MarketAxess Holdings' (MKTX) CEO Rick McVey on Q2 2014 Results - Earnings Call Transcript

Jul.23.14 | About: MarketAxess Holdings, (MKTX)

MarketAxess Holdings Inc. (NASDAQ:MKTX)

Q2 2014 Earnings Conference Call

July 23, 2014 10:00 AM ET

Executives

Dave Cresci – IR Manager

Rick McVey – Chairman and CEO

Tony DeLise – CFO

Analysts

Jillian Miller – BMO Capital Markets

Mike Adams – Sandler O’Neill & Partners

Ashley Serrao – Credit Suisse

Patrick O’Shaughnessy – Raymond James

Hugh Miller – Sidoti

Niamh Alexander – KBW

Michael Wong – Morningstar Equity 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 call is being recorded July 23, 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 Second Quarter 2014 Conference Call. For the call is 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, 2013. 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 second quarter 2014 results. We are pleased to report record revenues this quarter of $65 million in spite of the soft secondary trading conditions in fixed income throughout the quarter. Our momentum is evident in both emerging markets and high-yield trading where we set new quarterly volume records, and in Europe where our client volumes were up 28%.

As a remainder, secondary market conditions in the second quarter of last year were very different on the back of the Fed’s tapering announcement, leading to rising interest rates, higher volatility and wider credit spreads. In retrospect, last year’s second quarter was an anomaly in the multi-year trading environment trends.

Pre-tax income in the quarter just completed was down 2.5% to $29.1 million, and diluted EPS was $0.48 compared to $0.49 in the second quarter of 2013. Expenses were up 6.6% to $35.9 million. These year-over-year comparisons exclude the benefit of the out-of-period adjustment last year for the capitalization of certain software-related expenses.

Our adjusted estimated share of U.S. high-grade TRACE in Q2 was 14%. TRACE reported volumes show an increase on or around April 1 of double reported transactions versus prior years. Based on our own TRACE analysis and conversations with FINRA and several large dealers, we believe this double reporting has the effective increasing TRACE reported volume by approximately 3% versus prior periods. Our market share adjustment reduces trades volume by 3% to eliminate this double counting and make more accurate comparisons to prior periods.

Due to our strong cash flow and excess cash position, our board approved an increase in our share repurchase program from $35 million to $100 million, and a regular quarterly dividend of $0.16 per share. We believe that share repurchases will continue to improve long-term returns for our shareholders.

Slide 4 provides an update on market conditions. Market conditions during the quarter remain largely consistent with the first quarter of 2014. Combined U.S. high-grade and high-yield TRACE volumes were comparable to both the prior year and previous quarter levels, while credit spreads remained near all-time lows.

Credit spread volatility also remained low reducing the need for active portfolio turnover in the secondary markets. The quarter saw continued robust U.S. high-grade new issuance, up 20% compared to the second quarter of last year. The U.S. corporate debt market continues to get larger and is approaching a record $10 trillion. Corporate debt outstanding is up more than 50% since the end of 2008.

We have observed a positive correlation between high-grade new issuance and the percentage of TRACE volume represented by block trades. In the short-term, investor focus on new issuances and higher block trading volumes have a dampening effect on our estimated market share.

Excess demand for corporate bonds is evidenced in their current low level of credit spreads and in the low hit rates for offer wanted business on the MarketAxess trading system. We believe that more balanced order flow would improve overall hit rates.

Slide 5 provides an update on our key areas of investment. Open Trading creates all-to-all trading connections on the network and continues to be a major area of focus for the company. During the quarter, the number of active clients utilizing Open Trading protocols grew from approximately 175 firms to 260 firms. While Open Trading still accounts for a relatively small portion of our overall trading volumes, we are encouraged by the roughly 35% increase in prices back and trades completed in Q2 versus the first quarter.

We are seeing increased Open Trading adoption from both, dealer and investor clients, and we are confident that we are on the right track to build valuable new sources of liquidity for secondary credit markets.

We see continued improvement in our European business. Trading volumes from European clients were up 28% during the second quarter and European revenues were 20% of total company revenues. We are working on a number of enhancements to our Trax reporting, matching and data services in response to new incoming European regulations. Our Trax technology rebuild is on schedule for completion this year.

In CDS, we did see an increase in our CDS SEF volumes in market share during Q2. Important regulatory questions remain on CFTC rule interpretation and SEC rules for CDS single-name trading. In the short-term, aggregate CDS SEF volumes are lower than we expected, and regulatory costs to operate SEFs are far greater than current SEF revenues.

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 6 for a summary of our trading volume across product categories. Our overall global trading volumes were within 1% of the record volumes reported one year ago.

U.S. high-grade volumes were $116 billion for the quarter, down roughly 2% year-over-year. Adjusted estimated high-grade market share of 14% is largely flat with last year’s 14.1%.

Volumes in the other credit category were up 11% compared to the second quarter of 2013, led by record quarterly volumes in both high-yield bonds and emerging market debt. Our reported liquid products trading volumes were down 25%, largely due to the 37% decline in TRACE reported agency bond volumes.

Beginning June 30, FINRA initiated reporting of 144A securities. Based on conversations with FINRA in July month-to-date activity, we believe that 144A securities could add 10% to 15% to high-grade TRACE volumes and more than 50% to high-yield TRACE volumes. FINRA has not yet made available any historical data, so we don’t have the ability today to accurately recast our historical high-grade market share.

Share will go down with the 144 inclusion, but we would expect that the trend line in high-grade market share over the past several years would remain consistent with the previously reported figures, while at the same time the total secondary market opportunity is larger.

