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MarketAxess Holdings Inc. (NASDAQ:MKTX)

Q4 2013 Earnings Call

January 29, 2014 10:00 AM ET

Executives

Dave Cresci – IR Manager

Rick McVey – Chairman and CEO

Tony DeLise – CFO

Analysts

Ashley Serrao – Credit Suisse

Jillian Miller – BMO

Patrick O’Shaughnessy – Raymond James

Hugh Miller – Sidoti

Mike Adams – Sandler O’Neill

Niamh Alexander – KBW

Michael Wong – Morningstar Research

Operator

Ladies and gentlemen, thank you for standing by. 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 January 29, 2014.

I would now like to turn the call over to Dave Cresci, Investor Relations Manager at MarketAxess. Please go ahead, sir.

Dave Cresci

Good morning and welcome to the MarketAxess Fourth Quarter 2013 Conference Call. For the call, Rick McVey, Chairman and Chief Executive Officer, will review the highlights for the quarter and will provide an update on trends in our businesses; and then, Tony DeLise, 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 condition may differ materially from what is indicated in those forward-looking statements. For a discussion of some of the risks and factors that could affect the company’s future results, please see the description of Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2012. I would also direct you to read the forward-looking disclaimers in our quarterly earnings release, which was issued earlier this morning and is now available on our website.

Now, let me turn the call over to Rick.

Rick McVey

Good morning and thank you for joining us to discuss our fourth quarter and full year 2013 results. This morning, we reported fourth quarter revenues of $60 million up 24% from the prior year.

Pre-tax income for the quarter increased 12% to $25 million and diluted EPS was $0.41 up from an adjusted $0.38 a year ago. Organic growth was driven primarily by increasing market share and market volumes in our core products. U.S. tax rate volume, were up 15% from the prior year quarter.

Expenses were up 35% to $36 million reflecting ongoing investments in our organic growth and the impact of the Xtrakter Acquisition.

During the fourth quarter, we also reported an accounting gain of $7.6 million or $0.20 per share on the sale of Greenline. We saw growing momentum through the year in our open trading initiatives with increased client and dealer participation and the development of new functionality to facilitate all-to-all trading.

Slide 4, highlights our continued strong growth rates. Annual growth rates were volumes, revenues and EPS in 2013, were in line with our strong long-term averages with variable transaction revenues and EPS rose up 24% in 2013 compared to 2012 and total revenues up 16%.

Record transaction revenues for the year were driven by market share gains and record volumes across our core products, high-grade, high-yield in emerging markets. Total full-year trading volume of $694 billion was up 18% over 2012. U.S. high-grade estimated share for the year was 13.8% up from 12.4%. High-yield trading was our highest growth area with estimated market share up more than 200 basis points year-over-year, the 5.2% in 2013.

While no regulatory tape exists for EM, based on available information from EM-Tape, we estimate that our market share of the EM external debt market also increased by approximately 1 percentage point year-over-year.

Based upon these results, our board approved an increase in our quarterly dividend to $0.16 per share. In addition, our board approved a $35 million share repurchase plan primarily to offset dilution from stock compensation.

Slide 5, provides an update on market conditions. Combined U.S. high-grade and high-yield TRACE volumes for 2013 were up just 5% compared to the prior year. Corporate debt outstanding continued to grow at an, healthy pace on the back of record new issuance. 10-year treasury, yields rose steadily throughout the year reaching 3% in the fourth quarter, to the highest levels into the second quarter of 2011.

Meanwhile, credit spreads tightened significantly towards the latter part of the year, and despite continued outposts from taxable bond funds, demand for credit bonds outstrips supply. Their current secondary trading environment featuring strong demand and low dealer inventory creates challenges for investors speaking to add bonds to their portfolios.

Primary dealer holdings of high-grade and high-yield bonds picked up modestly. At the end of the year remained depressed compared to historical levels ending the year at $21 billion or slightly more than one day of TRACE volume. With the incoming regulatory capital requirements, we believe that pressure on primary dealer balance sheets will continue, reinforcing the need for new liquidity solutions in the market.

Slide 6, provides information on our progress in open trading. Our high-grade market share gains were more modest in the fourth quarter than long-term averages. While bid wanted hit rates were healthy at 85%, offer wanted hit rates declined due to the supply-demand imbalance.

Market turnover of outstanding corporate debt remains almost equivalent to the lowest change during the credit crises of 2008, reflecting the ongoing liquidity challenge in the bond markets. If U.S. high-grade bond turnover returned to a long-term average of around one-time per year, TRACE volume would be almost 50% higher than 2013 levels.

We continue to believe that connecting our dealer and investor participants through a range of innovative trading protocols will help to improve overall liquidity and turnover in credit products. In the fourth quarter, 75% of investor increased, were sent to the market list open order book compared to 40% in the prior year quarter.

Over the course of 2013, over $600 billion in live orders were available on market list resulting in over 14,000 open trades among system participants. Region open trading enhancements expand market-list for dealer initiated in, an offer-list orders, improve order matching alerts to system participants and add protocols designed to address larger trade sizes. With three trading days remaining in January, we currently expect high-grade market share to be modestly below the fourth quarter average and well above last January.

