Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Trey Gregory - Head of Marketing and Communications

Rick McVey - Chairman and CEO

Kelley Millet - President

Jim Rucker - CFO

Analysts

Daniel Harris - Goldman Sachs

Joe Heary - Banc of America Securities

Hugh Miller - Sidoti & Company

Howard Chen - Credit Suisse

MarketAxess Holdings Inc. (MKTX) Q3 2008 Earnings Call October 29, 2008 8:30 AM ET

Operator

Ladies and gentlemen thank you for standing by, and welcome to the MarketAxess Third Quarter 2008 Earnings Conference Call.

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 29th, 2008.

I would now like to turn the call over to Trey Gregory, Head of Marketing and Communications at MarketAxess. Please go ahead, sir.

Trey Gregory

Thank you. Good morning. For the call this morning, Rick McVey, Chairman and Chief Executive Officer will review highlights for the quarter; Kelley Millet will provide update on trends and 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 conditions may differ possibly materially from what is indicated in those forward-looking statements.

For a discussion of those 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 period year ended December 31st, 2007. I would also direct you to forward-looking disclaimers in our quarterly earnings release that was issued earlier this morning and is available on our website.

I would like now to turn the call over to Rick.

Rick McVey

Good morning and thank you for joining us today. Credit market turbulence reached new heights in the third quarter, including several notable financial institution failures and forced sales. Levels of credit spreads and credit spread volatility continued to soar and a wide range of funding markets seized up.

As a result of these events, liquidity in the corporate bond markets has been scarce, traditional market makers have reduced their appetite and trading is being done increasingly on a riskless principle or agency basis.

Our earnings per share for the third quarter of $0.04 down from $0.07 a year ago were disappointing. However, revenue of $22.7 million was up slightly from the prior year quarter, benefiting from our acquisition of Greenline.

We also took steps during the quarter to trim our expenses, in light of the market conditions, reflecting our continued focus on expense discipline. Cash flow continues to run well in excess of reported earnings.

The level of participation on the trading platform remains high, as evidenced by the number of investor clients submitting trade inquiries and the number of live orders submitted. Our dealer network expanded significantly during the quarter, with the addition of 21 new dealers. Direct order management system connections with investors also increased again.

Throughout the credit crisis, our trading network has continued to grow broader and deeper. I see the current market conditions as a unique opportunity to introduce new trading solutions that address the current credit environment.

In addition, to 21 new dealers on this system, we also introduced an open order book for bid and offer lists, which Kelley will talk more about shortly. We will continue to invest in technology and trading solutions that increase the pool of potential counterparties for credit market participants, in order to rebuild the secondary market liquidity.

We believe that the trading model will change for corporate bonds and CDS, and new sources of liquidity will emerge. MarketAxess is in a great position to benefit.

The signs of severe stress in the credit markets are evident from the metrics we provide on Slide 4. In the upper left hand corner, high grade corporate bond benchmark spreads gapped out further during the quarter.

The benchmark spread on corporate bonds as measured by LUCI index widened significant to 303 basis points at the end of the quarter, up from 214 basis points at the end of the second quarter.

Index spreads have spiked further in October. Credit spread volatility in the upper right hand corner has remained extraordinarily high for more than a year, with little sign that it will return to historical norms in the short term.

The bank funding spread, the treasuries as shown in the chart on the bottom right of this slide has increased, highlighting the elevated credit risk among financial institutions that has had such significant ramifications throughout the credit markets. Bank funding costs have retreated over the last several weeks.

In this environment dealers risk taking abilities are significantly restricted and liquidity in the corporate bond markets is greatly reduced. We do not see a quick resolution to these problems and anticipate a bumpy ride over the next few quarters. While credit events are having an impact on short-term earnings, I believe that the rapidly evolving credit markets present a significant long-term opportunity.

On Slide five, we highlight our valuable liquidity and balance sheet assets. Our more than $130 million in cash and securities and our strong free cash flow mean that we have the financial resources to not only ride out the current market turmoil, but also to invest in additional technology and trading solutions that will broaden liquidity and improve transparency in the credit markets.