Slide 7 displays our quarterly earnings performance. Revenues of $65 million were up 2% from a year ago on higher data sales and technology consulting revenue. To provide a better comparison of year-over-year results, the second quarter 2013 figures have been adjusted to exclude a one-time out-of-period adjustment related to the capitalization of certain employee costs previously expense has incurred.

Total expenses were $35.9 million, up 7% from the second quarter of 2013. The year-over-year increase was consistent with our longer term expense growth rate. The effective tax rate was 37% for the second quarter and for June 30 year-to-date. Many factors can influence the tax rate, and we are currently tracking at the low-end of the 2014 guidance range of 37% to 40%.

Our diluted EPS was $0.48 on a diluted share count of 37.9 million shares. The sequential decline in our diluted shares from the first quarter of 2014 was principally due to share repurchases.

On Slide 8, we have laid out our commission revenue, trading volumes and fees per million. Total variable transaction fees were down 3% year-over-year due to the 1% decline in trading volume and a 2% decline in overall fees per million.

U.S. high-grade fees per million were $178 in the second quarter. The average years to maturity of bonds traded of 7.6 years was consistent with the first quarter and within the post-crisis range experienced on the platform. The uptick in fee captured from the first quarter level was mainly due to a minor shift in trade sizes.

The year-over-year decline in high-grade fees per million was due to a combination of lower durations and a shift to larger trade sizes.

Fees per million in the other credit category were $308 in the second quarter, up $7 on a sequential basis and nearly identical to a year ago level. The sequential increase in fee capture was due to a mix shift within this category slightly favoring higher margin emerging markets and high-yield volumes and higher Eurobond fee capture.

U.S. high-grade distribution fees were up $1.2 million compared to the second quarter of 2013, due principally to several dealer migrations to the major U.S. high-grade dealer plan in the second half of last year. One additional U.S. high-grade dealer followed the same path in July 2014. We expect third quarter total distribution fees will be several hundred thousand dollars higher than the second quarter level.

Slide 9 provides you with the expense details. Second quarter 2014 expenses of $35.9 million were up less than 1% sequentially. The sequential drop in employee compensation and benefits was due to $900,000 seasonal decline in employment taxes and benefits, offset by higher wages and incentive compensation. Employee headcount was 318 at June month end, up from 300 at March 31.

Professional and consulting fees tend to vary quarter-to-quarter and are influenced by the level of expenses surrounding IT, consulting, legal, recruiting, audit tax and other fees. The sequential decline is largely due to lower legal and recruiting fees.

The sequential increase in all other expenses is primarily due to higher sales and marketing spend in support of new business initiatives. We are now midway through the year and have greater visibility on our operating expense and CapEx forecast for 2014.

We are reducing our full year guidance and now expect total expenses will be in the range of $144 million to $148 million, and our capital expenditures will be in the range of $15 million to $17 million.

We are continuing to invest in our core initiatives and are on track to meet our year-end headcount goal. The decision earlier this year to consolidate data centers, the timing of new hire on-boarding and lower variable incentive compensation were the principal drivers behind the guidance reductions.

On Slide 10, we provide balance sheet information. Cash and securities available for sale as of June 30 were $199 million compared to $200 million at year-end 2013. Free cash flow was a record $76 million for the trailing 12 months during a period when we have been investing heavily in Europe, Open Trading, CDS and other initiatives.

During the quarter, we repurchased 189,000 shares at a cost of $10.4 million under the $35 million share buyback program we initiated in March.

As Rick mentioned, the board took action in July to increase the buyback authorization to $100 million. The original program was established to offset dilution from employee equity grants. This expansion allows us to repurchase more shares when we believe the share price is undervalued.

There was no change in our capital structure during the quarter. We have no bank debt outstanding and didn’t borrow against our revolving credit facility.

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

Rick McVey

Thanks Tony. Second quarter results reflect continued momentum and a stronger competitive position in our core credit products. Open Trading adoption rates are accelerating and this remains a key area of our investment focus. European results are improving and incoming European regulations will create new opportunities.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will be coming from the line of Jillian Miller from BMO Capital Markets. Your line is open.

Jillian Miller – BMO Capital Markets

Can you hear me?

Rick McVey

We can now.

Jillian Miller – BMO Capital Markets

Good morning. So yes, you guys have this larger authorization for buybacks in place and the stock is at multi-month low. So just want to check back with you and see how you’re thinking. You kind of alluded to this in your comments that I guess am I right in interpreting those remarks to mean that the plan has kind of evolved from just offsetting dilutions to potentially getting more aggressive here?

Tony DeLise

Jillian, that’s exactly what this expansion is – why we’ve put it in place. You’re right that first $35 million when we announced it back at the beginning of the year we said it was to really offset the dilution cost from share grants. And we’ve been active. We’ve been in the market everyday buying against our 10b5-1 grid. And we have gotten questions at the time about whether we would expand that authorization. And clearly we had the capacity to do that.

Board did that act in July. The expansion allows us to buy more shares when the stock price is lower. So the different way to be more aggressive when we think the share price is undervalued. Right now we believe we can execute on that program within our existing cash resources and free cash flow generation, but the timing of when we execute on that plan is largely dependent on where the share price goes.

So it’s difficult to say exactly when will complete the plan. Right now, there is defined termination date of the plan of December 31, 2015 but again the timing of that will be dependent on the share price.

Jillian Miller – BMO Capital Markets

Okay. But right now you feel like the share price is one at which you would want to buying back stocks, in excess of offsetting dilutions?

