Marketaxess Holdings Inc (MKTX) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Thank you for standing by, and welcome to the MarketAxess second quarter 2009 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 Tuesday, July 28th, 2009.

I would now like to turn the call over to Trey Gregory, Head of Marketing and Communications at MarketAxess.

Please go ahead, sir.

Good morning, and welcome to the MarketAxess second quarter 2009 conference call.

For the call, Rick McVey, Chairman and Chief Executive Officer, will review the highlights of the quarter.

Kelley Millet, President, will provide an update on trends in our businesses, and then Jim Rucker, Chief Financial Officer, will review the financial results.

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 belief regarding future events that, by their nature, are uncertain.

The Company's actual results and financial conditions 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 the risk factors in our annual report, Form 10-K for the year December 31st, 2008 (sic).

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

Now let me turn the call over to Rick.

Good morning, and thank you for joining us to discuss our second quarter 2009 results.

Second quarter earnings per share were $0.08 on record revenues of $25.8 million, driven primarily by an increase in variable transaction fees.

Variable transaction fees are the main driver of our growth story and are up 32% versus the second quarter of '08, reflecting significantly higher fee capture across all three transaction categories.

Expenses were down 4%, reflecting continued expense discipline.

The combination of higher revenues and lower expenses led to an increase in our pretax operating margin to 22%, up from 19% a year ago.

We saw clear signs of improvement in the credit markets during the quarter, with credit spreads continuing to narrow.

Trace US high-grade market volumes for the quarter were up 41% versus the second quarter of '08.

Engagement on the platform remains strong, with investor inquiry count up 48% from year-ago levels, and the number of investors trading on the system up across all product categories.

Importantly, we now have 60 unique dealers making markets versus 31 one year ago.

Also of note during the quarter, we received a second US patent for our Electronic Request for Quote Method and System for client to multi-dealer trading of debt securities on a secondary market.

This patent follows closely on the heels of our recent patent covering electronic bid and offer lists for fixed-income instruments.

Key metrics on financial health remained strong.

EBITDA for the quarter of $7.4 million was up 13% from $6.6 million last year and our cash balance at quarter end was $145 million or $3.83 per diluted share.

We are beginning to see real benefits from the increase in the number of dealer-clients, the addition of hybrid voice execution services and the introduction of our open order book, MarkitLists.

I believe we are well positioned to benefit from improving market conditions with our broader and deeper trading network.

As you can see on Slide 4, market conditions in the second quarter showed clear signs of stabilizing.

High-grade credit spreads, as measured by the Credit Suisse LUCI Index, fell by more than 275 basis points from their highs in December of last year.

And credit spread volatility, while still elevated, declined during the quarter.

A key factor behind the improvements in overall credit market conditions has been the significant inflow of funds to the sector.

Taxable bond mutual funds and corporate bond exchange-traded funds saw inflows of approximately $78 billion during the quarter.

Quite surprisingly, the demand for credit has led to a shortage of available credit product, something no one would have predicted six months ago.

Another positive sign of normalization is the dramatic reduction in the financial industry's reliance on government-guaranteed debt.

During the second quarter, financial companies issued 65% of their corporate debt without government guarantees.

On Slide 5, you can see that although credit market conditions have significantly improved, liquidity has remained challenging due to the reduced balance sheets of primary dealers.

On the MarketAxess platform, investor order count is up 48% from year-ago levels.

However, as you can see on the right-hand chart, the ratio of bids requested versus offers has been unbalanced in recent periods.

Most recently, the majority of investors have been looking to buy corporate bonds.

With dealer balance sheets and secondary inventories down approximately 65% from pre-crisis levels, investors are having a difficult time executing secondary trades through traditional means.

As a result, we saw a reduction in the percentage of investors' inquiries, resulting in trades on the platform, which put pressure on hit rates and our estimated market share.

To address these issues, we have added new functionality and expanded the sources of liquidity available to investors.