Institutional investor clients are telling us that existing sources of liquidity are inadequate to run their business and they are actively seeking alternative solutions that will help to restore normal functioning of secondary credit markets. I believe that our strong cash balances leading position in corporate bond trading and deep credit markets experience will place MarketAxess at the forefront in creating these alternatives. We are witnessing a shift in credit trading from a principle business to an agency business, a transition that will ultimately favor greater electronic trading.

Let me now hand over to Kelly, who will provide more detail regarding some of these initiatives.

Kelley Millet

Thank you, Rick. On Slide six, we have laid out High Grade TRACE and our High Grade market share. High Grade TRACE for the third quarter 2008 was $429 billion down 16% from $513 billion in the third quarter of 2007. Our total US High Grade trading volumes for the third quarter was $27.5 billion down 31% from the third quarter of last year.

The overall TRACE volume declines as well as the decrease in average trade size highlights the severe illiquidity in the dealer community, which has continued into October. The market has returned to a traditional voice execution agency model, where investors have enforced back-to-the phone in order to complete their trades.

The year-on-year increase in trades of less than $1 million, as a percentage of trades in both count and volume reflects increased retail trading and underscores the importance of our recent dealer addition.

The left hand part of the slide seven shows the dramatic decrease in primary dealer holdings of corporate securities. A lack of principle risk taking is the driving force behind the reduction in overall TRACE volume and our market share.

Our opportunity is clearly demonstrated on the right hand of the slide. Although our inquiry count is up 21% year-on-year, our trade count was up only 6%. The 32,000 orders that were not filled provide us with an opportunity to deliver other sources of liquidity to complete these trades.

Among our initiatives for the third quarter, we added 21 new dealers to the platform. They bring strength and odd lots and could allow us to capture greater share in this high margin business despite market volatility, early results are encouraging.

We are in the midst of our on-boarding process and have obtained approximately of our target client commissioning for this new group, leaving significant upside when we get to critical mass.

In addition, we introduced market list that display live orders to our entire MarketAxess community. This allows for the clients and the users to see lists in real-time and should promote greater liquidity and flow over the system.

Importantly, it also leaves open electronic and hybrid means to more efficiently connect our entire customer base. We also saw continued progress in client connecting their order management systems to us through APIs, highlighting their strong commitment to our platform. Our mass connections increased to 181 at the end of the third quarter from 168 at the end of June.

On slide 8, we review our other North American businesses. In CDS we are fully supportive of the move to central clearing. Central clearing services will strengthen market integrity and at the same time mitigate counter-party risk. Greater use of electronic trading will increase transparency, reduce errors, and improve market efficiencies, all consistent with regulatory objectives for the CDS market.

In the credit markets, we have unsurpassed connectivity, straight-through processing and client and dealer desktop space. We believe we can play an important role in this market as it evolves.

In tech services, Greenline continues to perform well, despite difficult market conditions. Greenline was accretive to earnings once again in the third quarter. Trade West Systems our much smaller acquisition, has been challenged by its licensed model and the current condition of many of its dealer clients. We have, therefore, transformed this business to an ASP model and have focused our sales efforts on regional dealers and data services providers.

In our trading solutions business, we continue to seek ways to monetize our technology assets, especially in CDS and in the dealer-broker space. In info services, given the increasing need for transparency and best execution, demand for BondTicker remains high with record logons for the quarter. In addition, we launched European BondTicker in September and preliminary interest looks promising.

Finally, we will look to partner with others, pursue new asset classes and seek to broaden and deepen our relationships with new and existing data clients.

With that, let me turn it over to Jim for a review of our earnings. Jim?

Jim Bucker

Thank you, Kelley. Please turn to slide nine for our earnings performance. Results for the quarter reflected the challenging market conditions. Earnings per share were $0.04 compared to $0.07 in the third quarter of last year. Revenue for the quarter of $22.7 million was up 2% from a year ago and benefited from another solid quarter from the Greenline business, which is reflected in the technology products and services line.

