue, $0.90 fell directly to pre-tax operating income.

On Slide Six, we provide an update on some of the market factors that drive trading activity in the corporate bond market.

As I have indicated on previous calls, corporate bond trading volumes have been depressed due to the benign credit environment over the last several years.

We did however see some modest improvement during the first quarter.

The upper left-hand corner shows that liquid high-grade credit spreads continue to trade at levels very close to historical lows.

The upper-right corner shows the volatility of the Credit Suisse liquid U.S.

corporate index credit spreads.

And as you can see, credit spread volatility is running well below long-term averages.

Even a very modest increase in credit spread volatility in Q1 drove an improvement in corporate bond trading volumes.

In the lower left-hand corner, the inversion of the yield curve beginning in 2006 has caused many investment managers to concentrate more of their trading at the short end of the yield curve.

Due to the structure of our fee model, these shorter maturity trades have caused a reduction in our average transaction fees per million.

Lastly, in the lower right-hand corner, high-grade new issue volumes continue to be robust.

Overall we did see a slight improvement in trading conditions during Q1, leading to an 8% increase in high-grade trace volumes and we continue to believe that a further increase in credit spread volatility would benefit overall volumes.

On Slide seven, we show the growth we have experienced in our estimated share of the U.S.

high-grade market.

On the left side, we highlight consistent growth in our estimated market share of NASD high-grade trace volume with an all-time monthly record of 11% in March.

It is worth noting that we believe that one of the factors driving U.S.

high-grade market share higher is our innovative transaction feed plan introduced in June 2005.

We hope to follow this success in the U.S.

with a similar change to our fee model in Europe in the near term.

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

We define low margin flow margin within trace 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 floating rate note trades.

The corporate bond flow business, as defined, represented approximately 54% of NASD trades in the first quarter of '07.

On MarketAxess, 90% of our Q1 volume came from flow trades and 10% from fixed rate block trades.

We expect that the majority of our share will continue to come from moving low-margin flow business away from the phone and onto the MarketAxess system.

For your reference, the pure retail business is generally conducted in trade sizes below $250,000, which in the aggregate represents about 3% of NASD trace volume and even some of that volume represents odd-lot trades from institutions that we serve.

While we are confident that we continue to dominate e-share in the institutional high-grade corporate bond market, our share of the $350 billion quarterly addressable flow business is only an estimated 15%.

We expect the electronic trading share of the credit business to grow in the years ahead.

With that, I'll turn it over to Kelly Millet for an overview of our North American business.

Thank you Rick.

In North America, there are several areas that we are focusing on to drive increased revenues for MarketAxess.

First, we continue to build share and momentum in our U.S.

high-grade business.

Second, we continue to diversify our client-dealer cash business with other products, especially high yield and emerging markets.

Lastly, we are focusing on monetizing our existing technology infrastructure and fixed income expertise through a new technology services business.

We are currently engaged in an important technology assignment for a key customer.

On Slide nine, we updated the metrics we introduced last quarter, that show how we continue to increase our penetration into client workflows.

In the upper left-hand corner, we recorded a third straight quarter of estimated share of NASD high-grade trades above 9%.

In the lower left-hand corner, we have the trade volumes for high grade by quarter.

We are now in the third straight quarter of positive year-on-year quarterly trace volumes.

But overall trace volume is still 17% below 2004 first quarter levels.

Our strategy, to increase penetration with institutional investor clients, is paying off, as evidenced by the charts on the right-hand side of the page.

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

The number of trades initiated by client order management systems and the number of trades involved trade and post-trade messaging continues to grow.

We currently have 113 straight-through processing connections with our investor clients.

On Slide 10, we show we are also achieving deeper client product penetration in newer and higher margin markets.

On the left-hand side, we show the impressive year-over-year growth in high-yield inquiry and trade count, reflecting the significant increase in activity in high-yield on our platform.

On the right-hand side, we have an estimate of the high-yield market that we believe can realistically migrate to our platform over time.

This includes those trades of $1 million or less in size and whose dollar price is above 80 and all Ford and GM auto trades.

We believe that the addressable market is 20% of the $322 billion in quarterly high-yield trace volume.