Slide 7 provides an update on SEF-regulations. Since the implementation of SEF rules in early October for permitted transactions, the industry has seen a rapid decline in the electronic trading of swaps. We currently estimate that less than 10% of CDS index trading is taking place on SEF.

Electronic CDS volume on MarketAxess was up over 100% in the first three quarters of 2013 versus the prior year that fell 80% after SEF rules were implemented in October. The highly prescriptive CFTC SEF rules bringing documentation, counterparty credit, trade execution and curling challenges for industry participants. As a result, most swap trading is currently conducted away from SEF in the short term.

The CFTC made available in trade determinations have been finalized for on the run CDS industries and mandated SEF trading will begin in late February. At that time map CDS index below the block trading thresholds will be required to trade on SEF’s resident permitted to trade on SEFs. We estimate that approximately 75% of CDS index trades and 50% of CDS index volume will fall below the block trading exemption and will be subject to SEF trading requirements.

So, I need to provide an update on Europe. We continue to make progress with our European strategy to develop a comprehensive solution for trade execution, data and post trade services.

In the last couple of months, we have started to see the impact of renewed client engagement with a 30% increase in trading volumes from European clients in December and January compared to the same period a year earlier.

We are further expanding our suite of data products to enhance transparency in European fixed income markets consistent with the upcoming MiFID II regulatory requirements. We are also investing in broad transaction reporting services for dealers and investors in order to comply with upcoming MiFID II and near regulations.

We expect Xtrakter’s business to be accretive to earnings beginning in the second half of 2014, as our investments in technology and new product development begin to drive an increase in revenues and operating margins.

Now, I would like to hand the call over to Tony, for additional detail on our volumes and financial results.

Tony DeLise

Thank you, Rick. Please turn to Slide 9 for a summary of trading volume across product categories. Our overall global trading volumes were up 15% year-over-year to $171 billion. U.S. high-grade volumes were $106 billion for the quarter, also up 15% year-over-year.

Lower offer-wanted hit rates coupled with order flow favoring the offer side combined to reduce our market share gains in the fourth quarter. Volumes in the other credit category were up 13% compared to the fourth quarter of 2012. Year-over-year market share gains and high-yields were the primary driver of the others credit category improvement.

Slide 10 displays our quarterly earnings performance from continuing operations. Revenues of $60.4 million were up 24% from a year ago, principally due to a 14% increase in trading commissions and the inclusion of extractors post acquisition results.

Total expenses were $35.7 million up 35% from the fourth quarter of 2012. Excluding the Xtrakter operating expenses, total expenses were up 9% year-over-year and reflect the ongoing investments in people and technology to support open trading CDS and other initiatives.

Our diluted EPS was $0.41 compared to an adjusted $0.38 per share one year ago. For comparative purposes, the fourth quarter of 2012 tax provision has been adjusted to exclude a non-recurring favorable income-tax adjustment of $66.7 million or $0.18 per share related to certain acquired tax loss carry-forwards.

On slide 11, we have laid out our commission revenue trading volumes and fees for million. The 15% year-over-year improvement in variable transaction fees was due entirely to the increase in overall trading volume.

U.S. high-grades fees per million were $184 in the fourth quarter down $8 per million from the third quarter. As mentioned on the third quarter earning call, one dealer migrated from the all variable high-grade plans to the major plans during the third quarter and a second dealer followed the same path on October 1.

As a reminder, dealer move misdirection typically results in an increase in distribution fees and an offsetting decrease in variable transaction fees. At current volume levels, a single dealer migration impacts fees per million by roughly $5.

Fees per million in the other credit category were $321 in the fourth quarter up from $291 a year ago and from $317 in the third quarter. The year-over-year improvement is due to trading mix favoring high-yield volumes. Similar to the third quarter, emerging market and high-yield volume accounted for approximately 85% of the other credit category volumes.

Distribution fees were $16.1 million during the fourth quarter. We currently expect that first quarter 2014 distribution fees would be similar to the fourth quarter level.

Slide 12, provides you with the expense details. Fourth quarter 2013 expenses were $35.6 million up 3% sequentially from the third quarter. The fourth quarter and full year 2013 expenses were right at the mid-point of the updated guidance we provided on the third quarter earnings call.

The sequential decline in employee compensation and benefits is almost entirely due to lower variable expensive compensation. And the sequential increase in depreciation and amortization is largely attributable to our replacement primary production datacenter coming online late in the third quarter.

During the fourth quarter, we consolidated office space in London, and sub-let the legacy market access location. Fourth quarter 2013 expenses include a loss on the sublease and duplicate rent totaling approximately $600,000.

On slide 13, we provide balance sheet information. Cash and securities available for sale at the December 31, were $200 million compared to $180 million at year-end 2012. During 2013, we expanded approximately $38 million to acquire Xtrakter, a cash dividend totaling $20 million and spent $23 million on capital expenditures.

Cash flow from operating activities generated during 2013 was $91 million were more than sufficient to cover the investment and capital return. There was no change in our capital structure during the fourth quarter, we have no bank debt outstanding and didn’t borrow against our revolving credit facility.