Pretax income for the third quarter was $2.1 million, compared to $3.6 million for the third quarter of 2007. Excluding $1.5 million in charges relating to employee severance and a write down of intangible assets, pre-tax income for the third quarter of 2008 would also have been $3.6 million in line with the third quarter of last year.

The effective tax rate was 28% this quarter, compared to 40% in the second quarter. The lower tax rate relative to the second quarter, was due to a higher than anticipated year-to-date pre-tax contribution from our European business.

We anticipate that the effective tax rate for the full year will be between 39% and 41%. The 37.4 million diluted share count for the quarter; includes the impact of the second trench of preferred shares and warrants issued in relation to the investment in MarketAxess by TCV on July 14th.

On Slide 10, we've laid out our commission revenue, trading volumes and fees per million. Total trading volume for the quarter of 49 billion was down 35%, compared to the third quarter of 2007, resulting in variable commission revenue of $6.2 million.

Overall transaction fees per million were up 26% from the third quarter of last year. US high-grade fees were up 24% at $118 per million, benefiting from the longer maturity and smaller average size of trades over the platform.

Distribution fees for the US and European high-grade of $11 million were below Q2 levels, largely as a result of the recent consolidation in the dealer community. We anticipate that our US high-grade distribution fees will be down by a further 600,000 in the fourth quarter.

Total commission revenue for the third quarter of $17.2 million was down 9%, compared to the prior year quarter.

Slide 11 provides you with the expense detail. Total expenses were 11% above the second quarter of 2007, and include the impact of our acquisitions of Trade West Systems and Greenline.

Excluding the impact of expenses related to the acquisitions, our underlying expenses declined 7.3% when compared to the third quarter of 2007. Total expenses include 800,000 in employee severance charges resulted from employees terminated during the quarter.

Also included is a 700,000 write-down of the intangible assets recorded in connection with a TWS acquisition, as a result of revised revenue expectations for the business. This write-down represents approximately 75% of the intangible assets related to the TWS acquisition.

Employee compensation and benefits, as a percentage of revenue was 49%, compared to 46% in the third quarter of 2007. We expect that full year 2008 expenses will be between $80.5 million and $81.5 million.

Employee headcount as of September 30 was 185, compared to 181 in the third quarter of 2007. The 185 headcount number includes 42 staff from the Greenline and TWS acquisitions.

On slide 12, we show our strong free cash flow generation. Our free cash flow is well in excess of reported net income and provides a significant cushion in the event that revenue is adversely impacted by further deterioration in the credit markets.

For the nine months ended September 30, we generated free cash flow of $14.6 million. This is approximately two and a half times the reported net income of $6 million. Our cash and securities balances of over $130 million strong free cash flow and disciplined expense management have positioned us well to weather the storm in the credit markets,

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

Rick McVey

In conclusion the credit trading environment remains challenging for all market participants. However, MarketAxess is well capitalized, profitable and cash flow positive. The next few quarters may remain uneven, but we believe market forces will increase the demand for central E trading venues and central clearing.

We have the financial resources to invest in new solutions that will open up new sources of liquidity and help to improve secondary market conditions. We believe we have the best opportunity ever to become a more central part of the secondary corporate bond and CDS markets.

When we look back at this period, we believe we will see the current environment as a catalyst for change in credit markets that benefits open E trading, transparency and central clearing. The rewards for companies that are able to successfully invest and navigate through the current cycle will be high.

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

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Daniel Harris from Goldman Sachs. Please proceed.

Daniel Harris - Goldman Sachs

Good morning, guys.

Rick McVey

Good morning, Daniel.

Kelley Millet

Good morning, Daniel.

Jim Rucker

Good morning, Daniel.

Daniel Harris - Goldman Sachs

Rick you talked about the bank funding costs coming down over the past few weeks and we saw that in the charts you provided and it looks like we have actually seen industry volumes have been stabilizing through October and you are actually moving up through the trends that we have seen recently.

