Marketaxess Holdings Inc (MKTX) 2009 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

(Operator Instructions).

As a reminder, this conference is being recorded Wednesday, October 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 third quarter 2009 conference call.

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

Kelley Millet, President, will provide an update on the 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 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, Form 10-K, for the year December 31st, 2008.

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 third quarter of 2009 results.

The third quarter shows a continuing trend of solid growth, driven by increased investor order flow and improved liquidity on the trading system.

Revenue for the quarter was a record $30 million, up 32% from a year ago, and pretax income of $8.5 million was up more than 300%, showing the operating leverage in our business.

Earnings per share of $0.12 and operating margin of 29% were substantially above prior year and prior quarter levels.

The improvement in credit market conditions is driving increased demand for electronic trading.

Client inquiry count increased 78%.

The number of dealers on the platform has grown from 49 to 67.

Trading volume on our platform is up 64% and market share is trending higher once again.

Our trading volume is the highest it's been since the second quarter of 2007.

Our fee capture per million traded continues to climb and is up 40% from a year ago.

Higher volumes and higher fee capture drove a 136% increase in our variable transaction fee revenue, the key component of the Company's growth strategy.

Our cash flow for the quarter was strong, leading to cash balances of $162 million, up from $145 million at the end of the second quarter.

Preliminary estimates for October show an increase in TRACE volumes versus September and an increase in estimated market share.

The mix of business is comparable to the third quarter.

It is worth mentioning that we do normally see some seasonality through the holiday period in the fourth quarter.

Because we have consistently generated strong cash flow, and our cash balances are now well in excess of our anticipated capital spending needs, I am pleased to announce a regular quarterly cash dividend of $0.07 per share.

The steps we have taken to build our business through the past two years have enabled us to come through the credit crisis with a stronger and more diversified business.

Our priority continues to be further investment in the business to support our long-term growth aspirations.

As you could see on Slide 4, market conditions improved further in the third quarter.

High-grade credit spreads, as measured by the Credit Suisse LUCI Index, continued to decline, ending the quarter at 174 basis points over US treasuries.

We have now fully retraced the spread widening that occurred in 2008.

Credit spread volatility declined further during the quarter, but remains elevated.

Flows in the taxable bond funds and corporate bond EPS have been strong in 2009 and accelerated in the third quarter, reflecting the increased appetite for risk among investors.

Investment-grade gross new issuance during the third quarter was $195 billion in line with long-term averages.

Spreads and volatility in credit markets are returning to more normal levels, leading to renewed confidence in electronic trading.

On Slide 5, you can see that the solid progression of volume growth is evident across all three major product areas.

We believe that the broadening of our dealer market-making community has contributed to increased investor order flow, creating a virtuous circle for volume and revenue growth.

In US high grade, our fixed-rate transaction volumes for the quarter reached record levels and are now above pre-credit crisis levels, although floating rate note business has not yet returned.

In Europe, our volumes were 93% above a year ago, benefiting from strong growth in investor order flow and expansion in the range of bonds that can be traded on our European system.

In the other category, we saw year-over-year growth in both our high-yield and emerging-market volumes, demonstrating the continued progress we are making in growing these areas of our business.

It is worth nothing that electronic CDS volumes are still very small, but many of the current proposals for regulatory reform contemplate mandated electronic execution for standardized swaps.

We are taking all necessary steps to prepare for this potential shift in market structure.

It is reassuring to see consistent volume growth in all areas and motivational to know that so much share potential in electronic credit trading is still in front of us.

Now, let me turn the call over to Kelley for more detail regarding our third quarter business results.

Thank you, Rick.

Slide 6 illustrates how we've continued to expand and deepen our trading network.

Our level of engagement with investor clients has never been better.

The number of investor clients using the MarketAxess platform during the quarter was up across all major product categories compared to a year ago.

The total investor order count was a record 226,000, up 78%.

Investor clients are increasingly drawn to the efficiency of our electronic trading platform which is significantly enhanced for those clients that have created direct STP connectivity with us.

Over a third of the trade inquiries during the quarter were initiated from client order management systems through direct STP connectivity with MarketAxess.

The more trades an investor client has to execute, the more they benefit from the speed and efficiency of electronic execution.

As the hit rates on our system improve, which I will address shortly, the level of investor client engagement grows.

The higher the percentage of a client's inquiries that get executed, the more likely they are to increase the number of inquiries they submit to the platform.

Slide 7 illustrates the growing participation of the new dealers we've brought onto the platform.