While we are still in early stages, the new dealers on the platform are starting to make a more meaningful liquidity contribution to the system, improving the investor experience.

We were encouraged to see a pickup in estimated market share and volumes in June, our best volume month since July of 2007.

Current estimates for July show a continuation of that trend, with the market share slightly above June levels.

Now, let me turn it over to Kelley to discuss our business in more detail.

Thank you, Rick.

Although liquidity in the market remained difficult, Slide 6 shows that our overall trading business performance continued to improve.

As measured by inquiry count, our overall client engagement on the platform reached record levels, with over 200,000 trade inquiries submitted during the second quarter of 2009.

Responding to this record order flow, and an increasing number of new dealers, in the second quarter of this year, the new dealers that we have added since the beginning of 2008 accounted for 13% of all US high-grade and high-yield trades by counts.

We are encouraged by the performance of the new dealers and are focused on this higher margin business.

Our fee capture per million was 38% above year-ago levels.

Three factors have helped to maintain our fee capture at elevated levels in the second quarter of 2009.

First is the activity on the execution services hybrid trading desk, which helps clients find matching orders for trades that did not execute over the electronic system.

Second, our volume conducted by the regional dealers increased substantially, and third, our high-yield end crossover business grew rapidly.

As Rick mentioned, we were very encouraged to see that total variable transaction fees grew 32% from the second quarter of last year and represented over half of our total commission revenue.

Slide 7 illustrates how we have successfully expanded and deepened our trading network.

The number of investor clients who executed at least one trade in the second quarter increased across all of our major product categories versus one year ago.

As you would expect, the highest growth came in newer products, namely high yield.

As our investor network has expanded, so has our direct connectivity.

As of June 30, 2009, we are connected to 200 investor firms order management systems, an increase that were submitted through clients' OMS, grew to over one-third of total trades executed in the second quarter of 2009.

We have also continued to add new dealers to the platform, with 13 dealers joining in the second quarter, bringing the total to 54 in the US and 19 in Europe.

We expect to add dealers in the US and in Europe in the second half of 2009.

In Europe, these new dealers will expand our rates business, improve our non-core currency trading and deepen our regional dealer performance.

On Slide 8, we provide an update on Euro bond trading, other trading, Technology Services and CDS.

Our Euro bond commissions were up 16% in local currency from the second quarter of 2008, although commissions in dollar terms were down 8% due to the exchange rate.

Nevertheless, European trading has rebounded strongly off the lows seen in 2008, reaching their highest level since the third quarter of 2007.

Investor inquiry count has risen by 84% versus the second quarter of last year and transaction fees per million increased 20%.

In the Other category, commission increased 34% year-over-year as a result of slightly higher volume and a significant increase in the fee capture.

High-yield trading volume increased 120% and was a key factor in the increase in fee capture.

The environment for Tech Services remained difficult, as revenue was down 22% from the second quarter of 2008.

However, it appears that market conditions and IT budgets have stabilized and the Technology Services sales pipeline remains strong.

Let me now take the opportunity to provide a few thoughts on the CDS.

Regulators in the US and Europe are calling for increased transparency and electronic trading [new] credit derivatives.

Exchanges now have central clearing facilities in place for CDS in the US and Europe.

We have deployed three main trading protocols for CDS to be positioned for the inevitable move toward greater electronic trading.

The first is our client to multi-dealer RFQ platform, best suited for indices and single-name CDS.

The second is our patented bid offer list technology, which is a highly efficient way to execute lists of single names.

Finally, we have a live cross-matching engine for CDS that was originally developed [under] dealer trading, but could have broader applications in some scenarios.

Our expertise and existing end-to-end CDS e-trading solution position us well to contribute to a more efficient, liquid and sound credit market.

Now, let me turn the call over to Jim to discuss our financial results.

Thank you, Kelley.

Please turn to Slide 9 for our earnings performance.

Our record revenue of $25.8 million was up 1% from a year ago and 5% from the first quarter.