So, when you think about funding costs and volatility in the market and the variety of spreads you look at, what do you see as the most important direct impact on cash bond trading as it relates to what you are seeing in TRACE and certainly on your platform?

Rick McVey

I think, Daniel, there are a variety of factors. But certainly the dealer funding costs and the dealer balance sheet capacity have been important variables over the last three or four quarters. And I think it is important that it is those funding markets start to free up and funding costs come down, you should start to see risk appetite improve.

I think also, as markets start to stabilize, we should see better flows from traditional investors back into credit. It is too early to say that trend has started yet, but certainly institutional investors starting to come back into the market and take advantage of the wider spreads, it would be a signal of the beginning of the turnaround in the credit market. It should help TRACE volume to rebound and grow.

Kelley Millet

Daniel, its Kelley. We have not yet seen, although we have had a couple of decent days or more normalized days of consistent return to sort of hit rates to more normalized levels that would be a better reflection of the dealer's willingness to take risk.

Secondly, I think as you're well aware the new issue market really hasn't opened yet. We're beginning to see signs of that. I think that will be another important sign as dealers are underwriting and taking secondary positions against those new issues, as principal.

Then the other I think is as Rick kind of alluded to, a more even two-way flow. Historically our flow on our system has been reasonably balanced between bid and offer. It is very much skewed to bids currently, as the buy-side is looking for any sort of liquidity in the marketplace. So I would look at those three factors as well.

Daniel Harris - Goldman Sachs

Okay. That's helpful. I appreciate that. Just watching, I know that there are some days that are better and worst than others but with the volumes up closer to 7.6 this month versus what we've seen recently, it certainly seems like things were getting a little bit better. Just shifting a little bit over to Europe, the second quarter had bounced up a little bit, and the third quarter similar to the US has been very, very challenging.

Is the European market any different than what we're seeing here, especially, given the different countries and the different regulations? Or when you see the US market and the various factors that you're tracking get better, should we be thinking that the European volumes will improve as well or is there more of a limiting factor over there?

Rick McVey

I think that there are more similarities than differences, and I think the European credit markets have been impacted by the same factors as the US credit markets, so if funding conditions improve in the new issue calendar starts to reopen, we would also expect European volumes to rebound.

As we've stated in the past, there is a higher percentage of bank and finance paper in Europe than there is in the US and that paper, as you know, Daniel, has been the most distressed and the most volatile.

So the European markets arguably could have been impacted more by the crisis among the financial institutions, although it is very difficult to be too scientific about that, because of the lack of any central trade tape or TRACE like reporting mechanism in the European markets today.

Daniel Harris - Goldman Sachs

Just following up on that, then Rick this Euro BondTicker that you talked about during the call, what is that product that you're going to be launching? Just looking at what you've done on that data side before, 1.4 billion or so of quarter, how would you characterize that opportunity?

Rick McVey

I think similar to the US BondTicker, we're taking advantage of existing sources of data which come from private sources and dealer contributions in Europe, more so than they do from a regulatory trade tape. We're enhancing the sources of data by providing institutional analytics around those spreads and historical database and relationships in credit markets.

So we're excited about that launch. The data product will be integrated into the trading system in Europe as it has been in the US to help the market with real-time price transparency around corporate bond prices.

Daniel Harris - Goldman Sachs

Okay. But it's not going to be like a central tape?

Rick McVey

That's correct.

Daniel Harris - Goldman Sachs

Okay. Just going back to the new dealers that you guys added throughout the course of the quarter, the number that you added was much higher than I think Kelley that you had intimated last quarter. Now I'll take that as a positive.

But on the regional's that you've added or the 21 that you guys have talked about, does that represent the great majority of the regional's that you were hoping for, or are there still opportunities out there? I know that they're not all signed up with clients yet, so the impact hasn't been felt. But, should we expect that dealer count would increase at all?

Kelley Millet

I think the vast majority of the dealers that we are expecting are part of this 21 that we announced. There certainly could be a handful of others, but I think we feel very good about the critical mass that we are seeing.

