MarketAxess Holdings Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. MarketAxess operates an electronic fixed-income trading platform and related information and post-trade services. It reported one business segment and more than 1,200 active institutional investor and broker-dealer firms.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $103.9 million | $88.6 million | +17.3% |
| Commissions | $94.0 million | $79.1 million | +18.9% |
| Operating expenses | $48.3 million | $44.2 million | +9.2% |
| Income before taxes | $55.6 million | $44.4 million | +25.3% |
| Net income | $42.5 million | $29.0 million | +46.6% |
| Diluted EPS | $1.11 | $0.77 | +44.2% |
| Operating cash flow | $30.5 million | $(52.7) million | Improved $83.3 million |
Net margin was approximately 40.9%, versus 32.7%; pretax margin was approximately 53.5%, versus 50.1%. The effective tax rate fell to 23.6% from 34.7%, including $5.8 million of excess share-based-payment tax benefits recognized under newly adopted accounting guidance. Those benefits materially contributed to net income and EPS growth.
- Commissions accounted for 90.5% of revenue. Trading volume rose 27.2% to $394.4 billion: U.S. high-grade volume increased 23.4%, other credit 36.5%, while liquid-products volume was essentially flat.
- Commission growth was led by higher volumes, partly offset by lower average variable transaction fees per million overall ($197 versus $204). U.S. high-grade market share, as estimated using TRACE data, increased to 15.9% from 14.9%.
- Information and post-trade revenue was essentially flat at $7.8 million; transaction-reporting volume declined to 270 million from 301 million. Management said foreign exchange reduced revenue by $1.9 million overall.
- Expenses grew more slowly than revenue. Higher employee compensation was the largest increase; clearing costs declined 24.9%, following changes to third-party clearing agreements.
Cash, liquidity and capital
- At March 31, 2017, cash and cash equivalents were $137.7 million and investments were $218.6 million, totaling $356.2 million. Total assets were $530.7 million; total liabilities were $48.4 million. The balance sheet reported no drawn debt.
- The $100 million revolving credit facility matures in October 2017. $99.1 million was available after $0.9 million of letters of credit; the company was in compliance with covenants. The filing does not provide a post-maturity refinancing or renewal plan.
- Quarter-end cash declined $30.6 million. Operating cash flow was positive, while investing cash outflow was $29.0 million and financing cash outflow was $31.7 million, including $12.2 million of share repurchases and $12.4 million of dividends paid. The operating-cash-flow comparison with 2016 was affected by substantially lower purchases of corporate-debt trading investments in 2017.
- The company reported $128.9 million of aggregate regulatory capital and financial resources above required levels. It said $63.5 million of unrestricted cash was held by non-U.S. subsidiaries; regulated-subsidiary funds may be subject to restrictions on transfers.
Outlook, risks and notable items
- No quantified revenue, earnings or trading-volume guidance is provided. Management said resources were adequate for liquidity needs and capital expenditures for at least the next 12 months, while noting future needs depend on development, expansion and potential business opportunities.
- Management expects expenses to increase with investment in products and geographic expansion, and occupancy costs to rise in 2018 as new New York headquarters space is used. It also cited potential operating leverage from growing volumes and adding products without substantial infrastructure expansion.
- Key business risks include market and trading-volume declines, competition, rapid technology change, and regulatory developments. MiFID II/MiFIR were expected to take effect in January 2018 and could require significant compliance, technology and operating resources. Following the U.K.’s Article 50 notice, the company began establishing one or more regulated EU subsidiaries to maintain access to EU clients after Brexit; the impact depended on exit terms.
- Open Trading and matched-principal activity exposes the company to counterparty, settlement and execution risks. Management described additional automated credit controls but cautioned they may not fully mitigate exposure. Cash deposits were concentrated primarily at one major global bank.
- Operating lease commitments totaled $145.4 million, including $127.2 million remaining under leases for approximately 108,000 square feet of office space. Legal proceedings and regulatory examinations were described as not expected to have a material adverse impact based on information available, although ultimate exposure could not be determined.
- ASU 2016-09 was adopted January 1, 2017 and may make net income, the effective tax rate and diluted EPS more volatile. The filing also describes out-of-period tax-related adjustments recorded in Q1 2016; management said they were not material to prior periods.
Important facts for investors to verify
- How much of earnings growth persists absent the $5.8 million share-based-payment tax benefit, and how the new accounting treatment affects future tax rates and diluted EPS.
- Whether elevated trading volumes and market-share gains continue, and how commission yields and product mix evolve.
- The status and terms of the revolving credit facility after its October 2017 maturity.
- The cost and execution of MiFID II readiness and the planned EU regulatory presence, including implications of Brexit.
- The company’s ability to meet substantial long-term lease commitments while funding dividends, repurchases and investment in growth.