Tony DeLise

Jillian, we’ll set up a 10b5-1 grid. The grid will be established so that we’re more aggressive at lower share prices. The share prices sort of bounced around here lately, and we just envision us being more aggressive when we’re at $45 than when we’re at $55. It will be set up in that sort of grid.

Jillian Miller – BMO Capital Markets

Okay. Fair enough. And then just on the Tradeweb multi-dealer platform, I thought which is supposed to start in July. I actually haven’t seen any announcement about it commencing, but just wanted to get an idea for what you’re hearing from your clients and dealers. If you have a sense for, if this is going to be a similar trading model to yours, or if there is going to be kind of a different strategy and what your thoughts are on whether this is a competitive threat or not?

Rick McVey

Sure, happy to take that one. We don’t have anything outside of the media reports that are available to you and everyone else, but we are led to believe that they expect to launch in July as you say. We are not surprised at all that they are redoubling their efforts in credit given the growing size of the opportunity. And we respect them as a competitor. We’ve said all along that Tradeweb and Bloomberg both have the critical assets to be successful in electronic trading and fixed income, given the breadth of their network, the technology assets that they have and the resources that they have.

So we very much respect Tradeweb in the space as a strong competitor. A couple of things. This is not new. Tradeweb has been in the corporate bond market in the U.S. since 2003 in various spurts with different protocols offered into the market. We anecdotally hear from clients and dealers that the intent is to be offering protocols that look different than ours, and we have heard two things about that. One is it may involve some streaming levels from large dealers for U.S. corporate bonds; and then two, they may offer some connectivity into the recently acquired retail pool of BondDesk. So much remains to be seen from Tradeweb.

I think its wait and see from investor clients. We have not heard from them that they see anything or shattering in terms of anything new to the marketplace that we and others haven’t thought about, but we will learn more over the coming months or so as Tradeweb launches.

And they have a full agenda, right. They have – obviously are still integrating and digesting the acquisition of BondDesk in the retail space. They recently launched their inter-dealer government bond platform to take on NASDAQ and ICAP in the IDB government bond space. They are like, all of us new entrants in the SEF space and trying to make sense of the SEF space and simultaneously taking on credits.

So they have a full agenda. And I think our mantra here is the same as it’s always been, which is a competition is healthy for the market and we are highly confident that we are focused on in investing more in the credit space even in spite of our position, and continue to deliver new and innovative solutions to our clients. And I think as long as we do that, we feel very good about our competitive position.

Jillian Miller – BMO Capital Markets

Okay, thanks. That’s really helpful. And then the final thing I want to go back to. So, am I right in thinking that essentially the reason you guys didn’t provide us with like July to-date market share figures is because it’s almost impossible for you to determine, I guess apples-to-apples figure because of this new 144A stuff that’s included into?

Rick McVey

I think there are host of reasons, Jillian. First of all, we have eight important trading days still left in July, but yes, there are more moving parts right now in mid-month than normal. One, because of the addition of 144A is to the FINRA reported TRACE volume. And we’d like to work with you and the other analysts to make sure that we’re reporting that in the best way possible at the end of July to make it easy for you to make prior year comparisons.

The second thing is that we have the recently determined double counting that’s taking place in TRACE that we hope to learn more about through the month of July.

And then thirdly, the month starts on an odd week with the July 4 with holiday trading activity for a couple of days leading into the fourth weekend. So for all those reasons, there are a lot of moving parts in the July market share estimates.

What we would say is, and if you look apples and apples at the registered securities, there’s been reports you see high-grade numbers that are weaker in July so far, but that doesn’t come as any surprise to us given the July 4 holiday and some of the weaker days around that period.

The other thing of note about July is last week was the first signs of volatility returning to the U.S. credit markets with a very active week in high-yield. And the high-yield index yields went up about 35 basis points in a week. There were significant outflows in ETS and in mutual funds active in high-yield. And as you can see from the TRACE data, there was a significant increase in high-yield trading volumes and an improvement in electronic market share.

So it is a reminder that when we get better secondary trading conditions, it comes with higher overall market volume and higher electronic share.

Jillian Miller – BMO Capital Markets

Okay, got it. Thanks guys.

Operator

Thank you. Our next question will be coming from the line of Mike Adams from Sandler O’Neill. Your line is open.

Mike Adams – Sandler O’Neill & Partners

Hi good morning, Rick. Good morning Tony.

Rick McVey

Hello Mike.

Mike Adams – Sandler O’Neill & Partners

So to follow-up on that last question. Totally appreciate why you can’t really comment maybe on July market share, but could you give us a little color on the mix that you’ve been seeing on the trading platform this month in terms of dealer mix, trade size, the yield, the maturity, anything that would change pricing quarter to-date?

Tony DeLise

Mike, it’s Tony. When you look at month-to-date right now, there is nothing that’s mixed out. When we look at years to maturity, when we look at bid offer mix, other than what Rick just mentioned on the high-yield side where you did see a big shift in the bid offer mix and the high-yield side, but there is really nothing there in terms of trade size. And again it’s early in the quarter though, we’ve got 60 or 62 day quarter and we’re 14 days in. So a lot can happen over the balance of the quarter, but that’s far in July. Other than what Rick mentioned around high-yield activity, there is nothing that really sticks out right now.

Mike Adams – Sandler O’Neill & Partners

Got it. Okay, thanks. And then touching on some of the new initiatives here and specifically the Open Trading, Rick. I know you touched on the 35% increase to volume in the quarter. I am just curious, I mean we’ve seen pretty nice steady growth over the past couple of years, and this is really the first quarter where you’ve sort of broken out with really impressive gains. In your mind, what’s driving that? Is it traction with your sales force or is it more environmental in nature?

