MarketAxess Holdings Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods. MarketAxess operates an electronic fixed-income trading platform and related data and post-trade services. The company reported one operating segment and more than 1,100 active institutional investor and broker-dealer firms.
Financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $96.6m | $75.5m | $185.2m | $152.3m |
| Expenses | $46.1m | $38.4m | $90.3m | $76.7m |
| Income before taxes | $50.6m | $37.1m | $94.9m | $75.6m |
| Net income | $33.1m | $24.2m | $62.1m | $48.8m |
| Diluted EPS | $0.88 | $0.64 | $1.65 | $1.30 |
| Net margin | 34.3% | 32.1% | 33.5% | 32.1% |
Q2 revenue increased 28.0% and net income rose 36.7% year over year. For the first half, revenue grew 21.6% and net income 27.2%. Commission revenue was the principal driver: up 29.9% in Q2 and 23.9% for the half. Q2 total trading volume rose 38.2% to $338.3bn; first-half volume rose 32.7% to $648.3bn. Other-credit volumes increased 67.5% in Q2 and 55.2% for the half, while U.S. high-grade volume rose 27.1% and 24.7%, respectively.
Q2 expenses grew more slowly than revenue, lifting the pretax margin to 52.3% from 49.1%; first-half pretax margin was 51.3% versus 49.6%. Employee compensation and benefits remained the largest expense, increasing 25.4% in Q2 and 20.5% for the half. Management attributed increases partly to headcount, incentive compensation, consulting and matched-principal clearing costs. Average fees per million were broadly stable overall in Q2; lower other-credit fees per million partly offset volume growth.
Cash flow, liquidity and capital
- At June 30, cash and cash equivalents were $153.3m and investments were $146.3m, totaling $299.6m; total assets were $477.1m and stockholders’ equity $436.2m.
- First-half operating cash flow was negative $28.7m, versus positive $40.6m in 2015. Management said the change primarily reflected a $72.4m increase in corporate debt trading investments and working-capital movements, partly offset by higher earnings. Investing cash flow was positive $2.0m; financing cash flow was negative $19.6m. Ending cash declined $46.5m to $153.3m.
- Management’s non-GAAP trailing-12-month free cash flow was $105.1m versus $100.9m. Its definition excludes net purchases of corporate debt trading investments and subtracts capital expenditures and capitalized software costs; it is not the same as reported operating cash flow.
- No drawn borrowings are reported. The $100m revolving credit facility had $0.9m of letters of credit outstanding and $99.1m available, and matures in October 2017. The company reported covenant compliance. Regulated subsidiaries held $116.8m of capital and financial resources above required minimums, which can constrain transfers to affiliates.
- The first-half dividend declared was $0.52 per share. The board authorized a new $25m, two-year repurchase program; $19.6m remained authorized at June 30.
Outlook, commentary and risks
No quantified earnings or revenue guidance is provided. Management said existing resources should meet liquidity and capital expenditure needs for at least the next 12 months, while noting future needs depend on product development, expansion and potential acquisitions. A quarterly dividend of $0.26 per share was approved in July for payment in August, subject to the board’s discretion.
- Revenue depends substantially on fixed-income trading activity, market volumes, platform share, product mix and fees. Management cautioned that market or volume declines could materially reduce revenue and profitability.
- The filing discusses Brexit uncertainty, including possible effects on U.K. operations and the ability to serve EU clients, as well as MiFID II/MiFIR implementation expected in 2018 and continuing U.S. regulatory change.
- Open Trading matched-principal activity exposes the company to counterparty, settlement and execution-error risks. Clearing brokers may charge the company for counterparty losses, with no stated maximum under the agreements. No related losses or liabilities were recorded for the first half.
- Foreign exchange movements reduced reported revenue by $1.0m in Q2 and $1.7m for the first half, according to management. The company uses short-term forward contracts to hedge its U.K. net investment.
- Unusual item: a first-quarter out-of-period adjustment, deemed immaterial to prior periods, reduced deferred tax assets by $3.1m, reduced other comprehensive income by $2.1m and increased prepaid expenses and other assets by $1.0m.
- Federal tax examinations for 2011–2013 and New York State examinations for 2010–2013 were ongoing; timing and possible impact were not estimable. The company said outstanding legal matters were not expected to materially affect its financial position, but ultimate exposure could not be determined.
Important facts for investors to verify
- Whether trading-volume growth and estimated U.S. high-grade market-share gains persist, and whether management’s adjusted FINRA TRACE comparisons are reproducible.
- Whether revenue growth converts to cash: first-half operating cash flow was negative, largely because of trading-investment purchases and working-capital changes.
- The composition, duration and valuation sensitivity of the $146.3m investment portfolio and the distinction between available-for-sale and trading securities.
- Potential effects of Brexit and evolving U.S. and European market regulations on licensing, compliance costs and client access.
- Exposure from matched-principal trading, including potentially uncapped clearing-broker claims, and the amount of capital restricted within regulated subsidiaries.
- Progress and potential financial impact of the tax examinations, the out-of-period adjustment, and adoption of new accounting standards.