On slide 14, we summarize our capital management activities. Our recurring quarterly dividend remains an active part of our capital management priorities. With the announced increase to $0.16 per share, we’ve now increased the quarterly dividend in four consecutive years.

We’ve also increased our investment in open trading, CDS data and other organic initiatives including several new datacenter build-outs. We expect these investments to help drive future revenue growth.

Today we also announced the $35 million share repurchase program. Since the date of our last major repurchase in connection with the JPMorgan secondary offering in February 2012, our diluted share count has increased by almost 700,000 shares.

The purpose of this new program will primarily be to offset the increase in our diluted share count principally resulting from annual equity grants. We expect the program to live later in the first quarter.

We remain focused on capital management and investment in organic initiatives through our existing cash position, strong cash flow generation in line with credit borrowing capacity, we have the flexibility to meet our capital management’s investing priorities.

On slide 15, we have laid out our 2014 expense, capital expenditure and income tax rate guidance. We expect that total 2014 expenses will be in the range of $150 million to $157 million. The mid-point in that range suggests an approximate 9% increase in expenses over the second half of 2013 run-rate.

Employee compensation and benefit costs are expected to represent a little over 50% of total expenses, consistent with the trend over the past several years. The increase in depreciation and amortization reflects the higher level of capital expenditures in 2013 and 2014.

We expect another heavy year of investment in 2014 and estimate the capital expenditures will be between $17 million and $20 million, was about evenly between software developments and IT related equipment and software.

We expect the effective tax rate for full year 2014 will be between 37% and 40%. After adjusting for one-time items, the effective tax rate in both 2012 and 2013 was approximately 38%. Among other items, the mix of U.S. and foreign source income and change in tax rate could cause variations in the effective tax rate.

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

Rick McVey

Thanks Tony. 2013 was another strong year of growth for our core business in high-grade, high-yield and EM. Our dealer and investor clients continue to embrace electronic trading for a growing percentage of their credit trading activity.

Regulatory changes create new opportunities for open trading, transaction reporting, CDS and data products. We are pleased with our progress to expand our service offering in these large and important areas for our clients.

The combination of market driven demand and regulatory change creates an attractive environment for growth for the company. And we are excited about the opportunities they had in 2014 and beyond.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question comes from Ashley Serrao from Credit Suisse. Please go ahead.

Ashley Serrao – Credit Suisse

Good morning. Rick, it feels like two of the key hurdles for further buy side engagement in all-to-all trading are, maybe obtaining a reliable reference prices to price bonds and then compliances is designed for price takers. So I was hoping you could share some color on, your current real-time conversations with clients here. And also, your thoughts on the timelines for these two elements to involve?

Rick McVey

Sure, thanks Ashley and good morning. Absolutely, real-time price data is a core ingredient of moving toward a more open architecture. And they are moved by regulators to promote transparency certainly helps with the trades tape here in the U.S. and the method two consolidated tape planned in a couple of years. So there is more a transaction data out there and then you see analytical services and companies continuing to add pricing capabilities in real-time to expand beyond the set of reported bonds.

And we are working with ITC and importing prices from other service providers to help investors with that task. And we will continue to do so until those analytical capabilities continued to advance.

I think your second question relates to best execution requirements. And you’re right to point out that many of the investor best execution guidelines are antiquated from moving into an environment of all-to-all trading. Because in many cases the guidelines reflects getting three or more dealer prices. And we do see some movement in that and by the way this is not an SEC restriction, the SEC provides plenty of room for investor judgment on best execution. It’s just the default that many investors have used in the past.

So, we do see some progress there with investors using independent pricing from other sources as a means of demonstrating best execution. And I don’t think that that will be well, a meaningful obstacle in the progress on open trading.

Ashley Serrao – Credit Suisse

Great. Thanks for all the color there. And I guess, maybe switching to expenses, I thought it was like a meaningful ramp-up this year. And maybe if you could share some color on the revenue side, I presume Xtrakter will play a key role there. So, any color on what’s more hang-through, it was more aspirational. And just you’re thinking about the revenue side of the equation in general? We appreciate it. Thank you.

Rick McVey

And that specific to Xtrakter assay?

Ashley Serrao – Credit Suisse

Yes, Xtrakter and otherwise as well?

Rick McVey

Yes. So, with respect to Xtrakter, no real change there in the strategy and the growth expectations. The revenue growth really we think comes from two primary areas. One, continuing to develop and distribute high quality data products. And we have been working both internally to develop those products as well as with our dealer investor clients to make sure that we’re promoting volume and price information in a way that it’s constructive to the market and helpful to liquidity.

And the other area is continuing to expand our post trade services and especially around transaction reporting and trade matching. And the transaction reporting requirement in the past has been limited to the dealer community. It’s now moving out to the investment management industry. And we are expanding our services to be able to help those clients with transaction reporting. And we also see more opportunities to use the data we have within Xtrakter to promote real-time trade matching.

So those three main areas really drive most of what we expect in the revenue increase that lead to the comments that we made earlier about our hope that Xtrakter will be accretive to earnings in the second half of this year. And all of that is consistent, we also think with our core mission of also developing a broader electronic trading market in Europe.