Rick McVey

I think it’s a couple of things. The protocols are new and it takes a while for investor clients to change their trading behavior, embrace new ways of trading. And as we have mentioned in the past, the biggest thing that’s new is being at the receiving end of inquiries and leading with a price. And I think as the time goes on and they are seeing more and more trade opportunities on the system, they are putting more prices in and they are getting more trades completed. So that all looks very positive to us.

The other big change that I see during the quarter that I highlighted in the prepared remarks is the involvement of dealers in Open Trading. And increasingly we’re seeing more dealers viewing Open Trading as potentially an asset to their trading business and not necessarily a threat.

And everything we have built in Open Trading allows traditional dealers to intermediate these trades on behalf of their clients. And you do see even among large dealers, you saw the announcement yesterday from J.P. Morgan, even among large dealers, you see them starting to embrace agency trading in credit. And certainly that’s what this is all about. It’s a new tool for dealers to promote agency trading with their clients, and to clear and intermediate those trades on behalf of their clients.

And that combined with a very favorable feedback we continue to get from investors on how important that this is to them and their future liquidity in the credit markets as they are grappling with massive regulatory changes among their dealer counterparts. That combination is driving the growth and it’s giving us a lot of confidence that we are on the right track with the Open Trading strategy.

Mike Adams – Sandler O’Neill & Partners

That’s great color, Rick. Thank you. And shifting gears over to Europe. You’ve maintained all along that you expect Xtrakter to be accretive in the second half of this year, and now that we’re finally there, would you be willing to give us a little bit more detail maybe on the expected earnings accretion we can see in the coming quarters here?

Tony DeLise

Sure Mike. We’ve talked about Xtrakter and our Trax business over the last several quarters. And we look at the results to-date, it’s been about neutral to earnings since the acquisition. It’s probably mildly dilutive, a couple of pennies dilutive last year in 2013. It’s been neutral in the first half of the year.

The margins that coming out of the Trax business are pretty consistent with the historical margins, so in that 10% to 15% range, but when we overlay the amortization of our deal cost that must be getting us to neutral at this point in time.

We do expect in particular in the data sales side, we do expect some improvement in the second half of the year. We do expect Trax to be mildly accretive in the second half of the year. And that’s on the back of continued rollout of new data products. There is data products around market volume, historical data, some real-time data. And what you don’t see in the standalone Trax’s results is the effect on our trading business.

And we’ve said all along that what we’re trying to do is drive more flow on to the trading platform. And you’re seeing some of that come through with this 30% or so increase in overall trading volumes from European clients. There is a big increase in Eurobond volumes as part of that. So we do expect some accretion in the second half of the year. And I’d say, the improvement would be sort of mild uptick from what you’re seeing and to be mildly accretive in the second half of the year.

And Mike, just to put it in perspective, the revenues coming out of the Trax business, rough numbers were around $13 million first half of the year. So it’s not all of what you’re seeing in that infill and post-trade line but coming out of Europe it’s about 70% of that line item.

Mike Adams – Sandler O’Neill & Partners

Great. And Tony since you brought it up, I know you made some tweaks to some of your trade protocols in Europe. I think it was in late June, allowing more dealers to participate on the RFQs returning liquid bonds. Any early insight into the volume or market share pickup just in the first month or so?

Tony DeLise

I think the expansion in investor choice on smaller trade sizes in Europe is one of the reasons that volumes have been up so far this year, but I also think we’re benefiting from a broader product offering, right. There are higher quality data products coming from both our trading business and the Trax business that we’re providing to dealer and investor clients in Europe. And there is a pretty good bouncing back [ph] the post-trade services and expansion of transaction reporting and trade matching.

And we’re just three months away from the move to T+2 settlement in European fixed income, and that’s increasing demand for real-time trade matching. So I think the broader product offering is resonating with European clients, and it is driving the growth that we see in the trading business currently.

Mike Adams – Sandler O’Neill & Partners

Got it. Great. Thank you guys.

Operator

Thank you. Our next question will be coming from the line of Ashley Serrao from Credit Suisse. Your line is open.

Ashley Serrao – Credit Suisse

Good morning guys. Most of my questions have been asked, but I just want to get back to this concept of streaming pricing that Tradeweb is supposed to be providing. Just from a historical context, so any of your competitors to-date being able to do that who have not basically not been able to penetrate this market?

Rick McVey

The short answer is no. The ability to stream in credit is certainly growing, and we see that as the protocol of choice in the CDS index business on SEF. As you know as it gets much more complicated when you move further down the liquidity spectrum, and corporate bonds have always been a challenge to provide institutional liquidity and levels in a live or streaming environment.

So we have many dealers streaming on MarketAxess but they tend to stream in very small trade sizes with wider bid offer, and that obviously is not what investors are looking for, because typically they are getting better pricing than that through a competitive RFQ process. So it’s far from us to say it can’t happen but we haven’t seen that protocol be successful in credit yet. And like I said, I don’t know enough about the Tradeweb strategy to comment and whether that’s going to be a big part of the offering or not. That’s just what we’re picking up from the media reports is that’s one of the things that they are talking to dealers and investors about promoting.

Ashley Serrao – Credit Suisse

Okay. I appreciate the color there. And just sticking with Tradeweb. Maybe at what point granted as so far you’ve built a franchise, this withstood a lot of competitors threat, but if this were to gain traction, at what point do you look at them – how are you judging them, maybe is it market share or is it more on their number of clients they sign up, like how are you benchmarking their success versus you?