As I mentioned earlier, in terms of commissioning, as a group these dealers are only seeing about 45% of our total increase, i.e. they are commissioned with the bulk of the key clients, and that the process is ongoing and ongoing aggressively.

That's sort of as compared to approximately 85% of the increase, that an average dealer would typically see an average top 10 dealer.

So to date, despite market volatility, we see this group as a whole performing as a top 10 dealer on the system. We generally believe, as we complete the on-boarding process, and get any sort of market stability, that as a whole this group can perform as a top five dealer on the system.

Keeping in mind that their principal focus and almost exclusive focus is on odd-lot, given the significantly greater profitability on a dollars per million in the odd-lot sector, we think that this can be a very important addition to both liquidity on the system and obviously revenues.

Daniel Harris - Goldman Sachs

Okay, that's great, Kelley. I appreciate that. This is just more of a theoretical and the last one from me. The stocks obviously, similar to a lot of your peers in the sector have been over a lot of pressure over the last year, probably down the levels that I don't think any of us thought about 12 months ago.

But you haven’t implemented another repurchase here; at least you haven’t announced one. You have a very healthy balance sheet. How should we be thinking about the fact that, you've made a number of acquisitions, you have a lot of cash, and yet you're not repurchasing shares? How do you explain that out to the market? Then that's all for me, guys, thanks.

Jim Rucker

Hey Daniel, this is Jim. The way we think about it is that in the current constraint funding markets, such as the ones we're currently facing, we place greater emphasis on having strong cash balances.

So we are pleased to have those balances, and it allows us to pursue the new solutions to address the current credit environment that Kelley and Rick spoke about earlier.

So at the moment, our focus is on pursuing those new solutions and we have higher hopes in terms of the use of the cash balances than other potential uses.

Rick McVey

I think if the funding costs do continue to move down and smaller companies like us have access to them, and the spread returns to some normal relationship between potential funding costs and the return on our portfolio, I'm sure that our board will revisit the opportunity to look at buybacks at this time.

This is an environment though, that we're very please to have the strong balance sheet that we have. Other companies are not as fortunate, and we believe it allows us to continue to focus and grow our business, and not be worried about the cash position of the company.

So we are cash flow positive, and we're very pleased to have the strength of the balance sheet that we do through this environment.

Daniel Harris - Goldman Sachs

Thanks a lot.

Jim Rucker

Thanks, Daniel.

Operator

And your next question comes from the line of Chris Allen from Banc of America Securities. Please proceed.

Joe Heary - Banc of America Securities

Hi, guys. This is actually Joe Heary. How are you?

Rick McVey

Good morning, Joe. Good.

Kelley Millet

Hi, Joe.

Joe Heary - Banc of America Securities

I guess, this is a quick follow-up on the new dealers. When you are saying that you would expect them to be equivalent to a top 10 dealer you are saying in terms of the amount of balance sheet that they bring to the equation once they are fully commissioned?

Kelley Millet

It is actually sort of a measure on average of the amount of business they win over the platform.

Joe Heary - Banc of America Securities

Okay.

Kelley Millet

Right. So right now they are really functioning as a group as sort of a top 10 dealer. And then once we complete the bulk of the permissioning, as I spoke about earlier we think it is highly probable that they will function more in line with a top five dealer.

Just to give you a couple of examples, just for some numbers. I mean and the average top 10 dealer probably wins about 7% of the volume over the platform and an average top five dealer does about 10% of the volume.

Joe Heary - Banc of America Securities

So, this is more with respect to the trade count on your platform as opposed to the amount of available balance sheet out there to support activity?

Kelley Millet

I think that's the most specific measure. But I can’t say that and I'm not going to make a blanket statement, but a lot of these dealers were not faced with the same degree of challenge shall we say around sub-prime mortgage assets and other structured products.

So, it appears, at least, over this initial process have been at times able to be more aggressive than the larger institutional dealers, who have reduced holdings of corporate securities of the balance sheet, have reduced risks appetite overall for corporate securities.