Our estimate of our current share of this addressable market is under 5%, leaving us substantial upside.

There is a significant percentage of cross-over trades greater than $1 million in size in the $256 billion referenced above that could also potentially migrate to our platform.

The variable fees per million in the high-yield business are nearly three times of those in the U.S.

high grade and as clients increase system utilization, we would expect the percentage of pure high-yield, defined as those securities rated BA1, BB+ or below, to increase.

This will have a positive impact on average fees per million.

Slide 11 outlines the key factors that will drive the adoption of CDS to electronic trading.

It is fair to say that the dealer support for electronic trading and the over-the-counter derivatives market is in very early stages.

This despite the tremendous increase in trading velocity, tightening of bid offer spreads and the ballooning of processing costs.

There are similarities between the current conditions in the CDS market and where the corporate bond market was in 2002.

We have experience in helping transformed, market practices in a way that improves efficiency and drives down costs.

In CDS, we are focused on delivering what the market wants in order to improve adoption.

First, increased speed of execution.

The continued enhancement of our indexed product is showing some results.

In Europe, ITRAX ticket count was up 79% and 84% respectively and in February and March of this year, sequentially.

Second, increased efficiency.

The launch of our single [name]list product in January is leveraging key relationships and connectivity.

Our leadership in corporate bond list trading since 2002 gives us unique abilities to drive efficiency higher.

And third, drive down processing costs.

We are working with dealers and other parties to point our post-trade messages where they best reduce costs, which we are told run ten times higher for CDS trades versus a corporate bond trade.

On Slide 12, I wanted to provide you with an update on our DealerAxess business.

In June of 2006, we launched our DealerAxess business with the support of our dealers.

As part of this effort, a group of dealers agreed to pay monthly minimums, the majority of which will expire at the end of the second quarter.

With the DealerAxess technology build out near completion with our 5.8 release in August, we are now focusing on the longer term distance development of the platform through the generation of variable commission revenues.

The key components of our differentiated value position are, a fee structure that is significantly below the traditional voice brokers, our superior desktop presence and existing connections to all the most meaningful credit trading desks and finally an audit trail that DealerAxess provides that meets the growing demands for compliance solutions at our dealer customers.

With that, let me turn it over to Jim for a review of the financial results.

Thank you, Kelly.

On Slide 13, we've outlined our volumes from the 2006 and 2007 first quarters.

The first quarter of 2007 was another record quarter for trading volumes, with our total quarterly volumes surpassing $100 billion for the first time.

Total trading volume of $104 billion was up 24% over the first quarter of 2006, with record volumes in each of the three categories that we report.

Our U.S.

high-grade volumes were up 32% when compared to the prior year quarter with the market share gains that we recorded in the second half of 2006 carrying over into the first quarter of 2007.

European high-grade volumes were up 18% on the first quarter of 2006, benefiting from both higher local currency trading volumes, as well as the strength of the European currencies.

Slide 14 provides you with the revenue detail.

Our strong first quarter trading volumes translated into another record quarter for commission revenue.

Total revenue of $23.8 million was up 17% compared to the first quarter of 2006.

This record result was primarily driven by a 24% increase in U.S.

high-grade commissions, which include fees from both our client and dealer as well as our dealer to dealer business, DealerAxess.

The fixed U.S.

high-grade distribution fees for the quarter were $7.7 million, up from $7.2 million in the first quarter of 2006.

The monthly minimum fees from DealerAxess were $1.5 million during the quarter.

As Kelly indicated earlier, the majority of the DealerAxess minimum fee commitments expire at the end of the second quarter.

So our focus is shifting as we move past the initial implementation phase of this product, away from monthly minimums and towards variable commission generation that's more sustainable on a long-term basis.

The U.S.

high-grade variable transaction fees, excluding single dealer increase on which we currently charge no commissions, were $80 per million in the first quarter of 2007 compared to $95 per million in the first quarter of 2006.

The European high-grade transaction fees were $168 per million in the first quarter of 2007 compared to $181 in the first quarter of 2006.

Our fees per million are impacted by the mix of business traded on our platform and in the market overall.