Rick McVey

We’ve always felt that [indiscernible] important competitor in the space. Like I said we’ve been dealing with ebbs and flows of Tradeweb in credit for about 12 years now, so none of that has changed. With respect to the metrics, you’ve bring up a great point which is that Tradeweb does suggest that they promote transparency, but we don’t have a lot of transparency on their results.

So it would be a great asset to all of you and to the market, if we did have more information on their trading volumes and market share trends and revenue models by product, but we don’t have that whether it’s their recorded rate space or the retail space or the SEF, like we’re starting to see more information on SEF, but it would be great to have more transparencies so that all of you would have a way to compare their progress relative to other important players in the space.

Ashley Serrao – Credit Suisse

Got it. I guess finally going back to Xtrakter. As this kind of takes off in the back half and into next year, will clients have the option to either maybe soft dollar versus license some of these products?

Rick McVey

You’re talking about the data product, Ashley?

Ashley Serrao – Credit Suisse

Yes. So like I am basically trying to get a sense of should we expect revenues to flow through non-commissioned or commissioned income? Will they have that option?

Rick McVey

We would expect a little bit of both.

Ashley Serrao – Credit Suisse

Okay.

Rick McVey

Certainly we are rewarding active trading clients with expanded data products in Europe. And I think we’re in the very early stages of developing and delivering products that are going to be valuable to dealers and investors. The region is suffering from a lack of transparency. We think we have a role to play in fixing that to improve liquidity in the overall European market. We love the fact that we’re in the mix with dealers investors making what we think are very sensible compromises about what data products we deliver, what goes out in real-time, what comes out on a lag basis, but there is a lot of valuable data that we have in Trax that can help dealers and investors understand the liquidity trends and trading trends in the European credit markets.

So part of that we would expect to see coming through in growing trading activity from our clients, and part of it we would expect to see as data revenue.

Ashley Serrao – Credit Suisse

Got it. Thanks for taking all of my questions.

Operator

Thank you. Our next question will be coming from the line of Patrick O’Shaughnessy from Raymond James. Your line is open.

Patrick O’Shaughnessy – Raymond James

Good morning guys.

Rick McVey

Hello Patrick.

Patrick O’Shaughnessy – Raymond James

I wanted to go back to the topic of the 144A securities. So I guess the first question there is you guys don’t currently facilitate trade in those securities, do you? And if not, I think you mentioned about this – is this an opportunity for you going forward now?

Tony DeLise

Patrick, we have always traded 144A securities. And let’s say in the high-grade space, when you look back over the past three plus years, in the past 3.5 years, it’s been fairly consistent around 6% to 8% of our volumes of our high-grade volume has been in the 144A space. So it isn’t zero. The comment we made in the prepared remarks about increasing sort of the addressable market or expanding the secondary market opportunity, when we look at least the July information. And again unfortunately we’re in the situation where TRACE is – where FINRA has not released any historical information. So our dataset is fairly limited, but if you look at the July month-to-date information, it’s about 14% increase in U.S. high-grade TRACE volumes with the inclusion of 144A.

So the important message, we have been trading 144A. It’s been a very consistent part of our high-grade volume. Probably the more important takeaway just the size of the market opportunity is bigger. So when we sized up – for example we in the past, we’ve talked about what 1 percentage point increase in market share would be across our product set. We now look at high-grade and we think that that 1 percentage point increase in market share is a bigger number today. And with this limited dataset right now, for July it’s about 14% larger.

Listen, Patrick, I wish we had the historical information we could recast this, we can give you what we all want in terms of share, we just do not have that information today.

Patrick O’Shaughnessy – Raymond James

Got you. But basically it’s actually kind of making your market share more consistent right now, because your volumes are 144A and non-144A and now the denominator is going to be reflecting the same, right?

Tony DeLise

That’s correct. Exactly.

Patrick O’Shaughnessy – Raymond James

Okay. And same story with high-yield. You guys are trading 144A high-yield instrument as well?

Tony DeLise

Again we’ve been trading 144A high-yield. And that one story is a little bit different in that the impact on the reported high-yield TRACE numbers is going to be bigger. At least what we’ve seen in July month-to-date, it could be a 60% increase in high-yield TRACE volumes. And we’ve been trading high-yield 144A just like we’ve been doing it for high-grade. It hasn’t been necessarily as consistent as a consistent portion of our high-yield business, but just to put it in perspective for this year-to-date, it’s probably about 20% of our high-yield volumes has been 144A.

And again all things equal, the reported market share will go down, but we think the opportunity set is bigger, and in this case a lot bigger.

Patrick O’Shaughnessy – Raymond James

Okay, got you. That’s helpful. And then I guess just touching the double counting issue. What’s the argument that some of the dealers are making, and why they are reporting these trades twice?

Rick McVey

We’re not privy to the decision that one or more of them have made on reporting, but Patrick we believe it has to do with back to back trades that are going to a non-U.S. legal entity that has not been reported twice previously and the decision was made in the second quarter to begin reporting both legs. We know through our conversations with FINRA that they are aware of this. They expect to take it up internally to make a decision on how they should address it going forward. So we would expect that somewhere around this time next quarter, we may have some guidance from FINRA on how to treat what is now these double reported trades.

Patrick O’Shaughnessy – Raymond James

Got you. And then last one from me. So you guys talked about record high-yield in emerging market volumes this quarter. How much of that do you think is attributable to market share gains from you guys in those businesses versus relatively robust overall trading environment in those products?