Ashley Serrao – Credit Suisse

Thanks for taking my questions.

Operator

Thank you. And our next question comes from Jillian Miller from BMO. Please go ahead.

Jillian Miller – BMO

Thanks guys. Sticking with the Europe topic, I think you mentioned that the training was up like 30% year-on-year in January. And I was just wondering how much of that is related to share gains because of some of this other data versus just general market strength?

Rick McVey

Jillian, it’s – we don’t think it’s on those volume improvements are coming on the back of increase in trading and overall market trading volumes. We do have some increased visibility on trading volumes coming out of Europe and we think it’s probably half of the trading volumes we see here in terms of high-grade trade volume. So we don’t think it’s on the back of the improved overall market volumes.

And Rick’s comments were sort of a combination of both December and January, so, what’s interest for the one-month period. And just important to note when, when we talk about volumes coming from our European clients, it’s not just euro bond volumes, our European clients are very active in emerging market high-grade in particular. So they are – those volume improvements are across multiple products including what we consider North American credit trading product.

Jillian Miller – BMO

Okay, got it. So, it’s not euro bonds that are 30% trading from European clients as of 30%?

Rick McVey

Correct.

Jillian Miller – BMO

Okay, got it. And now I just want to confirm, the U.S. high-grade, investment-grade compression. And I’m interpreting your comments right, that that was related to the dealer migration to that new plan versus anything going on with the yield curve or other factors?

Rick McVey

Yes. So, Jillian, yes, if you look at sequential quarters, third quarter to the fourth quarter, it is almost 100% of that variance that $8 per million was the migration of the dealers. And mention that prepared remarks when we have also you can see, one dealer migrating in the direction that happened which was going from the all variable plans for the fixed plan, it’s roughly $5 per million in variable fees, neutral to overall revenues with $5 per million in variable fees.

Jillian Miller – BMO

Right.

Rick McVey

It’s beyond – it’s a little more complicated when you get the comparisons from the fourth quarter of last year 2012 to fourth quarter of 2013, there is lot more noise in there. We have the dealer migrations would have been a negative to speak after. But we had interest rates rising, all things equal, that’s a negative. We have longer duration which would have been positive. And also another positive, this is year-over-year again, our dealers on the all-variable plan they continue to win more trade. So that’s a little more complicated year-over-year. It’s easier to explain sequential third quarter to fourth quarter.

Jillian Miller – BMO

Okay, got it. And then, on capital, in the demand, I guess that you guys want to hold on the balance sheet kind of in flux at the moment from what I understand just because you’re acting more often as restless principle on the all-to-all transactions.

So maybe you can fill us on kind of what your plans are there, like how much cash – do you like you need the whole based on what you’re doing currently. And then, if you’ve made any decisions with respect to whether you’ll look to outsource that kind of little manned position to dealers eventually or is it’s something you think you can monetize and want to keep doing?

Rick McVey

Yes, on the first question we’re very comfortable with our capital position even with the return of capital that we’ve outlined this morning and the increased dividend and the new share repurchase plan. So, we are in very good shape for the kind of business and the amount of business that we’re clearing. And it should be for the foreseeable future.

We’re really like most things taking our lead from clients in terms of how they would like to clear open trades. And we have a variety of solutions available to them, both through us and also through traditional counter parties. So, it’s difficult to predict how that will play out during the coming year or two. But right now we’re very comfortable with our balance sheet position given the amount of clearing that we expect to do.

Jillian Miller – BMO

Okay. And then, just one final numbers question. The loss from the sublease, is that like a one-time thing or should we expect occupancy expense to stay elevated?

Tony DeLise

Yes. But Jillian that loss on the sublease and the duplicate rent element of it as well. If those are one-time. So we exited the legacy MarketAxess space, we exited some Europe facility that Xtrakter was occupying. We leased new office space. We moved in right in the middle of the fourth. That sublease is a one-time charge.

Jillian Miller – BMO

Okay. Thanks guys.

Operator

Thank you. And our next question is from Patrick O’Shaughnessy from Raymond James. Please go ahead.

Patrick O’Shaughnessy – Raymond James

Hi, good morning guys.

Rick McVey

Hello Patrick.

Tony DeLise

Hello Patrick.

Patrick O’Shaughnessy – Raymond James

So, my first question is, obviously one of your better growth stories has been high-yield corporate bonds. And I’m looking at the industry-wide volumes in high-yield. And it’s been pretty lackluster even though we’ve seen investment grade really bounce back so far in January, high-yield really hasn’t. So, can you talk about the industry dynamics that are taking place with high-yields such that trading volumes there just aren’t as robust as what we’ve seen over the past year?

Rick McVey

Yes. When you look at the combination of high-grade and high-yield, you might get a better read Patrick. And that’s where I mentioned earlier in the call, for the full year in 2013, the combined volume was up about 5% or so. But part of the reason is to upgrade, where certain large high-yield issuers have now moved up to investment grade. So that’s a piece of this story. But I do think that you’re seeing a slight increase overall in TRACE volumes when you look across the two product areas.