So, I think it's the combination for some of the stronger balance sheet and then wanting to take advantage of an opportunity, where they feel that in this environment they can take share from the traditionally larger dealers.

Joe Heary - Banc of America Securities

Are you at liberty to say, how much collectively in terms of balance sheet they sort of fill in terms of the hole created by the leveraging effect on the large dealer size?

Rick McVey

I think it is less of a balance sheet capacity issue as much as it is. They are providing an important service to institutional investors through this credit event in smaller trade sizes because the regionals tend to operator at the seam between small institutional order flow and retail trading business.

All signs point to retail trading and fixed income being up. When you look at the increase in odd lots in corporate bonds and the increase in activity in the municipal bond sector, it would appear that retail trading is on the rise.

So, as a result I think the regional dealers have a viable business model, where they can operate with small institutional orders and distribute out through their retail channels. That is increasing the available liquidity on our platform to institutional investors for smaller trade sizes.

Joe Heary - Banc of America Securities

Right. Then you guys earlier mentioned that your pricing plan for the new dealers is entirely variable but that you would reconsider or evaluate it towards the end of the year, has your thinking changed at all in that regard?

Trey Gregory

We will look selectively, depending upon the performance of the dealers within that group, whether it makes sense for some combination of a fixed license fee for that handful of dealers and a transactional fee that would be somewhat lower than that majority group who pays no fixed license fee, but rather pays a significantly higher transactional fee per trade.

And I think it would be a function of, overall performance and as a handful of these, "regionals" begin to perform very, very well individually, they begin to see the merits of a fixed license fee and they evaluate their sort of overall cost per million for their execution.

So we feel very good about having a number of different alternatives as we look at our dealers, in terms of potential portfolio of pricing plans. They try to look at those that prefer a fully fixed license fee for the year. Those that may prefer something that is a combination of a fixed license fee, and a transactional fee, and those given their business model who really would seek and benefit best from their own strategy to be fully a transactional model.

So we obviously are going to have to be flexible in this environment, but feel good about that opportunity to be flexible.

Joe Heary - Banc of America Securities

Okay. Just switching gears a little bit to the technology services, what percentage of the revenues at this point are recurring? Trey, I know in the past you said about 15% was maintenance fees, but that should build sort of over time.

Then as a second question with respect to this, what's the pipeline like? Are you seeing any adverse impact as technology budgets start to come under pressure, with regard to the sales cycle or the pipeline?

Trey Gregory

In terms of the pipeline, the pipeline has continued to grow, obviously, taking into account quarterly sales, as well as the fact that the variables or factors as to how we calculate that pipeline has not changed since acquisition.

So, I think that's very good news. Keep in mind, also, the pipeline for Greenline is more diverse, away from the credit markets into the exchange community, and asset classes like equities, FX, futures and the rest, is also more diverse geographically, with presence not only in the US and London, but in Asia, Brazil and Dubai.

So we feel good about that. Clearly what we're watching in the fourth quarter is what I call average days to close. We haven't seen a significant change to that, but obviously in this market environment with tight purse strings that that's something very important.

If I look at, for example, our quarterly results, without getting too specific on the background, we're looking at about 25% to 30% now that we believe are more sort of consistent repeatable revenues, which can be obviously maintenance, a rental versus a licensed model, and certain elements of our pro-services, professional services business that is highly probable to be maintained through quarters, depending on the length of those assignments.

So these are what I would call repeatable revenue as a percentage of overall revenue is growing, and certainly that was one of Rick's pushes to all of us as we acquired Greenline to help transform a little bit more consistent repeatable revenue as part of the overall revenue mix.

Joe Heary - Banc of America Securities

Okay, great. Just a last question on the expense side, taking a quick look at the guidance you gave. It looks like you're saying the fourth quarter would be $19 million to $20 million in expenses. That's an increase of about $2 million to $3 million, relative to the $17.2 million that you referred to as sort of the core expense run rate in the third quarter.

I was wondering, what would be driving that increase. Is the 17 sort of a way to think about what a good core run rate would be as we head into next year, or is there something else we need to be factoring in?