Tony DeLise

Yes, it’s probably a little bit of both, Patrick. The best we can measure market share on the EM side, it looks like a little bit of an uptick and it looks like the velocity has picked up a little bit more in the EM side. In high-yield, when we look at the TRACE volumes and we look at market share, probably it’s small uptick in market share on that side.

The bigger gains – on the record volumes, the bigger gain was on the emerging market side than the high-yield side. And that’s when we have less information or not as reliable information to judge the market share.

Patrick O’Shaughnessy – Raymond James

All right, the after data that comes out about three months is too late?

Tony DeLise

Exactly right. Exactly.

Patrick O’Shaughnessy – Raymond James

All right, got you guys. Thank you.

Rick McVey

Thanks Patrick.

Operator

Thank you. Our next question comes from the line of Hugh Miller from Sidoti. Your line is open.

Hugh Miller – Sidoti

Hi, good morning.

Tony DeLise

Good morning, Hugh.

Hugh Miller – Sidoti

So one question with regards to just some of the distribution fees you guys have talked about. I was wondering if you could provide some color. I think you mentioned a few hundred thousand dollars in distribution fees that you’d anticipate being incremental in the third quarter and how we should be thinking about the buckets there? And then color on kind of within the liquid product segment, noticing kind of an uptick in that fee, the distribution fees being a little over $200,000 versus normally seeing that closer to $50,000 for the quarter and what might be driving that?

Tony DeLise

Sure. Hugh on the – I’ll kind of take them piece by piece. On the U.S. high-grade distribution fees, we’ve got this one dealer who will migrate in July from an all variable plan to one of our fixed plan, one of our distribution fee plans. And so that one by itself will cause an increase in distribution fees. And as you know, all things being equal, that will cause us a little bit of a decrease in our fee capture. And we’ve talked about how that’s pretty consistent. It’s pretty neutral in terms of overall revenues, but it does cause a little bit of mix difference there.

On that liquid product one, what’s in there now and the majority of what you see in that distribution fees, that’s what little we’re charging for CDS on our SEF is residing in that bucket. So it was less than $150,000 in the second quarter was CDS related. We’ve put it in that distribution fee line. It’s really dealers who are streaming prices into our SEF. We are charging them. And again it’s sort of a modest number. And all things being equal, we expect to see something similar like similar to the second quarter in the third quarter and going forward.

Hugh Miller – Sidoti

Okay. And I realize that the revenue on the U.S. high-grade is neutral with variable versus fixed rate. Can you just remind us again and how we should be thinking about the fixed rate portion from the step-up from the one dealer?

Tony DeLise

On the fixed rate side, it will be $0.5 million or more. And on the variable side, this one, given where our trading volumes are right now and all else being equal and you know there is lots of elements that go into the high-grade fee capture, but if it was solely this one item, this one dealer migration, you’d expect the fee capture to go down $5 or $6 per million. But again realizing there is lot to go into that fee capture number.

Hugh Miller – Sidoti

Yes, and I certainly understand. And just going back to kind of your discussion around in Slide 5 with seeing kind of a shift here in the prices back during the quarter and seeing that incremental rise, can you just talk about whether or not, is that a function of a kind of handful of larger dealers that are changing their processes and getting comfortable with putting back prices, or is it kind of disseminating more wildly across the platform that you’re seeing. Any color on that for the rise [ph]?

Rick McVey

What we’re encouraged by is that we’re not only getting an increase in prices back and trades and volumes, but the breadth of participants is much larger. And I mentioned the total firms involved have seen a significant jump in Q2 from 175 or so to 260. So it’s very broad based. And there are more and more sophisticated alerts built into the MarketAxess trading system that are allowing both dealers and investors to identify potential trade matching opportunities. And those alerts are starting to take hold, prompting investors and dealers to provide a price back on a trade where they may have a match.

So we’re very encouraged to see the breadth of people and participants through Open Trading. There are all kinds of examples of where in the old world, market participants could not connect with each other and through Open Trading they can. And some examples are on the dealer side and some are on the investor side and we’re seeing healthy growth from both.

Hugh Miller – Sidoti

Okay. And the feedback you’re getting from clients about that change incentive in a willingness or comfort level to be able to provide back those prices and maybe trade on the alerts. Is it more of a function of just kind of now having it for several quarters and being more comfortable acting on it, or is it kind of advances in technology that you’re providing them with different protocols, any thoughts there on feedback?

Rick McVey

Yes, it’s a little bit of both, right. We have thousands of trade matching opportunities that are triggering thousands of alerts each day. And I think as investors look everyday at more alerts, let’s say you have a potential trade match, they are reengineering their trading process to be in a better position to respond opportunistically when they have a potential match. So I do think that the sophistication in the alerts and the integration that we have with order management systems is a big positive. And with that investors are starting to respond more regularly with leading with a price when they have a potential match.

Hugh Miller – Sidoti

Okay. And then the last question I had is given kind of that feedback you’re receiving, are there additional protocols that you guys are testing and considering rolling out in the coming quarters that would provide further advances, or do you think that the set of tools that you’ve provided is kind of sufficient at this point?

Rick McVey

Never sufficient, right. Credit is not a one-size-fits-all market. And our investment is broad based in terms of providing a menu of choices to meet the challenges that credit presents in terms of different liquidity in the securities in our market. If you look across the platform today from CDS through to cash, we have seven or eight different protocols up and running and we expect to continue to add to that. So there are certain enhancements that are available now that clients and dealers are just beginning to digest around things like RFQ add-ons, and we expect to be rolling them out in the second half of this year and beyond.