Patrick O’Shaughnessy – Raymond James

Okay. That’s fair. And then, moving on to CDS, so, couple of days ago, intercontinental exchange kind of put out a press release about a CDS trading platform that they’re going to have and they’re going to have three dealers I believe streaming quotes. Can you talk about just – how do you feel about the liquidity providers to your CDS offering and how you think that – what you are going to offer is going to stack up to some of the other ventures that are out there?

Rick McVey

Sure. I think developments in the electronic CDS market continue and different approaches and different models are out there as you would expect. I could be wrong but I don’t think the recent announcement necessarily so they had three dealers streaming quotes. I think they said three dealers participating. And one of those dealers talked about their role as agent for bringing clients on to the platform as opposed to principle for market making.

So, we’re – we’re really pleased with the progress that we’ve made on our own central and middle order book. And we have a great partner to begin with in Barclays, who continues to expand the markets that they make on the platform and is on-boarding more and more end clients each month.

And we and Barclays both remain open minded about expanding the platform with more investors and more dealers at the right time. But we’re very pleased with the progress that we’re making on the platform. And obviously one of the big benefits that we have is all the buy-side connectivity that already exists here.

Patrick O’Shaughnessy – Raymond James

Okay, great. That’s helpful. Thanks. And then, last question from me. So as we’re talking about Xtrakter and becoming accretive in the back half of this year. Does that imply that you’ve already begun the sales process for some of these Xtrakter products that you’re going to be rolling out, presumably the sales cycle there is going to be at least a few quarters right?

Tony DeLise

Yes, it will be Patrick. And Rick had mentioned in his remarks that we are active out there, we are rolling out new products. We’re in front of clients right now. And I suppose on the data side and on some of the new trade reporting services. And just the other side of the equation on the margin side or incremental to margins is the expense side.

And we’re pretty much there in terms of ramping up, the ramp up we experienced in 2013 and in the Xtrakter related expenses. If you looked at the expenses for the fourth quarter there was some comment in the earnings release around fourth quarter Xtrakter expenses. That’s probably pretty representative of the expense run-rate for Xtrakter in 2014.

So, the combination of expenses leveling off then, we’re – as we ramp up on the revenue side on the data and both the trade reporting side, that’s when we can get through this accretive situation in the second half of 2014.

And there is one other element to bear in mind, when we talk about accretion, we’re also absorbing the amortization of intangible assets created on the acquisition. So when you go through purchase accounting, you allocate the purchase price, the very fact that you’re acquiring one of the elements or intangible asset.

That’s sort of overhead or overhang for the amortization of intangibles was about $2.5 million. So, we’re including that when we say that we expect the Xtrakter to be accretive beginning in the second half of the year.

Patrick O’Shaughnessy – Raymond James

All right. Got you. That’s very helpful. Thank you guys.

Rick McVey

Thanks Patrick.

Operator

Thank you. And our next question comes from Hugh Miller from Sidoti. Please go ahead.

Hugh Miller – Sidoti

Hi, good morning.

Rick McVey

Good morning, Hugh.

Tony DeLise

Good morning, Hugh.

Hugh Miller – Sidoti

So, I guess, I had a question following up on the CDS trading opportunity and those questions that you’ve previously answered. Given how close we are against to the commencing of that trading. Can you just talk about what you guys are kind of expecting with regards to the pricing and anything you’re hearing on the pricing competition side?

And then, as we think about the single-name trading aspect in that opportunity, is there anything more that you’re hearing out of the SEC about making some headway there on rules?

Rick McVey

Sure. I think it’s still an open question. I can tell you first hand. And I’m sure every other staff would say the same thing. The expenses are very real. So, one would expect that as we get through the finalization of the rules that there would be sensible pricing in revenue models that begin to emerge in assessed phase. And we would expect at the beginning into the second quarter, we would have a modest revenue event from our CDS index activities.

So, as you think we’ll probably see some changes around pricing coming up in the next several months. I’m sorry, the second question Hugh was?

Hugh Miller – Sidoti

Just with regards to the SEC and progress with single-name trading and rules there and your expectations as we look at 2014?

Rick McVey

We really haven’t heard anything at all from the SEC with respect to their time table on single names. They obviously have a full plate, we’re not aware of anything that has been publicly stated by the SEC in terms of when they would expect to get to their rules.

So our plan for 2014 is really about building out the organic single-name CDS trading platforms. And we do not expect to have any significant regulatory change throughout this year.

Hugh Miller – Sidoti

Okay, all right. And as you talk about the expense guidance that you’ve given out, I guess, at the mid-point coming in to touch higher than what we were looking for and a little bit higher I guess you guys were talking about high single-digit rate off at the second half of ‘13 which was a bit elevated. But, can you just give us a sense of what’s kind of driving a little bit of more expense growth, is it – is it more of the Xtrakter deal, is it investment for CDS, is it the open trading protocols?

Tony DeLise

Sure, sure Hugh. We thought the second half was better compared to – or better jumping off point compared to 2014. We stated about 9% increase that’s a mid-point. And when you look at the biggest expected increases, as you’d expect it’s in employee compensation and benefit. It’s a little over 50% of where we’ve been in terms of total expenses.

