MarketAxess Holdings Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; comparisons are with the corresponding 2010 periods unless stated otherwise. MarketAxess operates an electronic fixed-income trading platform, with commissions as its primary revenue source.
Financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $46.6 million | $37.4 million | $136.0 million | $107.6 million |
| Commissions | $39.8 million | $31.2 million | $116.7 million | $89.9 million |
| Income before taxes | $22.3 million | $13.5 million | $59.9 million | $36.5 million |
| Net income | $13.4 million | $8.6 million | $36.2 million | $22.5 million |
| Diluted EPS | $0.34 | $0.22 | $0.91 | $0.57 |
| Operating expenses | $24.3 million | $23.9 million | $76.1 million | $71.2 million |
Revenue grew 24.5% in Q3 and 26.3% year to date; net income increased 56.1% and 60.9%, respectively. Commissions represented 85.5% of Q3 revenue and 85.8% of nine-month revenue. Net margin was approximately 28.9% in Q3, versus 23.0% a year earlier, and 26.6% year to date, versus 20.9%. The filing reports pretax income rather than a separate operating-income line.
Q3 total trading volume rose 31.1% to $131.7 billion; nine-month volume rose 34.2% to $399.8 billion. U.S. high-grade volume increased 35.8% in Q3 and 37.8% year to date, while Eurobond volume fell 29.2% and 26.8%, respectively. “Other” volume increased 43.4% in Q3 and 56.7% year to date. Management attributed U.S. high-grade gains principally to increased platform market share, and weaker Eurobond activity partly to sovereign-debt concerns and competitive conditions.
Cash, liquidity and capital
- At September 30, cash and cash equivalents were $157.6 million and available-for-sale securities were $80.2 million, totaling $237.8 million, up from $197.5 million at December 31, 2010.
- Nine-month operating cash flow was $46.8 million, compared with $41.6 million; investing cash outflow was $8.8 million and financing cash outflow was $4.5 million. Cash increased $32.6 million during the period.
- Management reported free cash flow of $62.8 million for the 12 months ended September 30, 2011, a non-GAAP measure.
- The company reported no short- or long-term debt, no bank credit lines, and $0.7 million of equipment-related capital lease obligations. It stated that resources were adequate for at least the next 12 months.
- Total liabilities were $33.4 million and stockholders’ equity was $305.8 million at September 30. Regulatory subsidiaries reported excess net capital of $72.2 million in the U.S., $21.2 million in the U.K., and $0.1 million in Canada.
Material changes and unusual items
- Q3 commission growth included higher trading volumes and $3.9 million more distribution fees, partly reflecting six U.S. dealers moving to plans with monthly distribution fees and the addition of dealers. Average variable fee per million across all products decreased to $180 from $188.
- Year-to-date expenses rose 6.9%, slower than revenue growth. Higher compensation, consulting and marketing costs were partly offset by lower general and administrative expense, including a $0.7 million sales-tax reimbursement and lower bad-debt expense.
- In January 2011, 3.5 million Series B preferred shares converted into common stock. The conversion increased the common share count and eliminated the preferred stock balance.
- The President resigned in June; cancellation of unvested awards resulted in a $1.4 million reversal of previously recorded stock-compensation expense.
- The company fully used its unrestricted U.S. net operating loss carryforward during 2011, increasing cash taxes. Cash taxes paid were $9.6 million for the first nine months, compared with $1.6 million in 2010.
- After quarter-end, the board authorized up to $35 million in share repurchases and approved a $0.09-per-share quarterly dividend, payable November 24, 2011.
Outlook, risks and contingencies
No numerical revenue or earnings guidance is provided. Management cited market activity, client participation, dealer liquidity, product mix and fee levels as key drivers; a decline in trading volumes could materially reduce revenue and profitability. Other risks include competition and pricing pressure, technology or security failures, regulatory change, and counterparty non-performance on riskless-principal trades. The company expects to pursue a swap execution facility and/or security-based swap execution facility, subject to regulatory rulemaking, potentially requiring additional regulatory capital.
Commitments include approximately $20.0 million of operating lease payments and $0.7 million of capital lease payments. The company also has $1.6 million of standby letters of credit and contingent exposure under a previously assigned lease. Clearing arrangements expose it to uncapped losses if a counterparty fails to perform; no liability was recorded for this exposure. No legal proceedings were reported, and the filing said there were no material changes to previously disclosed risk factors. Disclosure controls were assessed as effective.
Investor verification priorities
- Whether U.S. high-grade market-share gains and higher “Other” volumes persist, and whether Eurobond trading recovers.
- How recurring distribution fees, volume growth and lower variable fees affect commission yields and margins.
- Cash tax levels following the use of U.S. tax-loss carryforwards, and the sustainability of operating cash flow.
- Execution and capital requirements for any swap execution facility, including the evolving Dodd-Frank rules.
- Potential counterparty exposure under clearing agreements, as well as lease and other indemnification commitments.
- Effects of the announced $35 million repurchase authorization, dividend payments, and common-share dilution following preferred conversion and equity awards.
- Related-party exposure: JPMorgan Chase was the company’s sole stockholder broker-dealer client; verify the ongoing scale and terms of those relationships. No client contributed more than 10% of revenue, though one client represented 14.9% of nine-month trading volume.