The added liquidity provided by the new dealers has been important in improving the hit rates on client inquiries, particularly in smaller trade sizes.

The new dealers have also been an important source of new revenue to MarketAxess.

Although participation of these new dealers has been modest in volume terms due to their focus on smaller trade sizes, their activity measured as a percentage of trade count has increased to 17% of all US high-grade and high-yield executed trades in the third quarter.

We anticipate some additional growth in new dealers on our RFQ client-to-dealer platform over the next few quarters, but we believe that the [paid to dealer] acquisition will slow.

Typically, it takes many months for a new dealer to be connected and to trade with a significant number of investor clients.

As these points of connectivity between dealers and clients grow, the contribution of the new dealers will increase.

We believe we still have some way to go before reaching critical mass in this regard.

Therefore, we expect the number of inquiries that new dealers see to increase significantly.

Currently, new dealers on average see only 21% of the inquiries, while existing dealers see 78%.

The expected growth in the number of inquires that new dealers see will further improve hit rates on the platform.

On Slide 8, we show our improving hit rate due to improved dealer risk-taking and the growing participation of our new dealers.

As market conditions stabilize, the capital available for market-making among primary dealers has improved, but only modestly, but continues to be low compared to pre-crisis levels.

However, we have observed the capital is less concentrated among the large dealers post-credit crisis.

The number of unique dealers has grown globally and now stands at 67.

By adding new dealers to our trading network, we have enhanced the liquidity available with capital that is not represented in this primary dealer group, underlining the importance of our new dealer effort.

The combination of improved dealer risk appetite overall and the increased participation of new dealers has helped to raise our hit rate in US high grade to 69% as of September of 2009, significantly improving the experience for investor clients.

However, while hit rates have increased in the last six months, they remain below our historical pre-crisis levels of approximately 80%.

As highlighted on Slide 9, we are encouraged by the strong fee capture we achieved in the quarter.

We saw a significant increase in our variable fee capture per million which was up 40% versus the third quarter of 2008.

The increase in fees per million was driven by first, a higher number of transactions by new dealers in US high grade; second, an increase in business conducted by our execution services desk; and third, improved performance of our other clients' dealer profits, namely high yield and emerging market.

Combined, high yield and EM trading volume increased 47% over the third quarter of last year.

The third quarter also represented a strong period for total variable transaction fees which increased 136% to 14.6 million.

We are pleased to see this healthy growth story continue, as variable transaction fees accounted for 58% of our total commissions in the third quarter.

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

Jim?

Thank you, Kelley.

Please turn to Slide 10 for our earnings performance.

Revenues for the third quarter grew by 32% leading to a 307% increase in income before taxes, highlighting the leverage in our business.

The revenue growth was driven by 47% increase in our commission revenue.

Technology Products and Services revenue was in line with the prior year, but 24% above the second quarter.

We have seen some signs that the environment for our Technology business is getting better, but anticipate that further improvements over the next two quarters will be modest.

We continue to be negatively impacted by reduced yields on our investment portfolio and the effect of foreign currency rate changes on our European earnings.

Our tax rate for the third quarter was 46%, and was adversely impacted by an adjustment to our deferred tax asset as a result of newly enacted apportionment rules in New York City.

The new rules will favorably impact our overall tax rate going forward.

It is important to note that a favorable decrease in tax rates will result in a reduction in our deferred tax asset balance and as a result, an increase in tax expense in the period in which such changes occur.

In future periods, the lower tax rate is applied.

We anticipate that the tax rate for the fourth quarter will be in a range of 42 to 44%.

Our diluted earnings per share of $0.12 was the highest we've experienced as a public company and was $0.08 above the third quarter of 2008.

On Slide 12, we've laid out our commission revenue, trading volumes and fees per million.

Distribution fees of 10.7 million were down 3% from the third quarter of 2008.

Fees from new dealers have largely offset those we lost due to bankruptcy and mergers in the dealer community.

We anticipate that distribution fees for the fourth quarter will be approximately 800,000 above Q3 as a result of further dealer additions in both the US and Europe.

Variable transaction fees of 14.6 million were more than double the year-ago level, highlighting the significant momentum in volume and fees per million that Kelley and Rick discussed earlier.

Slide 12 provides you with the expense detail.

Expenses of 21.5 million were up 4% from the third quarter of 2008.

Employee compensation and benefits increased by 18%, principally as a result of increased employee cash compensation (inaudible) based on operating income.