The expectation, it was fully staffed up based on our plans. The expectation is headcount would be up another 10% plus over what you see at year end. And the areas where we’re adding people are the areas you expect would be adding people. It’s in technology and sales related areas and it’s around the new initiative.

So, yes, it’s exactly where we expected to happen. Quite frankly I think the – after reading some of the notes this morning and looking back at the estimates for next year, I think one of the – one area where you’re all playing catch-up on is in the depreciation and amortization area.

We’ll have – if we hit that CapEx plan for 2014, $17 million to $20 million or there about. We’ll have spent over $50 million on CapEx from the past three years, 2012, ‘13, ‘14, over $50 million. I think when you revisit your models you’re going to see that – it’s the depreciation area where you’re going to play a little bit of catch-up.

Outside of employee compensation and benefit, headcount driven, outside of depreciation and amortization, driven by CapEx spending. If you look at all the expense categories and what we’re inferring from that is that it’s largely inflationary type increases in those other expense categories, outside of comp and benefits and depreciation and amortization.

Hugh Miller – Sidoti

Okay. That’s very helpful. And I guess, switching gears as we think about kind of your efforts with open trading and some of the advances you’ve made there this year in 2013 and then last year in 2013, as you head into ‘14. Should we still be thinking about growth in market share similar to kind of grinding out we’ve seen in prior years with couple of hundred basis point rise in market share? Or do you anticipate that this could be the year where you start to see kind of an inflexion point with share growth?

Rick McVey

Yes, we are ramping up our investments Hugh. Because we expect an acceleration in electronics share at some point. And our views are shared broadly by the industry and by the various analysts that cover our industry when you look at the projections that are out there for the likely electronic share in credit over the next two to three years.

It’s very difficult to anticipate the pace of share gain, especially given that open trading is brand new and involves a fairly significant change in trading process for investors and dealers and other market participants. But clearly, whether you look at bonds or swaps or even Xtrakter, we’re investing heavily because we think electronic solutions and connectivity and post trade services are going to be a much larger product of the market environment over the next three years.

Hugh Miller – Sidoti

Okay. And have you started to see any kind of change in the institutional client’s you’re working with and their willingness to kind of become more of a market-maker as opposed to just take a price from the dealers and changing kind of the way that they go about investing?

Rick McVey

Well, I would take issue with the term market-maker. We don’t see any of them that want to be in the market-making business and we’re seeing a change in behavior in terms of being willing to lead with a price when they see a potential match in the system, we absolutely are.

So, we’re delivering an awful lot of trade opportunities through market list every day. And the solutions that we have to increase the sophistication of the alerts that our investors are getting – continuing to grow each quarter. And with that combination, yes, we are seeing a significant ramp-up in the places back in market-list orders which is leading to the growth in trades.

So, that behavioral change is still in the first inning. But it is underway, but in no way do we see any investors that are trying to directly compete with the market-making business. But they are starting to change their behavior so they can respond with the price when they have a trade match.

Hugh Miller – Sidoti

Sure. I certainly understood, I apologize for the terminology of use of market-making. But that’s what I meant, with the change in their behavior and willing to kind of go out there and then lead with the price. But anyway, I thank you for the insight there. Very helpful.

Rick McVey

Thank you, Hugh.

Operator

Thank you. And our next question comes from Mike Adams from Sandler O’Neill. Please go ahead. Mr. Adams, please check your mute button.

Mike Adams – Sandler O’Neill

Sorry about that, can you hear me now?

Rick McVey

Hi Mike, we can.

Mike Adams – Sandler O’Neill

Good morning guys. So, a couple of questions here. One, on the market share in high-yield, I appreciate the disclosures you added to the deck of this quarter. But could you give us a sense for the high-yield quarterly market share trends maybe exiting the year, was that above the overall full-year market share of 5.3%?

Tony DeLise

Mike, it was slightly above the average for the year. And if you look at it year-over-year, and I’ll just give you one sort of data point would be for the fourth quarter, well that’s about 200 basis points year-over-year in the fourth quarter. And that ramp up happens throughout the year, it did peak in a similar to high-grade market share. It did peak in the third quarter. But there was a ramp throughout the year.

Mike Adams – Sandler O’Neill

Okay, great. And then, Tony, following up on some of your comments on the buy-back. It sounds like you know, it’s not really offsetting future dilutions, it’s actually going to be plain order but it will catch up on some of the share dilutions on 2013. Is that the right way to think about it, so that diluted share count should come down over the course of the year?

Tony DeLise

Yes, Mike, I think that’s the way – that’s the way to look at it. And this is a new program that the board adopted. We said it was to offset the increase in the diluted share count. It has crept up in the last – in the last seven quarters now.

We’re going to setup a – it’s viewed as a maintenance type program, we’re going to setup a 10b5-1 plan. We’ll be in the market for small amounts of repurchases each day. It really wasn’t meant to be this sort of large opportunistic. But we obviously have the capacity to do something if the opportunity presents itself.

But think of it more as a maintenance program and you think about being in the market throughout the year. It’s not – yes, you can do the math – it’s not a big, it’s not a big program. And today the price sits – it’s roughly 600,000 shares. If we’re in the market accordance with this 10b5-1 program, it’s probably in the course of a year where we’ve exhausted the program.