Jim Rucker

Joe, the midpoint as you say for the guidance, for the fourth quarter is about $19.7 million. Now that's about $1 million down from our total expenses, which obviously includes expenses from the acquisitions as well, in the third quarter.

So the guidance clearly anticipates lower expenses in the fourth quarter than we had in the third quarter, and I think in my prepared remarks I did talk, for instance, about employee severance that we took in the third quarter that would lead to lower expenses as we move into the fourth quarter.

Joe Heary - Banc of America Securities

Okay. But I guess the question is more like if you had 17.2 million --

Rick McVey

Joe, I think the 17.2 does not include the new expenses from our acquisition.

Joe Heary - Banc of America Securities

So you mean recurring stuff like D&A and other factors?

Rick McVey

I think we gave the 17.2 number that you're referencing as a way to compare the core operating expenses from the most recent quarter with the third quarter of last year. That was prior to the time we made the new acquisitions.

So the run rate that Jim mentioned that we're targeting for the fourth quarter includes the expenses associated with the acquisitions, and it would reflect a decrease sequentially from the expenses that we had in the past quarter.

Joe Heary - Banc of America Securities

Okay, great. I think that 's it. Thanks, guys.

Rick McVey

Thank you.

Jim Rucker

Thanks, Joe.

Operator

(Operator Instructions) And your next question comes from the line of Hugh Miller from Sidoti & Company. Please proceed.

Hugh Miller - Sidoti & Company

Hi, good morning.

Rick McVey

Good morning, Hugh.

Hugh Miller - Sidoti & Company

I was wondering if you could touch base a little bit more and add some color on the TWS decision to switch to an ASP model and what's been happening with their business line and some of the challenges you see and how you are looking to over come those.

Rick McVey

The original model for TWS, its end consumer which effectively were some, they brought us some 28 in a sense plug-in adaptors, were very large broker-dealers. Those broker-dealers have dramatically reduced their spending over the past four months, if not the last six months.

So as we evaluated that model, and we evaluated that client base; we began too see that with the addition of 21 new dealers to the platform. As we expanded our data product across a number of different fronts, we saw the need for connectivity grow between and among the regional dealers and multiple electronic trading platforms, and these data service providers were consumers across various sources of data.

But the feedback was that a hosted ASP model, resulting in a rental stream as opposed to an up-front license stream was going to be the preferable sale for the likes of the regional dealers and these added companies. After what was a poor second quarter, we saw some real traction as we transformed that model into the third quarter.

In addition, TWS serves two other functions. They work very closely with us internally in providing electronic connectivity for things such as TRACE gateways and work with our BondTicker products in London. They also provide a source and a less expensive source of high class technology assets in people in Salt Lake vis-à-vis, New York. So they can also be a part of our near-sourcing strategy going forward.

Hugh Miller - Sidoti & Company

Okay. Great color there. I guess obviously you guys have had tremendous success adding the regional and diversity dealers and the focus there is on the odd lot trades. Any thoughts there on whether or none, there is the potential to allow them to trade larger size transactions? Or is that really not something that you guys are comfortable with any time in the near future?

Jim Rucker

We have to be cognizant and respectful of the fixed licensed fees that our large dealers do pay. The way in which we think about the value that the system provides is the disclosed nature of inquiry from our 600-plus strong clients in the US, for example, as well as the STP and connectivity and efficiency that the system provides.

So, the quid pro quo of allowing any “regional dealer” to see greater than a million in size, has to be based on their performance in that under a million in size and their potential willingness to pay a fixed license fee as well.

So, in my mind, if there is that ability it would be based on both performance as well as the willingness to pay a fixed license fee and I think that would be fair as we try to balance fairness across all of our dealer constituents, but recognizing we have to provide greater sources of liquidity to the buy size.

Hugh Miller - Sidoti & Company

Okay. I wonder if you could touch upon what you guys are seeing out there with regards to acquisitions, obviously evaluations have improved dramatically here. But any areas that you guys are looking at that you see as opportunities to really grow the business, any color on that would be great?