In both the U.S.

and Europe, we have seen an increase in the mix of floating rate versus fixed rate business over the platform.

And we earn lower fees per million on floating rate note trades.

We've not made any changes to our fee plans during this period.

As and when market conditions result in more fund managers moving out along the yield curve, we would expect the mix of bonds traded on the platform to migrate back to longer maturities and accordingly higher fees per million for us.

Slide 15 provides you with the expense detail.

Total expenses in the first quarter of 2007 were $19.3 million, an increase of $350,000 or 1.9% compared to the first quarter of 2006.

Employee compensation and benefits increased 12% to $11.5 million.

The most significant factor impacting this, this increase, was a higher bonus accrual for our employees based on the improved earnings.

Employee compensation and benefits as a percentage of revenue decreased from 51% in the first quarter of 2006 to 48% in the first quarter of 2007.

The increase in employee compensation and benefits was partially offset by a 28% decrease in professional and consulting expenses as a result of reduced audit, tax, and consulting costs.

On Slide 16, we are reiterating our full year 2007 expense guidance of an increase of 4% to 8% over full year 2006 expenses.

We are very comfortable with a 4% to 8% range based on the first quarter 2007 expenses of $19.3 million.

As a reminder, we have significant non-cash expenses, including depreciation and amortization and stock compensation costs.

Furthermore, we're not cash taxpayers.

For the full year 2006, free cash flow generation was 1.9 times 2006 reported net income and we would expect the ratio of free cash flow to reported net income for 2007 to be at a similar level.

Our CapEx for the first quarter of 2007 was $1.2 million and we now expect to be at the lower end of the CapEx guidance range for the full year of $6 million to $9 million.

Please turn to slide 17 for our earnings performance.

As you can see from this slide, a 17% increase in revenue, when compared to the first quarter of 2006, with expense growth contained to 2%, has driven a 219% increase in pre-tax income and a 126% increase in net income.

Operating margin for the quarter increased 12 percentage points to 19%, up from 7% in Q1 '06.

We reported diluted earnings per share for the first quarter of 2007 of $0.07.

The effective tax rate for the first quarter of 2007 was 45% compared to 22% in the first quarter of 2006.

In the first quarter of 2006, our tax provision benefited from an adjustment to deferred tax liability of $200,000.

In the first quarter of 2007, the tax provision was adversely impacted by a $230,000 adjustment to the deferred tax asset as a result of a change in our anticipated income tax rate, applicable to the use of our net operating losses in future periods.

Excluding the impact of this $230,000 adjustment in Q1 '07, our diluted earnings per share would have been $0.08.

The diluted number of shares for the first quarter of 2007 was 34.5 million, down 3% from 35.7 million in Q1 '06, reflecting the positive impact of the share repurchase program.

On slide 19 -- sorry, on Slide 18, we have summary balance sheet data.

Let me first provide an update though on the $40 million stock repurchase program that our Board approved in November.

During the first quarter, we repurchased 1.4 million shares at a total cost of $18.5 million.

As of today, we have purchased a total of 1.7 million shares at a total cost of $23 million.

That leaves $17 million remaining in the current program.

We have been very pleased to see that at the same time that we've been buying back shares, the liquidity in our stock has increased.

In the six months prior to the start of the buy-back program in December, the average daily volume in our stock was 175,000 shares.

Since the start of the buy-back program, the average daily volume has increased 39% to 244,000 shares.

As you can see from this slide, our cash, cash equivalents, and securities totaled $113 million or $3.26 per share as of March 31, 2007, down 14% from $131 million at the end of 2006, but still above the $112 million recorded at the end of the first quarter of 2006.

We continue to have no debt.

Annual employee bonuses accrued during 2006 totaling $11 million were paid out in January 2007.

The fact that our cash balances are above 1Q '06 levels after $23 million in stock repurchases again highlights our underlying strong free cash flow generation.

Total stockholders' equity was $179 million as of March 31st, representing book value on a diluted basis of $5.18 per share.

Now I'd like to turn the call back to Rick for closing comments before the Q&A.

Thank you, Jim.

In sum, we have started the year off with a very strong quarter.