Mike Adams – Sandler O’Neill

Got it. That’s it guys. Thanks. Congrats again.

Rick McVey

Thanks.

Tony DeLise

Thanks Mike.

Operator

Thank you. And our next question comes from Niamh Alexander from KBW. Please go ahead.

Niamh Alexander – KBW

Hi, good morning. Thanks for taking my questions.

Rick McVey

Hi Niamh.

Niamh Alexander – KBW

If we could talk a little bit about the fourth quarter, I guess, just on the high grades and some of big revenue lines being an important earning driver. How do we think about maybe why the market share peaks, usually we’re used to kind of seeing a bit of a spike in the fourth quarter and then market share comes off typically in the first quarter because there is so much issuance the primary is scattered. So, what can you share there about maybe the market share is dropping off a bit in the fourth quarter and what can you share about January so far?

Tony DeLise

So, Niamh, you’re right. On the fourth quarter we’re affording volumes every month. You see the market share. You see the TRACE volumes. If fourth quarter market share was down about 100 basis points over the third quarter, up slightly from the fourth quarter of last year, honestly it sort of bucked the historical trend here. It’s rare where we would see that sort of decline from the third quarter to the fourth quarter.

But when we look at market share, we always say it’s a function of client order flow and hit rate. But when you get more granular, it’s a mix of flow between the bidding or it’s hit rate, on the bid side if hit rate is on the offer side, it’s new issuance block trade. There is a lot of other elements in between it.

We just – we’ve finished a four-consecutive quarters ending with the third quarter where we had flow favoring the bid side. And we had a healthier offer side hit rate, we move into the fourth quarter and we had this sort of inverse happening where we have flow favoring the offer side. And then we had hit rates on the offer side which were extremely low.

And we’ve had pockets like this before. If you look back at October of 2012, you’re going to see a similar situation. If you look back beginning in 2009 when the market was turning and it was very much an offer wanted market. You’ll see that same kind of experience.

I’ll give you this one little – one other sort of data point here. If you look at December, and December was a very good month for us. It was 15.4% market share. It was a good month. It could have been better. It was – we had a lot of enquiries flow coming in, but we had a situation which was very heavy offer wanted. We had the offer side hit rate was down to crisis level, below 50%. So, it was good as it was.

In December it was still a challenging environment for us. So, this could set some of the comments that Rick made earlier about providing solutions to help to cope the liquidity challenges. And we went through a pocket just now in the fourth quarter. It’s hard to dig out of that October-November situation with the offer wanted, lower offer wanted hit rates. How hard to dig out of that one. And when come to January one, Rick did make a comment that January share rate now is modestly below the fourth quarter level. Typically in January…

Niamh Alexander – KBW

It’s for high-grades not high-yields right?

Tony DeLise

For high-grade correct.

Niamh Alexander – KBW

Thank you very much, okay.

Tony DeLise

And typically, you’ll see – it’s a pretty dramatic decline. It’s probably a 100 basis points decline between the fourth quarter and January. So the view we’re giving you or this early read on January suggests that you’re not going to see that type of typical decline there. The market is little bit different here in January, it’s more of a bid-wanted market. Hit rates have been changed but the market has turned a little bit in terms of the order as well.

Niamh Alexander – KBW

Okay. That’s helpful. Thank Tony. I appreciate it. And then, the high-end of the emerging markets, can you talk a little bit about the current environment because with the emerging markets, sorry, I guess middle of last year, the big challenge in the industry was like – I guess the offer wanted again, I mean, liquidity kind of dried out.

And you were one of the few electronics that people turn to. So, what can you share about the current environment, are you seeing a lot more kind of similar kind of trend like a lot of people trying to sell or – you’re kind of seeing better hit rates in those sickle markets right now?

Rick McVey

The EM environment is definitely choppier than the U.S. high-grade or high-yield environment. There is political unrest, there is concerns about growth rates in the markets has just been more volatile and choppy. And that – the best proxy we have is looking at M2 volumes that are released quarterly. And a portion of EM corporate comes through on TRACE.

And it did look like the second half market volumes came off in EM relative to what we saw in high grade and high yield. But these are all estimates based on the best information that we can get. So, not the overall environment is quite as healthy as it is in high-grade and high-yield but the good news is, EM is consistent with the other product areas. And that everything that we can tell we continue to gain share.

Niamh Alexander – KBW

Thanks Rick, I appreciate it. And then just lastly if I could, and Tony you said we all kind of have to catch-up of the DNA. I guess, we just didn’t know when all this CapEx was going to kind of translate to the revenue generation phase where you were going to start recruiting the DNA. Can you guide me to maybe it’s a good geography but you already seem like the Xtrakter should be free until second half.

Which areas should we be looking forward kind of build up the revenue, could we expect higher revenue with the higher expenses, I mean, investment payback. Is it the information post grade services or we should look for more of that or is it the technology or is it more you’re expecting just more on the trading side?