Hugh Miller – Sidoti

And so do you view 2Q as kind of an inflection point and do you have any color into what you’re seeing with regards to month-to-date July, and whether or not we’re kind of seeing consistent levels from 2Q or growth there from thereafter?

Rick McVey

I don’t even know the answer to that. The two weeks in July in the long-term are really not that relevant, Hugh, especially since one week was the July 4 week. Are we encouraged not just by what we see, but the thousands of meetings that we have every month? We are. There is a major shift going on in market structure caused by the regulatory changes. And large investors are really concerned about what the regulations have done to constrain dealer balance sheets for market making, and they are looking to find new sources of liquidity and increase the number of counterparties that they have available to them.

And part of the shift in the second quarter is dealers get involved in helping with that solution and getting more comfortable with the notion that part of this market going forward is going to have dealers operating as agent as well as principal. And so both the anecdotal feedback that we see in all the meetings that we have combined with the metrics that we have provided to you today do increase our confidence that we are well on our way being as a key solution to liquidity challenges in credit.

Hugh Miller – Sidoti

Great color, I really appreciate it. Thank you.

Operator

Thank you. Our next question will be coming from the line of Niamh Alexander from KBW. Your line is open.

Niamh Alexander – KBW

Hi, thanks. Just to finish up on this. Thanks for taking my questions and a solid quarter here too, congrats. The share repurchases, I guess it is very much a change from what we would have seen in the past. And just did I catch you correctly Tony, did you say it expires at the end of the year or it doesn’t have an expiry date?

Tony DeLise

No. With any sort of 10b5-1 program that you set up, you have to put an expiration date. And we can expand, we can extend, and this one we happen to take the view through December 31, 2015. And if we’re trading at $65, it’s going to take a longer time to act on that entire capacity under the program.

Niamh Alexander – KBW

So it’s just the program, the authorization doesn’t have an expiry date, but the program you’ve put in place expires on December 31?

Tony DeLise

That’s all it is, exactly.

Niamh Alexander – KBW

Okay, fair enough. Thanks. And then I guess just on kind of the change in the strategy there with respect to the share repurchases. And in Europe, maybe if you could just help me understand, because part of the Open Trading initiative was maybe you stepping in and being the clearing broker if that’s what the client wants just as an intermediate solution until you kind of come across some other clearing brokers. Is there anything changing there? Have the clients kind of moved more towards using the dealers if they select reflecting dealers clearing broker or are you still kind of in that position there and you don’t feel the need now to continue to build the capital?

Rick McVey

Niamh in the short-term there hasn’t been much change. There are some large investors that are choosing larger financial firms to intermediate open trade than the MarketAxess system, and we would expect that to grow. We don’t believe that longer term we will be the clearer of choice for these trades. And as I mentioned earlier, we have offered all the dealers on the platform the opportunity to clear and intermediate these trades on behalf of their clients. So I think its early days to really say exactly how the clearing will be conducted for open trades.

We have provided a straight through service to investor clients in the short-term that they value, but there is no reason why major dealers can’t offer that same straight through service to their clients and intermediate more of these trades going forward.

Niamh Alexander – KBW

Okay, fair enough. I mean I thought that was maybe one of the reasons you were not distributing capital either way, something until now but it seems like some of the big clients are using some of the big dealers. Okay. And then I guess moving onto the CapEx, the pullback on the guidance and the expenses there. I think you’ve given some reasons there, Tony, with primarily kind of incentive comp-driven coming down and what not, but are the three initiatives that you’ve given us the color on to-date, is there anyone specific one there that maybe you’re pulling back on some of the spend like the SEF or something like that drives the lower CapEx as well as run rates?

Tony DeLise

Really not Niamh. When we had the first quarter call, we had guided towards that lower end of the range at the time. And we’re half way through the year now. Obviously we have a lot more visibility into the spend. And I mentioned a couple of specific items. So we’ve made a decision earlier this year around the data center consolidation. That does not impact what we’re doing around investing in Europe and Open Trading and CDS. So we did make a data center consolidation decision.

That has an impact on ongoing run rate for software costs, hosting, capital expenditure spend. So it’s a pretty big impact on that one item. Even things around incentive compensation that I mentioned. When we’ve built our model, our budget for this year, I can’t say that we predicted the market conditions were going to be similar to what we’ve faced over the last six months.

We had some different expectations built in. That’s a pretty big variable from where we were originally in terms of the guidance to where we are now.

The other part, I want to just make sure it’s clear on, even though our salary, pure salary line is trending lower than the expectations, we are 100% on track with our year-end goals, our year-end employee headcount goal. And maybe the timing of when those new hires were on-boarded shifted out a little bit, but in no way have we deviated from those expectations. And today we’re sitting there with 318 odd employees at the end of the June. The expectation is by year-end we’re going to, depending on turnover, we will add to that number and we’ll end the year with 325 or 330 employees. And those additions we’re making are in all those key – surround those key initiatives.

So we have not really deviated from that. I will say the second half of the year – the biggest variable in the second half of the year and where we come out on expenses, big variables where we come out on incentive compensations, where revenues are in the second half of the year. And the other ones that could bounce back and forth is just how successful we are with on-boarding new employees and where we are with employee turnover. But you see we’ve tightened up that range and we’re out in a different spots than where we were three months ago, but in no way do we feel like we’ve cut back the investments in the key growth areas, particularly Europe and Open Trading.