Compared to a year ago, we saw an 8% increase in commission revenue that was partially offset by lower Technology Services revenue and reduced investment income as a result of lower yields on our investment portfolio.

We have continued to carefully manage expenses that were down 4% from a year ago.

The decline in the value of the UK pound compared to the US dollar since the second quarter of 2008 had the effect of reducing revenues and expenses of our European operations by $1.3 million and $800,000 respectively.

Pretax income was $5.7 million, an increase of 21% compared to the second quarter of 2008.

Operating margin increased to 22%.

Our effective tax rate for the quarter was 44%.

The tax rate reflects an increase in the projected tax rate on foreign source income.

We anticipate that our effective tax rate for the full year will be between 42% and 44%.

The diluted share count increased by approximately 3 million shares compared to the second quarter of 2008, primarily as a result of the issuance of preferred stock in June of 2008.

Diluted earnings per share of $0.08 were in line with both the prior quarter and the prior year quarter.

On Slide 10, we've laid out our commission revenue, trading volume and fees per million.

The increase in commission revenue compared to the second quarter of 2008 was driven by a 32% increase in the variable transaction fees.

Although transaction volumes were down slightly, fee capture was up significantly.

Distribution fees were down 9% as a result of the exchange rate impacts on our European distribution fees and the consolidations over the past year in the dealer community.

We currently expect total distribution fees for third quarter to be approximately 300,000 below Q2 levels.

Slide 11 provides you with the expense detail.

Total expenses were down 4% compared to the second quarter of 2008.

The primary drivers of the reduced expenses were a decrease in legal expenses and technology consulting costs, but are both reflected in the professional and consulting line.

Employee headcount as of the end of the quarter of 200 was the same as the year-ago.

We now expect our 2009 full-year expenses to be between 79.5 million and $82.5 million.

On Slide 12, we highlight the strength of our balance sheet.

Cash, cash equivalents and securities as of June 30th were $145 million or $3.83 per share on a diluted basis, compared to 143 million at year-end 2008 and 118 million at the end of the second quarter of 2008.

Total stockholders' equity, including the Series B preferred stock as of June 30th, was $235 million, representing book value on a diluted basis of $6.21.

We continue to have no bank debt.

Now, let me turn the call back to Rick for some closing comments.

Thank you, Jim.

In conclusion, credit market conditions are beginning to normalize and the outlook for the second half of the year remains positive.

Transaction fee revenues are growing again due to the addition of new dealers on the system and momentum in new product areas.

Our business is more diversified than ever before.

The key to earnings momentum remains revenue growth due to the operating leverage in our business model.

We are pleased to see so many signs that institutional credit markets and MarketAxess are once again on a growth trajectory.

Now, I would be happy to open the line for your questions.

(Operator Instructions).

And the first question comes from the line of Howard Chen from Credit Suisse.

Please proceed.

Good morning, everyone.

Good morning, Howard.

Good morning, Howard.

Good morning, Howard.

Kelley, you alluded to this in your prepared remarks, but the language during -- within the Treasurer's White Paper about utilizing electronic trading platforms and leveraging existing ones, could you just provide us a sense and the Company's perspective on -- if regulators, administration, is distinguishing between electronic trading platforms such as what you own, and those owned by the exchanges, which are self-regulatory organizations?

Yes, Howard, why don't I ask Rick to answer that, given his recent involvement, both across the regulatory, as well as some of the exchange conversations?

Howard, thanks for the question on CDS.

Our view right now is that regulators are very anxious to promote transparency, greater electronic trading and central clearing in the CDS market.

And we currently expect that regulatory and legislative action will take place somewhere around the end of this year.

I think that there's been very intentional and consistent terminology utilized in many of the White Papers that you mentioned that suggest with respect to electronic trading that the regulators would like to see greater use of regulated and transparent electronic trading venues.

And we think that's intentionally to leave open the concept of electronic trading that would take place in OTC-derivative markets, in addition to some of the options that may become available on exchanges.

Okay, great.