Tony DeLise

Niamh, we’re not – we really don’t give the guidance around the revenue expectations. So I’ll try and give you a couple of data points and help you zero in a little bit. The revenue growth for next year will not come from that x-services line. Yes, it’s a small piece of what we’re doing, it’s less than 3% of our revenue and that’s not where the growth is going to come from.

There are expectations on that information on post grade services line, as Rick mentioned a couple of times around growing data revenues and post grade services. There is some expectations of revenue growth there. You’re going to see growth on that line year-over-year just by virtue of the fact that Xtrakter is in there for 12 months. But over and above that that 12-month adjustment. Yes, there is some expectation of revenue growth there.

And you know what drives our business, what drives our business is market share gains and we’ve got that one big line there for commission revenues. So, when you’re doing your modeling just like we do our modeling here, it’s still very much a commission driven outcome. So, it’ll come from that commission line, some contribution from information and post trade services and then the tax service lines today are small piece of what we’re doing.

Niamh Alexander – KBW

Okay. That’s helpful. Thanks and I appreciate it. And then lastly if I could, with respect to open trading and overall, especially the level of integration to the order management systems, I mean, we’re really interested in that aspect and as you roll out to more debt. Help me understand are there few big kind still to catch there or to kind of you can walk not finance obviously but maybe in terms of timing, how that progresses – how are you making progress there?

Rick McVey

Niamh, it’s an important piece because trading efficiency and connectivity we think is a key part of being successful in open trading. And as you know, we’ve being doing a lot of work with BlackRock Aladdin around system integration for BlackRock and the other Alladin clients which totaled approximately 60 investment management firms.

And it’s really compelling to see how trading efficiency has improved for Aladdin clients with the integration of market list orders into the Aladdin order boarders to make it easier for those clients to identify potential trade matches and provide a price on market list increase. So, we’re very pleased with that. BlackRock has been through their word of being very focused on Aladdin integration and improved efficiency for Aladdin clients.

They’ve also been leading the pack with respect to trading activity and order flow in them market list, so we’re very pleased there. But we are consistently finding new ways that we can also increase that level of efficiency for clients beyond the lag. So, the ecosystem is growing so that the technology can really be much more relevant to clients in terms of the way that display trade opportunities to them throughout the trading days. So, this is a key part of what we’re investing in and we made a lot of progress in the fourth quarter, especially with BlackRock Aladdin and more to come in 2014.

Niamh Alexander – KBW

Okay, fair enough. Thanks Rick.

Operator

Thank you. (Operator Instructions). And our next question comes from Michael Wong from Morningstar. Please go ahead.

Michael Wong – Morningstar Research

Good morning.

Rick McVey

Hello Michael.

Michael Wong – Morningstar Research

Are there one time projects in the 2014 CapEx budget or is this a fairly normal level going forward?

Tony DeLise

That’s a good question Michael. I’d say certainly both 2013 and 2014, I wouldn’t call that the normal run-rate or sort of normal maintenance run-rate for CapEx. And right now there is sort of one – at least one discreet area and that’s in Europe. And today we still reside within the Euro clear datacenters which is part of the acquisition. So our technology environment has been the euro clear datacenters.

We will be moving out of those datacenters. So, there are some what I would call not necessarily one time but big chunky cost that won’t recur every year. And that is one element. But looking at it different way, if you think about what the sort of maintenance, longer term maintenance CapEx would be, I’m going to give you a pretty good range but it’s probably more like $10 million to $15 million.

And we’re still spending a lot on product enhancements on software development, you could see those numbers and we’re pretty transparent about those numbers. It’s been sort of in that $7 million or $8 million or $9 million range. And then you pack on top of that sort of maintenance CapEx and that’s $2 million to $5 million and you add them together and you get, $10 million to $15 million. So, that’s probably the longer term view. And again, 2013 and ‘14 would have some chunky items in there.

Michael Wong – Morningstar Research

Thanks. And can you talk a little bit about commissioning or who has delivery to see or actually two orders on your SEF?

Rick McVey

Sure. They’re all in partial access rules within the SEF rules that require that any participant on the SEF be in a position where they could both send and receive orders. So our SEF does operate in that way.

Michael Wong – Morningstar Research

Okay. And just really quick one, I mean, with changing interest rate expectations, I mean, you’re seeing some increase in volume trades for floating rate debt, I know it has a low variable fee capture. But do you still expect that to climb from here or is it more or less that’s hygienic well growth?

Rick McVey

I think you know, as expectations grow in a rising interest rate environment, it would be reasonable to expect that the interest and floating rate notes will grow. We do report them separately because the fee capture as you point out is very different so that you can track growth in fixed rate business separate and apart from floating rate business.

But overall, we think a rising interest rate environment is going to make the trading opportunities much more interesting and correct. And we have a little snapshot of that in June last year which happened to be our largest month for the year in terms of sharing volume. So, we actually think that the environment overall portrays volume and market activity will be better in a rising rate environment.

Michael Wong – Morningstar Research

Okay, thank you.

Operator

Thank you. And I’m not showing any further questions at this time. I would now like to turn the call back to Rick McVey for any further remarks.

Rick McVey

Thank you for joining us this morning. And we look forward to catching up next quarter.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.

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