We now anticipate that full year expenses will be in a range of 83 to $84.5 million, the midpoint of which is up 5% from full year 2008 expenses.

We now expect full year 2009 capital expenditure to be in a range of 7.5 to 8.5 million.

The guidance includes 3.3 million of capital expenditure in the fourth quarter as a result of the planned move of our New York head office to new premises early next year.

On Slide 13, we highlight the strength of our balance sheet.

Cash, cash equivalents and securities as of September 30 were 162 million or $4.25 per share on a diluted basis compared to 143 million at year end 2008 and 145 million at the end of the second quarter.

Total stockholders' equity, including the Series B preferred stock, as of September 30 was 242 million, representing book value on a diluted basis of $6.34.

We continue to have no bank debt.

On Slide 14, we show the trailing 12 months free cash flow.

Free cash flow for the trailing 12 months was $30 million or 2.4 times the net income of 12.6 million.

As Rick mentioned earlier, the Board has approved the payment of a regular quarterly cash dividend with the first dividend of $0.07 per share to be paid to holders of record as of November the 11th.

The total amount of the dividend for this quarter will be 2.7 million.

The Board elected to pay our first cash dividend because we have consistently generated strong cash flow and hold significant cash balances.

Our priority for uses of cash continues to be investing in the business to support long-term growth while maintaining our strong financial profile.

We anticipate that our cash balances will continue to grow, even with the payment of a regular quarterly dividend.

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

In summary, we continue to meet investor demands for new sources of liquidity in credit markets and they are responding with greater order flow.

The steps we have taken to expand our dealer and product network are driving an important increase in fee capture per million traded.

Incremental margins in our business remain very high, driving earnings momentum.

Importantly, electronic trading and credit is still in early stages and there are many potential catalysts to cause an increase in adoption rates.

Before opening the line for questions, I would like to thank our employees for their hard work and perseverance throughout the credit crisis which positioned the Company to realize the record results we announced today.

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

(Operator Instructions).

And our first question comes from Howard Chen, Credit Suisse.

Howard, you may proceed.

Good morning, everyone.

Rick McVey; Good morning, Howard.

Good morning, Howard.

Good morning, Howard.

My first question, Rick, with respect to the push for more electronic trading, you mentioned the Company is taking all necessary steps to be prepared.

I was curious, could you provide a bit more detail on what exactly you're doing and a time frame that you potentially see this playing out?

Sure, I'd be happy to.

I think first of all, we've equipped the system to be prepared for the new standardized single-name contracts in CDS and we have built all possible trading protocols that we think might be relevant in the new CDS space.

So at this point, we have requests for quote capabilities for CDS indices, as well as singles names.

We have our bid and offer list technology available for single-name lists and we also have our cross-matching technology available that was built originally for the inter-dealer business and dealer access.

So I think the technology enhancements are in place.

We believe that the credit trading network is already actively using the system for corporate bonds and we think we're in the right position should the market move forward with greater demand for electronic trading in the CDS space.

With respect to the timing of the regulatory reform, everything that we can tell is that the legislation is likely to be passed around the end of the year or early in 2010 and the new rules would be in effect somewhere around the end of 2010.

Okay, thanks.

And then switching gears, you're seeing good contribution from the new dealers.

If new dealer contributions continue to grow faster than that of existing dealers, can you just remind us what that does to the fee capture, all else being equal?

Yes.

Howard, good morning.

It's Kelley.

As I noted in the presentation, we do believe that the pace of growth in terms of the percentage of order counts that [decent] dealers do will continue to increase.

And a big part of that, as I mentioned, was the [permisioning] aspect of trying to get the average increase that they see up from the 20% currently towards, and close to, the average of the existing dealers on the system.

Overall, we would expect that would be a positive event and would be one factor in support of continued strength in fee capture and fees per million.

And as you're aware, there are a number of other factors, as I noted -- execution services, the growth in our other business and then overall macro factors that can affect fee capture.

Okay, thanks.

And then a final question from me, Rick, is as you and the Board went through the capital management discussion, I'm curious how you settled on a normal course dividend versus other uses of capital like a share repurchase or a strategic acquisition, and maybe touch on the timing of the decision.

Sure.

I think that as Jim pointed out, the trailing 12-month cash flow has been very strong and our cash balances are well in excess of our capital needs for organic growth.

So that combination put the Board in the position of believing that the time was right to start returning some cash to shareholders.

And you can tell where we've decided to start is around a third of trailing 12-month cash flow.