Building on the revenue, market share and earnings momentum we built in the second half of 2006.

Our competitive position in corporate bond trading continues to get stronger with plenty of growth potential ahead.

We have meaningful revenue opportunities in new markets as well as ancillary services such as data and technology solutions.

We believe we continue to deliver attractive revenue growth with disciplined expenses, driving superior earnings growth rates.

It is an exciting time to be in the middle of the electronic fixed income market and we see plenty of opportunity ahead.

Now I would like to open the call up to your questions.

(OPERATOR INSTRUCTIONS) And your first question is from the line of Joshua Carter with Goldman Sachs.

Please proceed, sir.

Hi.

Thanks for taking the question.

I wanted to just ask a little more of a follow-up on the IP and technology outsourcing that Kelly mentioned.

Could you just give us a little more color on that and what the magnitude might be and what future opportunities are?

Certainly, Josh.

I think one thing to remember is that at our core, we are a technology company and that technology we rely on in terms of delivering value to our customers.

And I genuinely believe we have an outstanding technology and technologists.

And if you look at the investment that we've made, given the scale of this company, it has been significant, I think as you know, over the past five years.

As we've listened to our customers, we've heard and seen their needs for what we do.

For what we do day to day and for what we rely on, in a sense, through the experienced expertise that we possess at our core.

So we are excited about this opportunity, but we are going to be very, very selective in terms of the engagements that we pursue and take on.

So as -- I think that's probably as much detail or granularity that we could probably share at this point.

Okay.

Thanks.

Moving to another topic, on CDS, I mean it clearly continues to a huge opportunity for whichever players can increase their involvement there.

I mean the inter-dealer brokers are making every effort they can to get electronic training on their platform.

But can you just comment a little bit on how that continued battle evolves from your perspective and what your differentiated aspects are of your platform relative to a credit match at TFI for example or a [Credit X] platform?

And specifically your question is within the inter-dealer market or client-to-dealer market?

Within the inter-dealer market maybe first and then secondly client-to-dealer would be great.

Within the inter-dealer market, as I spoke, we think our value proposition that can differentiate us from the competitive landscape is first and foremost a very, very aggressive commission schedule.

I think as many people know, the size of dealer brokerage costs at a minimum are in the tens of millions of dollars.

And I might also estimate, given my Street experience, that in some of the larger broker dealers, it could be in excess of $100 billion across cash and CDS.

So I think given our lower marginal costs and the ability to provide potential caps to our dealer customers, we think our model, which is essential E, without that same voice component and the inherent complexities of that, is advantageous.

We also think our long standing dealer relationships, giving our clients the dealer business, helps us as well as the desktop space and the connectivity that we have with those dealers.

In the client-to-dealer business, as I said earlier, it's in early stages.

We do believe that we have seen a similar set of issues in the cash market and we have the experience and the technology and the connectivity to help transform that market.

Yet I acknowledge the fact that it is a competitive landscape.

We do believe that the focus on both the index of technology in terms of speed and ease of execution and delivering a robust technology within the single named CDS list product is in fact the right strategy.

Great.

Thanks.

And then maybe just a final question on the competitive landscape within the cash products.

If you could just give us an update there on how you see that evolving, what's the state of play right now relative to Thompson Trade whatever, relative to New York's continued efforts, understanding they're coming from a different footprint and a different legacy.

But just an update there would be helpful.

Thanks.

Sure, thanks Josh.

I think in the institutional markets, our accelerating market share gains would reflect a strengthening of our competitive position, so based on feedback that we consistently get from our dealer and investor clients.

We believe that our e-share of the corporate bond client-dealer business has never been higher.

So we feel quite good about the gains that we've been able to achieve there.

As you and many others know, the New York Stock Exchange relaunched corporate bond trading at the beginning of last week.

It's important to remember, with the New York Stock Exchange, that this is new technology, not a new concept.

The New York Stock Exchange has had an electronic corporate bond market for about 30 years and many others tried to take the corporate bond market into an exchange environment five or six or seven years ago.

And we continue to believe that those efforts will be hampered by the extreme fragmentation of the corporate bond market where very few corporate bond securities trade on a continuous basis as a result of a model that has worked best for institutions, which is a competitive request for a "multi-dealer" model, where dealers can respond to their order flow rather than being expected to make continuous markets in thousands of securities.