And then switching gears, on the US business, you've all used the slide in the last few quarters, speaking a bit about the product mix and specifically duration.

I didn't see that within this quarter.

Could you just give us a flavor for some of those drivers underlying the business?

Yes, Howard, it's Jim.

In terms of the overall business and the fees per million particularly in the hybrid area, I think Kelley mentioned a couple of the drivers that have driven the fees per million higher compared to a year ago, which is the new business areas, namely the trading execution services business, as well as the increase in business that we're getting from the regional dealers.

As you mentioned, if you go back a little bit further, the increase in the average maturity of bonds traded over the platform has also been a driver of higher fees per million over a slightly longer period.

When we look at the average years of maturity of the trades that took place in the second quarter, it's very similar to levels that we've seen over the past two or three quarters.

So no really big -- or no significant change there.

Howard, the other thing I would add is that we continue to see almost all of our volume driven out of the fixed-rate product in the US.

If there is one part of the business that really hasn't come back due to the points that Rick made vis--vis the lack of balance sheet, it is the short end of the bank and finance market in the specialty floaters.

And obviously, with a much higher percentage of fixed versus floating, it's a higher duration business and a more profitable business on a fee-capture basis.

Okay, great.

That makes a lot of sense, thanks.

And then regarding Slide 6, the graph that you provide on the inquiry count, I can see the positive progression over the past few quarters, but could you just provide us a flavor for how those current figures compare to what we would have seen pre-crisis and at peak levels for the Company?

Yes, those numbers are still significantly above the levels that we would have had in the first half of 2007 before the onset of the credit event.

Okay.

And then finally for me, cash balances continue to grow.

Rick, you've historically said you wanted the Company to be acquisitive.

Just could you provide us your latest thoughts and an update on the M&A landscape as you see it?

Thanks.

No change there really, Howard.

We're mostly focused on our organic growth opportunity.

We see terrific opportunities in all the businesses that we're developing and the potential to see a significant acceleration of the electronic share in credit overall.

We do obviously opportunistically have the financial flexibility to look at acquisitions.

We continue to see a few opportunities in the marketplace, but we do not have any imminent plans on that front.

And just with a follow-up to that, Rick, clearly, focused organically, pretty constructive about the potential trajectory of organic results -- just thoughts on reinstating kind of some of the buyback and getting a bit more active on share repurchase.

Yes, I think the Board considers all possible uses of cash each quarter to create value for our shareholders, and at this time, there's no change in the thought process.

We think that the financial strength of our balance sheet is unique and creates additional flexibility for us going forward, and for now, no changes on our plans.

Okay.

Thanks so much for taking all my questions.

Thank you.

And the next question comes from the line of Hugh Miller with Sidoti.

Please proceed.

Morning.

Morning, Hugh.

Morning, Hugh.

Morning, Hugh.

I was wondering if you could just give us a sense of the monthly finance ratio?

You had put it in a slide this quarter but I was wondering if you could possibly give us a sense for the month-to-month change in the second quarter, and I guess any sense of where that might come in in July and what you're seeing there for the bid-ask balance.

Well, Hugh -- it's Kelley.

As Rick mentioned, we did have a better performance through the second half of the second quarter, and I think the reasons for that were really twofold.

One was a more balanced bid offer flow in that sort of four to six week period of time, and obviously, the second being the accelerating importance of the new dealers and the regional dealers in responding to that flow.

July, it has been at times balanced, but also at times, offer wanted.

That being said, again, I think the combination of trading and execution services, as well as the importance of the new dealers and the continued strength and high yield, as Rick said, seems to give us some positive momentum in both sort of overall commission revenues as well as in share.

Okay.

So even with July being maybe a little bit of a mixed bag on the bid-ask balance during the month, you still anticipate a modest improvement in market share over the June month?

Yes, I mean, forward-looking statements are very problematic and also day-in, day-out, you can see significant swings in that sort of bid- wanted, offer-wanted sort of flow, but currently, we see some signs of modest improvement in the July timeframe.

