MarketAxess Holdings Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. MarketAxess operates electronic fixed-income trading platforms and related information and post-trade services, serving more than 1,700 institutional investor and broker-dealer firms. Results are unaudited and interim results may not indicate full-year performance.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | Change |
|---|---|---|---|
| Revenue | $164.0 million | $131.6 million | +24.6% |
| Operating income | $87.8 million | $66.0 million | +33.1% |
| Net income | $67.8 million | $54.0 million | +25.5% |
| Diluted EPS | $1.78 | $1.42 | +25.4% |
| Operating margin | 53.5% | 50.1% | +3.4 percentage points |
- For the first nine months, revenue was $517.8 million (+35.7%), operating income $283.0 million (+48.9%), net income $226.4 million (+46.4%), and diluted EPS $5.94 (+45.6%). Operating margin was 54.7%, versus 49.8% in 2019.
- Q3 commissions, 91.8% of revenue, grew 25.6%. U.S. high-grade and other-credit trading volume rose 16.5% and 11.3%, respectively; Open Trading volume increased 41.3% to $200.3 billion. Higher volume, market share and average fees contributed. Information-services revenue increased 10.5% and post-trade services 23.9%.
- Q3 expenses rose 16.1% to $76.2 million, led by employee compensation, depreciation and amortization, technology, and clearing costs. Clearing costs were higher in connection with Open Trading activity, U.S. Treasuries and the transition to self-clearing.
- Nine-month net cash from operations was $176.9 million, essentially unchanged year over year. Investing provided $103.1 million and financing used $117.4 million. Cash, cash equivalents and investments totaled $341.6 million at quarter-end; cash and cash equivalents were $310.4 million, including $50.0 million segregated for regulatory purposes. Cash, restricted cash and related deposits totaled $437.3 million for cash-flow-statement purposes.
- Management-reported non-GAAP free cash flow was $244.9 million for the first nine months, versus $154.6 million. Its definition excludes specified trading and self-clearing balance changes and deducts capital expenditures and capitalized software costs.
- No borrowings were outstanding at September 30. The revolving facility had $449.0 million available after $1.0 million of letters of credit; the self-clearing subsidiary also had $200.0 million of undrawn collateralized borrowing capacity. The revolving facility was amended after quarter-end to mature no later than November 16, 2020, unless replaced earlier.
- Total assets were $1.246 billion and stockholders’ equity $897.5 million. Operating lease liabilities were $93.7 million. The balance sheet also included $380.9 million of broker-dealer and clearing-related receivables and $138.1 million of corresponding payables associated with matched-principal activity.
Material changes versus the prior comparable period
- Market disruption and increased fixed-income trading activity during the COVID-19 pandemic, together with gains in market share and fees, supported substantial revenue and earnings growth. Management noted that market volumes and volatility tightened from the extreme conditions earlier in 2020.
- MarketAxess converted a U.S. broker-dealer subsidiary to self-clearing in August. It began financing transactions, maintaining clearing deposits and holding a $50.0 million customer reserve balance; related positions, deposits and reserves totaled $270.3 million at quarter-end.
- LiquidityEdge, acquired in November 2019, expanded the platform into U.S. Treasuries. For Q3, MarketAxess Rates contributed $2.4 million of revenue and $3.3 million of expenses; for the first nine months, it contributed $10.5 million of revenue and $12.1 million of expenses.
- Dividends declared were $0.60 per share in Q3, versus $0.51 a year earlier. The company repurchased $15.5 million of shares during the first nine months.
Outlook, commentary, risks and unusual items
- Management gave no specific numerical earnings or revenue guidance. It stated that available cash and investments, operating cash flow and borrowing capacity were expected to meet liquidity and planned capital needs for at least 12 months. It cautioned that a prolonged recession could reduce market liquidity and trading volumes.
- Management said remote operations maintained uninterrupted client service and that it continued hiring, capital spending and platform expansion, while reprioritizing some technology projects. Reopening offices may bring added costs and operational challenges.
- Two acquisitions announced in September—Regulatory Services GmbH and MuniBrokers LLC—were expected to close in Q4, subject to customary conditions. Aggregate consideration was approximately $88.0 million in cash plus transaction costs, including $39.0 million payable at closing and up to $48.0 million in contingent consideration.
- Key risks include volatile market volumes and trading activity, competition, COVID-19 impacts, cybersecurity and operational risk, and the liquidity, financing, technology and settlement risks of self-clearing. Management reported increased fail rates in the period immediately following the self-clearing conversion. The company is also exposed to counterparty credit risk in matched-principal trades.
- The company was designated an eligible seller for the Federal Reserve’s Secondary Market Corporate Credit Facility; management said the facility’s effect on its trading volumes could not yet be predicted. Brexit-related regulatory divergence and compliance costs were also noted.
- Q3 included a $4.8 million additional provision for unrecognized tax benefits. New York State tax examinations cover 2010–2017 and New York City examinations cover 2016–2018; timing and any financial impact were undetermined. Management did not expect outstanding legal matters to materially affect financial position, but said ultimate exposure could exceed accrued reserves.
- Management reported disclosure controls as effective. The self-clearing conversion was identified as a material change in internal control over financial reporting since the prior assessment; the filing did not report that it had materially impaired those controls.
Important facts for investors to verify
- Whether elevated trading volumes, market share and average transaction fees persist as market conditions normalize.
- Self-clearing performance, fail rates, funding needs, reserve requirements and counterparty exposures as the business scales.
- The status and replacement of the short-dated revolving facility, and the availability of the stated borrowing capacity.
- Closing, funding and contingent-payment terms for the two announced acquisitions.
- Potential outcomes of tax examinations and legal or regulatory matters, as well as pandemic, cybersecurity and Brexit-related developments.