And based on the early results that we have seen from the New York Stock Exchange, the pattern is similar to their results prior to the technology switch a week ago in that they continue to focus and serve primarily retail sized trades.

It looks like the trading activity has been approximately one trade per hour at an average size of about $30,000.

And the stock exchange has said in fact that their primary focus today is the retail market.

So we currently do not see that overlapping with what we do and we believe that we do have the right trading protocol for the institutional corporate bond market, which in the end is driving our market share higher.

Great.

Thank you.

And your next question is from the line of Howard Chen with Credit Suisse.

Please proceed sir.

Hi, this is [Adam] on for Howard.

First question, with respect to market share, things obviously seem to be trending in the right direction.

You had a record March and then you noted that you're seeing continued traction into April.

Do you see any barriers to this going higher in the near term?

Or asked another way, with respect to the domestic high-grade market, how much of that do you think is addressable given the offerings you have in place right now?

I think that we're very pleased with the market share gains and you're right to point out that March and April have taken us to a new plateau.

And I really believe that given the economic factors at work in the corporate bond market today and the quality of our technology and our fee model, there is significant potential ahead for the electronic share on MarketAxess to grow.

And when we talk with our dealer and investor customers, the flow business that we described earlier is very time consuming, it involves a heavily manual process and there is increasing support on both the buy side and the sell side to take that business electronic on the MarketAxess platform.

And if you use that flow business category within trace as a guide, as we pointed out earlier, it's about 54% of total corporate bond high-grade market volume.

So we see the e-share in this market going significantly higher because of the benefits that it provides to dealers in terms of reducing their costs and the benefits that it provides to investors in terms of getting a very competitive price of execution, better efficiency and clearer audit trails to demonstrate best execution.

Great.

Thanks.

And then, one follow-up.

I believe last quarter you noted that with the DealerAxess platform you had 90 traders at 18 firms currently active.

I was wondering if you could provide us just an update on where that stands now?

I think the question was that in the last quarter we discussed the fact that there were approximately 90 traders that were active on the platform.

That number has increased, over 100.

And I think overall we are pleased with the -- with dealer engagement and again in terms of the value proposition that I laid out, both in cash and in CDS, coupled with our recent 5.7 technology release.

We believe we're on the right track and feel good about our strategy going forward.

Great.

Thank you.

And your next question is from the line of [Fred Thompson] with FW Thompson.

Please proceed, sir.

Yes, sir.

I would like to know how you could explain the headcount drop from 189 to 171?

And secondly, could you give me the net position of shares outstanding after buy-back, plus the issuance of options to present shareholders -- or present employees?

Let me address the headcount issue.

At the end of each year, we evaluate both the quality of performance as well as the mix of employees, i.e.

senior and junior.

And we did so again at the end of this year.

And we will continue to do so going forward.

Clearly I think that reflects the operating leverage as well as the relative low marginal cost to generate each dollar of incremental revenue.

There was no across-the-board or no defined headcount reduction plan.

But rather, a real assessment of both the quality as well as the mix of staff, especially in North America.

Thank you.

I'd just add to that too, remember that we can improve productivity both through additional activities out of the existing base as well as what we're able to do selectively with outsourcing.

So we do believe that we're right sized today for the existing businesses that we're in and each quarter we're making tangible steps to increase the productivity of the workforce.

And Jim, do you want to handle the question on the share count?

Yes, the diluted share count for the first quarter was 34.5 million and that includes the net impact both of restricted stock and stock option issuances that we made during the quarter to employees.

And typically what we do is at the beginning of the year, we make the annual awards to employees as well as the impact of the share repurchase program.

So that 34.5 million number reflects both of those.

Where would it have been a year ago?

A year ago, it was higher by just over 1 million shares.

It was 35.7 a year ago.

Thank you.

(OPERATOR INSTRUCTIONS) And at this time, I'd like to turn the call back over to Rick McVey.

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

Thank you for attending today's conference.

This concludes the presentation and you may now disconnect.

Have a great day.