Okay.

And can you give us an update on the progress that you are making with the European dealer initiative, anything that looks promising on the horizon with regards to signings and what the plan is on a go-forward basis and into next year?

Yes, as I mentioned earlier in my prepared remarks, we clearly have seen a substantial rebound in volumes in both the second quarter, as well as in comparison to previous quarters with record levels really going back to the 2000 timeframe in terms of overall volumes.

My colleagues in London are focused on adding dealers for a couple of purposes -- one, new dealers to support the core offerings across Euro bond, sterling and [SAS], but also a more, shall we say, specialist group of dealers to accelerate our rates business, some more specialists that provide growth potential in sort of non-core currencies, and finally, tapping into truly regional -- and by that, I mean by geography, not necessarily size -- who can provide us with better execution, let's say, in Italy, in Belgium and in France, as examples.

So we feel good that the value of the platform is being recognized both in the US and in Europe, both in terms of new larger dealers coming on board, as well as supplementing sort of the diversity of our dealer mix to grow the multiple asset classes that I just discussed.

Okay.

I guess is it reasonable to expect maybe in the second half of the year that you'd be successful at bringing on possibly a handful or just a couple of dealers in Europe?

I'm not going to get into a specific prediction, but in working with again our colleagues in London, we would expect to add new dealers in both the US and in Europe.

Okay, great.

And is it possible for you to give us a sense of the fixed versus variable rate commissions for the second quarter in Europe?

I just wanted to get a sense there of how that played out.

Obviously, I can wait for the Q, but is that possible?

Yes, on the slide I had on commission revenue, where we break out the fixed versus variable commissions for both the US and Europe, so you can see what the second quarter numbers are.

I think I said in my prepared remarks, overall, we expect to be down a little bit, about 300,000, in total fixed distribution commission across both the US and Europe.

Okay.

Thank you very much.

Thank you, Hugh.

(Operator Instructions).

And the next question comes from the line of Daniel Harris with Goldman Sachs.

Please proceed.

Good morning, guys.

Morning, Daniel.

Morning, Daniel.

Morning, Daniel.

Kelley, I was hoping you could give us a flavor.

You spent some time on the CDS platform, more than I've heard, I think, in the last quarter or two, but who's using that today versus maybe who was using it a year ago?

And you also talked about the three different types of product that you guys are using in the client to multi-dealer, the bid-offer list and the live cross-matching and how you're seeing the mix of business on those change over the last couple of quarters.

Right.

Although we don't break out specific volumes within the other category, I think I would characterize the volumes in CDS traded over the platform as modest.

What we've seen in terms of the history is that the emerging markets asset class has been more open to electronic trading of CDS, both within the inter-dealer platform and client-to-dealer.

And I think that's a function more of its global market and the fact that, as you know, it involved really out of electric screen-based market from London.

As Rick said, it's still a work in progress from a regulatory and a market-structure standpoint, but certainly, as we see it, we are prepared and can provide multiple trading protocols that can fit specific parts or segments of the CDS marketplace.

When you think about exchanges and exchange-traded products, you need to have something that has significant and continuous liquidity.

One could argue that maybe (inaudible) indices.

There may be a handful of single names that also would benefit from an exchange-traded environment, but again, it's difficult because it needs to be consistent in continuous liquidity.

So what we've done, in light of the changes that are going on with the Big Bang and standardization of contracts, is we have made sure that we have end-to-end connectivity and can provide those three different protocols that I mentioned to take advantage of how the market evolves over the coming quarters.

So we don't have specific clarity yet on timing and how these different products, i.e., indices, single names and lists, may trade, but I think we do believe there's probably going to be some combination of exchange-traded products, as well as OTC derivatives, that will trade over an electronic platform such as ours, where we will provide transparency and deliver post-trade messages to the designated clearing houses.

But that's far what you're seeing, and would you characterize it more as the dealer-to-dealer on your inter-dealer platform or the dealer-to-client on the CDS platform?