Clearly, with the strength in the balance sheet that we have, all options are still open to the Board, including buybacks or acquisitions, but at this time, we believe that the dividend was the right way to start returning some cash to shareholders.

Okay, makes sense to me.

Maybe if I could just squeeze in a follow-up to that.

Jim mentioned the priorities being reinvestment.

I guess I was a bit surprised deals weren't mentioned in that conversation, given your commentary in the past.

Could you just give us a sense of what you're maybe seeing on the M&A landscape, Rick, and maybe the bids and the asks versus what's out there?

Sure, I'd be happy to.

I think we continue to look at a variety of acquisition opportunities that could expand the product capabilities of the Company or the client reach.

However, at this time, we do not see anything that matches the growth prospects that we have for our own organic business.

So at this time, that's occupying our full attention.

Great.

Thanks so much for taking my questions.

Thank you.

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

Hugh, you may proceed.

I appreciate you guys taking my questions.

I had one with regards to your thoughts go-forward on the overall TRACE volumes, now that we have seen kind of spreads retrace and come back in towards pre-crisis levels -- your thoughts there, not necessarily from your volumes -- obviously, you can gain market share, but overall TRACE volumes.

Hugh, good morning.

It's Kelley.

As Rick mentioned, in trying to give some guidance around what we're seeing in the market, in October, we have seen TRACE volumes pick up again versus the September time frame.

We should see a seasonal pattern such that TRACE volumes will reduce around Thanksgiving, the holidays and the new year.

So as I look at 2010, there are a number of factors, some assumptions around in-flows into the marketplace, some assumptions around the new issue calendar, some assumptions around continued but modest growth in dealer capital.

We would expect TRACE volumes to be in and around current levels or slightly lower year-over-year, but that's just one person's assessment.

And I would be very cautious in sort of taking that as the only source of that information, but certainly, for planning purposes and to ensure that we maintain expense discipline, we're in that sort of modest decline scenario, but as you say, what drives us is continued market share, continued building of the network, and strong fee capture.

Okay.

Yes, I certainly appreciate the color there.

And if you can talk a little bit about -- you mentioned an improvement in distribution fees in the fourth quarter in the US and Europe for signing of some dealers there.

Can you give us a sense on that 800,000 on what the split is, US versus Europe?

Yes, Hugh, it's Jim Rucker.

The increase in distribution fees that I mentioned for the fourth quarter of 800,000 over the third quarter comes from both the US and Europe, but a bigger piece of it will come from the US.

Okay.

And can you just talk about then with a switch there towards the distribution fee type model what we can assume on the variable rate fee per million go-forward?

I think as Kelley had told to -- in his prepared remarks, Hugh, there are a number of things that are driving the higher fee per million.

The new dealers and their impact on the fee per million is one of those and it's a trend that we certainly see continuing.

New dealers are having an impact, some of them through distribution fees as they move onto fee plans for distribution fees, a number of them and they're on the variable fee plan and having a positive impact on the fees per million.

Okay.

And the last question I had is with regards to the Technology Service fees.

Obviously, you mentioned there was a nice improvement on a sequential basis in the third quarter that you anticipate in the near term kind of more modest growth.

But can you talk about what you saw that was kind of driving the sequential improvement during the quarter?

Yes.

Again, Hugh, it's Kelley.

I mean, just to preface my remarks, we continue to believe that the importance of that business is twofold.

First and foremost, very much integrated into our core business strategy and in a sense, having that business available to more quickly and more efficiently on board customers and/or to make them more efficient in responding via API or auto quoters, it's a very, very important element of like core client-to-dealer strategy in North America.

Digging down into the results, we had a modest improvement in license sales and I think what we're seeing is that with the exchanges and high-frequency, low-latency buyers, there appears to be a bit more of a budget and a bit more of a discussion than there was earlier in the year.

And it feels like when we bottomed, they bottomed sort of six months after that.

So I think as Jim said in his prepared remarks, we like that business.

We think it's very strategic, but in and of itself, the results, we're seeing some improvement.

We would expect that to continue, but probably a little bit more modest than the sequential improvement we saw second quarter versus third quarter.

Okay, great.

Thank you very much.

(Operator Instructions).

And our next question comes from the line of Stacy Collins from Financial Research Associates.

Stacy, you may proceed.

And we are showing Stacy has disconnected.

(Operator Instructions).

And at this time, we are showing no further questions available.

Rick McVey, you may proceed.

All right.

Thank you for joining us this morning for the quarterly call and we look forward to catching up with you next quarter.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a great day.