Just one sort of side note on CDS. There is probably a little lower spend on CDS in the second half of the year than there was in the first half of the year. And we’re in a bit of a quiet period or sort of stasis period right now where legal fees will come down. We’ll probably be more disciplined around some expenses. So there will be slightly lower spend on that one.

Niamh Alexander – KBW

Okay, that’s very helpful. Thanks Tony, I appreciate the color. And then just following up on earlier question lastly [ph], the central limit order book, do you have one in place. It’s just back to the kind of potential streaming prices. I am just wondering have you kind of reached out recently to see if there was more interest on the part of the dealers to stream prices. Is that something that your competitors are offering? I think it’s something you could offer too. Have you revisited that recently with some of the dealers and streaming some prices on there, or is it kind of more you see there is kind of list functionality in Open Trading and the alerts there is kind of much more captivating as potential for catching actually trades?

Rick McVey

We revisit protocols with dealers’ every day. We have a broad sales effort with the dealer community. We have a team that works with their trading desk every day. And we believe that our priorities in terms of protocols are determined based on the dealer input we get and the investor input. We do not see any broad based view among investors or dealers that a central limit order book for corporate bonds right now is likely to be a viable solution for the market given the fragmentation and the liquidity in the corporate bond market.

There may come a day. I think that day will come from a combination of advances in market making technology, but importantly changes in issuer behavior that will lead to larger benchmark deals. And we have not yet seen a significant change in issuer behavior, but some level of standardization in the way that they issue bonds would certainly help secondary liquidity and would help move the market to something that could or at least the subset of corporate bonds operate in a more live environment. And we’re highly confident when the market is ready for that, we’re ready to provide the technology.

Niamh Alexander – KBW

Okay. Thanks so much.

Operator

Thank you. (Operator Instructions) Our next question will be coming from the line of Michael Wong from Morningstar. Your line is open.

Michael Wong – Morningstar Equity Research

Good morning.

Rick McVey

Good morning, Michael.

Tony DeLise

Good morning.

Michael Wong – Morningstar Equity Research

The other fixed income transaction fee line has become more important. Do all of the factors that would affect U.S. high-grade pricing affect the other category, like duration of bond trading and larger trade sizes? And are there any other characteristics that are particular to the other fixed income type pricing that might trump [ph] the ones I just mentioned for U.S. high-grades?

Tony DeLise

Michael, it doesn’t have quite the same dynamics. So at least the way that these plans work today for the three principal products there which is high-yield, emerging markets and Eurobonds. Those bonds typically trade on price and we have just a pricing grid that we charge off of. It’s not dependent on duration, it’s not dependent on where years of maturity are, where yields are. So we don’t have those sorts of elements. The biggest challenge there is that this other credit is a amalgamation of a couple of products. And the single biggest factor causing shifts from period-to-period is the fact that one product might be growing faster or slower than other products. So it’s just a shift between the three products right now.

So we don’t – at least today, we don’t have those same sorts of dynamics affecting the other credit piece.

Michael Wong – Morningstar Equity Research

And then I guess just in general for U.S. high-grade. I think you’ve mentioned before what the duration or years to maturity has been since the financial crisis, but do you see the duration of bonds traded on for U.S. high-grade on your platform decreasing much more from here?

Tony DeLise

For the last couple of quarters, we’ve been right around let’s say between 7.5 and 8 years. And that’s within our post-crisis range. So we look post-crisis over the last four or five years and the average years to maturity has been between 7.5 years and 10 years, and it does bubble around, but it’s been fairly consistent in the last several quarters. So that is a big influence. It’s something to keep an eye on when we talk about fee capture and how it’s moving around quarter-to-quarter. Duration in particular years to maturity tends to be a big influence, and it hasn’t – last couple of quarters, it hasn’t really moved all that much. It’s down a little bit from the one year ago level, but still within that post-crisis range.

Michael Wong – Morningstar Equity Research

And can you remind me if you’ve ever said what the years to maturity check on the platform was before the financial crisis?

Tony DeLise

We’ve probably haven’t talked about it recently, but I can tell you that in the sort of period immediately preceding, talking about 2006 and sort of midway through 2007, when we talk about sort of onset of the crisis it was when the floating rate note market dissipated in the second half of 2007. The years to maturity in our platform looked like 5.5 years or six years. It was much different environment back then. It was – the yield environment was different, the credit environment was different.

The yield curve was a flat or an inverted yield curve at times. There is not a lot of trading at the long end of the curve. It’s different than what we see today, but yes it has been lower pre-crisis.

Michael Wong – Morningstar Equity Research

Okay. Thank you.

Rick McVey

Thanks Michael.

Operator

Thank you. Our next question will be coming from the line of Jillian Miller from BMO Capital Markets. Your line is open.

Jillian Miller – BMO Capital Markets

Thanks. I was just wondering what your CapEx was for the quarter?

Tony DeLise

Yes, it was – Jillian it’s a little bit more than $4 million. On year-to-date for CapEx, it’s a shade north of $9 million. And just on that one – I had mentioned in the prepared remarks that we had lowered the range for CapEx. It’s now $15 million to $17 million. It’s down a couple of million. It is solely and almost exclusively around the data center consolidation when we sort of bubble that through the forecast, that’s the reason for the decline.

Jillian Miller – BMO Capital Markets

Got it. Thanks.

Operator

Thank you. And at this time I am not showing any further questions.

Rick McVey

Thank you for joining us this morning. Enjoy the rest of your summer and we’ll talk to you next quarter.

Operator

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

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MarketAxess (NASDAQ:MKTX): Q2 EPS of $0.49 beats by $0.03. Revenue of $65M (+2.4% Y/Y) beats by $0.43M.