I guess if I think about the content of CDS contract outstanding, it seems like 80% is more inter-dealer and that 20% is the dealer to client.

And I'm wondering if that dealer-to-dealer segment is what you think your platform will be best suited to transact.

Dan, it's Rick.

Let me just expand a little bit on Kelley's comments.

I think it's broadly understood today that there's very little electronic trading taking place in CDS in the US market full-stop, whether that's in the inter-dealer client segment or the institutional customer segment.

The market structure needs a catalyst to promote electronic trading and we feel the odds of that are growing, based on what we see out of various regulators and financial services' committee representatives over the last three or four months.

You're right that the market historically has been extremely professional, with the majority of trading taking place between dealers' banks and hedge funds.

However, we see one of the by-products of greater standardization of contract terms, greater transparency of the market and sound central clearing being an increase in market participation that will include more traditional investment managers.

Those investment managers are the ones that are active on our trading system today and we are optimistic that these changes in the CDS market will favor a greater degree of electronic trading across all major segments.

Okay, Rick, that's helpful.

I just want to follow-up on also the comments you made about the patent that you've received over the last few months.

And I guess my question is, as you think about your products that -- and products you may or may not want to be in versus others -- do you ever consider licensing out that technology for the RFQ product for other products that are not necessarily in direct competition with your fixed-income products?

I think in each market segment, we consider the opportunities for our shareholders to go it alone and build organically, as well as to partner with existing market participants that may have unique advantages in terms of certain client connectivity to different segments, or certain product capabilities.

And it's really the benefit of operating not only a trading business, but having developed now a Tech Services business.

So we are open to that and we have engaged in those discussions over the recent past.

Okay, perfect.

And then Jim, just one or two for you.

On the tax rate, you had said 43% is a decent target for 2009.

Does that sort of persist into 2010 and '11 at this point?

It's a little bit hard to look that far forward, Dan.

Obviously, a lot can change over the course of a couple of years, but it's certainly a good rate through the end of this year.

And I guess everything else being equal, it's also the kind of level we'd expect going into next year as well.

What drilled that -- I mean, I guess the change over the last few quarters, it seems a little bit dramatic this quarter.

Just the mix of business has changed that significantly?

The key thing that is driving a slightly higher tax rate is the fact that we are now in a positive retain earnings position in our London operation.

So on the basis that we are able, if we wanted to remit dividends back to the US, we are liable for additional US taxes on the UK-earned income.

So that's what changed, and I think if you look over the first half of the year, Dan, and you combine the first quarter and the second quarter, again, the rate averages out, coming close to that 43%.

Okay, yes.

No, that's fair.

And then just lastly for me, on the fee rates in the quarter, or actually, maybe even thinking back over the last year or so, they've stayed particularly high in US high grade and obviously, some of that has to do with the maturity and the product mix that you talked about.

But how much of that fee rate change is also owed to the new dealers that you guys have added to the platform?

I think that last quarter, you had said there was a 94% year-over-year increase in high yield.

This year, it's -- this quarter, it's like 120%, but also regional dealers played a particular part in that.

Is that -- even if we went back to a higher mix of the -- I mean, a more historic mix of your fixed-income products, do you think that that base is just generally higher than where it had been, say, in '06, '07 timeframe?

Yes, I think as I've already said, Dan, there are really two things more recently that have driven the higher fees and one thing, that it has been trending over a longer time period.

Two, shorter term things have been the execution of trading services business and the new dealers and the longer term thing has been the increase in the average maturity of trades over the platform.

So irrespective of what happens with the average maturity of trades, we would still expect fees to be higher than they were if you go back three or four quarters because of the new business areas.

Did that answer the question or not?

Yes.

No, that's perfect.

Thank you.

Thank you.

(Operator Instructions).

And there being no further questions at this time, ladies and gentlemen, this concludes today's question-and-answer session.

I would now like to turn the call back over to Mr.

Rick McVey for closing remarks.

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

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.