Jim Rucker

I think that our acquisition focus remains largely the same. We are pleased with the growing connectivity assets that we have as a company. There continued to be some interesting opportunities in the E trading space. As we mentioned earlier demand for quality and real-time credit data continues to grow. Having said that, in the near term we are mostly focused on our organic opportunities because the transformation that we see going on in credit markets.

We are very excited about the changes that are taking place on our platform for corporate bonds and the changes that are likely to take place industry wide in CDS trading and clearing. So, our focus on the near term is on maximizing the opportunity in the organic business. But as always we are interested in acquisitions that would allow us to broaden and diversify our sources of revenue.

Hugh Miller - Sidoti & Company

Okay. Great. Obviously you guys have mentioned that the tax rate implied for 2008 in the 39% to 41% area. But can you talk about 2009, I mean, is it more likely that we will probably see they are heading towards roughly 43% next year?

Jim Rucker

I think at this point Hugh, it is difficult to be that clear on it but I think, for the full year '08, the expectation is for tax rate around 40%, I gave the range of 39% to 41%. I don't see any particular reason why at this point it would be too different in '09 to the full year of '08.

Hugh Miller - Sidoti & Company

Have you updated us at all on the CapEx guidance? I didn't notice anything there, but any update on that for this year, and any thoughts for next year on that?

Jim Rucker

No update on the CapEx guidance for this year, so in line with previous expectations. I would expect that, we wouldn't update '09 CapEx until our first quarter call.

Hugh Miller - Sidoti & Company

Okay. Thank you.

Jim Rucker

Thank you.

Operator

Your next question comes from the line of Howard Chen from Credit Suisse. Please proceed.

Howard Chen - Credit Suisse

Hi, everyone.

Jim Rucker

Good morning, Howard.

Rick McVey

Good morning, Howard.

Howard Chen - Credit Suisse

First, just a broader question for Rick and/or Kelley, in the past few years the credit asset class has seen growth in the derivatives volume in CDS outpaced that of the high rate bonds. As you hit the road and speed the clients, is there any qualitative color, that we might be seeing that reversed a bit in the near term given increased worries about counter-party risk, et cetera. Are you hearing any of that from clients?

Rick McVey

I think it is too early to tell. I do think that credit investing is returning to more traditional securities, and we have seen in past cycles when credit spreads increased significantly, as they have over the past four quarters, once you start to see stabilization, and turning point typically, institutional investors will commit more capital to the asset class and start to come back in primarily through corporate bonds.

I think you're right in CDS the market is suffering because of the counter-party concerns in the market today, and the deleveraging that is taking place among hedge funds in particular. I think that can only be addressed if the market structure becomes more sound through the move to central clearing and central trading venues. So we see that as an opportunity for us going forward that would be different than in the past even in what might be a smaller market for CDS in terms of total trading.

Howard Chen - Credit Suisse

Okay. Great. And then, Jim, apologies if I missed this in the prepared remarks, but can you just touch on where and how you're investing the cash, what you have today? I know you've had some I believe auction rate securities exposure in the past. Could you just give an update there on how things stand?

Jim Rucker

Our cash is all invested either in strongly-rated money market funds, or highly-rated municipal securities of pretty short maturities, less than two years. So, the portfolio is very strong. In terms of the auction rate securities, as of quarter-end we have $7.7 million in auction rate securities.

One of those for a value of $1 million is since redeemed and we have also been advised by the investment manager that manages the remaining $6.7 million, that they will purchase these back from us at par during the fourth quarter. So we basically will be out of all of the auction rate securities by the end of the fourth quarter, and our cash portfolio is invested in very strong assets.

Howard Chen - Credit Suisse

Okay. Thanks so much, everyone.

Rick McVey

Thanks, Howard.

Operator

You have no questions at this time, sir, and I would now like to turn the call over to Rick McVey for closing remarks.

Rick McVey

Thank you for joining us today. We look forward to talking to you next quarter.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MarketAxess Holdings Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts