BATS Global Markets' (BATS) CEO Chris Concannon on Q2 2016 Results - Earnings Call Transcript

| About: BATS Global (BATS)

BATS Global Markets (BATS:BATS)

Q2 2016 Earnings Conference Call

August 4, 2016 08:30 ET

Executives

Mark Marriott – Director, Investor Relations

Chris Concannon – President & Chief Executive Officer

Brian Schell – Executive Vice President, Chief Financial Officer & Treasurer

Bryan Harkins – Executive Vice President, Head of U.S. Markets

Analysts

Rich Repetto – Sandler O'Neill

Ken Worthington – JPMorgan

Michael Carrier – Bank of America Meryll Lynch

Brian Bedell – Deutsche Bank

Kyle Voigt – KBW

Operator

Greetings and welcome to the Bats Global Markets Second Quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mark Marriott, Director of Investor Relations for Bats. Please go ahead, sir.

Mark Marriott

Thank you, Kevin, and good morning, everyone. Our CEO Chris Concannon leads the call today, along with our CFO Brian Schell. As part of today's discussion, we will reference our Second Quarter 2016 Earnings presentation accessible via our website at Ir.bats.com.

Our comments will include mention of non-GAAP financial measures which are defined on slide 3 and reconciled in the appendix to this presentation. While we believe these financial measures provide investors useful information about our business trends, they do not replace and are not superior to GAAP measures.

Certain statements in the prepared presentation may relate to future events and expectations and as such, constitute forward-looking statements. Actual results may differ materially from those projected in these forward-looking statements. After our prepared remarks from Chris and Brian, we will open it up to any questions you may have.

With that, I will pass it to Chris.

Chris Concannon

Thanks Mark. Good morning, everyone, and thank you for joining. I'll begin on Slide 4. The second quarter of 2016 was another strong quarter for Bats as we recorded net revenue of $110 million, net income of $18 million and diluted earnings per share of $0.19. Normalized EBITDA was $71 million, normalized EBITDA margin was 65%, adjusted earnings were $34 million and diluted adjusted earnings per share were $0.35.

Despite lower industry market volumes across all aspect classes when compared to the first quarter, we were able to deliver exceptional results. While achieving these numbers, we also built upon our market-leading positions. In the second quarter, we maintained our position as the number one exchange in U.S. equities trading excluding auctions and remained the number one market in ETF trading. We also remain number one in European equity trading and European trade reporting.

In U.S. options while we are the fourth largest options exchange operator, we remained the number one priced time priority market and the market leader in single-leg equity options trade, while also reporting record-market share during the quarter. In addition, we made progress on several key initiatives. First, we continue to see success in our ETF listing business as we welcome 23 new ETF listings and three ETF transfers to the back of ETF marketplace. We also welcome four new issuers to our market during the quarter. The 23 new listings accounted for 28% market share of new listings coming to market compared to a 6% share last year during the second quarter.

Second, as we continue to grow market share in U.S. options business, we remain on-track to deliver auctions capability on our EDGX options exchange by the end of this year. The first part of the auctions roll out occurred on July 11 and the remaining capabilities will be completed by the end of 2016, bringing important new functionality to our market as we broaden our options offering. Similarly, we remain on-schedule to launch FX forwards on our Hotspot platform by year-end, delivering on a promise we made when we purchased the asset in 2015.

In addition, we continue to make headway in growing non-transaction revenue, adding new significant customers in June to our batch proprietary market data products. Non-transaction revenue continues to make out more than 55% of our net revenue and was responsible for 68% of the total net revenue growth in the second quarter, compared to a year ago.

Another key initiative during the quarter was our launch of UK benchmark's index products in Europe. The new UK index series includes 18 different index products covering large to small cap securities across 12 industry sectors. These products are published by Bats Europe in real time, a contrast to the competitive offerings which are provided with a 15-minute delay.

Also at the end of June, we were able to successfully refinance our existing term loans to take advantage of our improved credit profile and favorable market conditions. Brian will provide more details on this topic shortly. Most important, we continue to be well-positioned to grow all of our businesses by focusing on our customer's needs and working to become or remain the number one in every market in which we operate.

Turning to Slide 5, U.S. options which continue to be a great growth story reached record market share of 11.6% for the quarter, versus 9.7% a year ago and 10.2% in the first quarter, this growth especially impressive as we nearly doubled net capture to $4.9 in the second quarter from $2.6 last year. And again, we remain the number one price time priority options market in the second quarter and we're also the market leader in single-leg equity options trades with 17% market share.

The big news in the second half of this year will be the launch of the remainder of our auction capabilities on the new EDGX options exchange. Second quarter market share on our U.S. equities business was slightly lower than a year ago at 20.4% versus 20.8%. While not pleased with that slight decline, we maintained our leadership position for USF-PCF [ph] trading with market share of 24.7% for that quarter, a distinction we have held since February 2014.

European equities market share ended the quarter at 22.9% versus 24.6% a year ago, offset by a 15% year-on-year increase in net capture, due to pricing changes implemented earlier in the year. The pricing changes are working as intended, improving net capture, even as we maintain aggressive prices as compared to our major European competitors. Further on the European front, I'd like to briefly mention the potential impact of Brexit on our business. First, we believe that as a small nimble company, Bats is uniquely positioned to respond to Brexit. In the short term, we expect to see episodic volatility and volume spikes that the UK begins the two or three-year process to leave the EU. Longer term, we may choose to establish a small office or registration within an EU country while we maintain the majority of our operations in London.

As for the global effect business, overall market binds hold back in the second quarter due to a lack of volatility. Product market share for the quarter was steady at 11.6%, an increase of 60 basis points compared to last year. With that, I'll pass it to Brian.

Brian Schell

Thank you, Chris. I'll begin with Slide 6. As highlighted earlier, second quarter net revenue grew by 11% to $110 million from $99 million a year ago.

Net income decreased slightly to $18 million from $20 million a year ago with the decline reflecting among other things, a pre-tax charge of $18 million incurred as a result of refinancing credit agreement. Before I continue, let me point out there are second quarter GAAP results, includes certain items that impact comparison of our operating results and that we believe are not indicative of our core operating performance. These items are detailed in our reconciliation of non-GAAP measures, providing the appendix of our earnings presentation materials, as well as in the earnings press release.

Now turning to the next slide, I want to highlight our organic revenue growth rate of 11% for the quarter, an 18% year-to-date. Part of this growth was the result of the run-rate benefit of connectivity feed cruising changes implemented during 2015. The remainder of the variance was driven by higher net capture in our European equities and U.S. options businesses and higher market volumes in our U.S. equities and U.S. options businesses.

For the quarter, our percentage of non-transaction revenue again made up the majority of our net revenue, coming in at nearly 56%, almost 2 percentage points higher than the second quarter last year of 54%. As such, non-transaction revenue growth outpays transaction revenue growth. It actually made up 68% of our total net revenue growth compared to a year ago.

From the segment perspective, U.S. equities are responsible for 60% of net revenue growth, followed by U.S. options contributing 45%. U.S. equities growth was driven by an increase in proprietary market data in connectivity feeds, U.S. options growth was due to a strong increase of net capture and record market share.

Moving to Slide 8, total operating expenses were $52 million, compared to $50 million last year. However, normalized operating expenses decreased slightly $50 million as direct [ph] offset increases in compensation and benefits along with an increase in G&A expenses due to a one-time operating tax credit recorded last year. We continue to realize synergies from both the direct edge and Hotspot acquisitions. In the quarter, we realized $11 synergies from the direct edge transaction and nearly $2 million in Hotspot.

For the full year 2016, we are providing guidance for total operating expenses for our current operations to be on the range of $205 million to $215 million. Our effective tax rate for the quarter was 40.7%, compared to 43.6% last year, due to lower effect to state income tax rates.

Turning to the next slide, a few additional comments about our earnings; diluted earnings per share fell to $0.19, compared to $0.21 last year, a decrease of 10% reflecting the previously mentioned pre-tax charge for early extinguishment of death. However, adjusted earnings for the quarter which excludes special charges including IPO, acquisition-related and debt restructuring cost, as well as acquisition-related amortization grew to $34 million compared to $25 million last year which is at 38% increase.

On a diluted per share basis, adjusted earnings increased 50 basis points, reducing interest expense by approximately $7 million for the remainder of 2016, by nearly $11 million for the full-year 2017. In addition, we also significantly reduced the mandatory annual amortization payments, thereby providing us with additional capital allocation flexibility. And as part of our allocation plan and as previously announced on our last earnings call, we plan to initiate our first regular cash dividend of $0.8 per share, payable maximum on September 28 to stockholders who have record to close the business on September 14.

Finally, our adjusted cash was the sum of our cash and financial investments excluding the cash and collective perspective to 31 piece was $62 million as of June 30. For growing capital expenditures, we spent $5 million in the second quarter and maintain our annual CapEx guidance for 2016 of $15 million to $20 million.

With that, I'll pass it back to Chris to summarize the call.

Chris Concannon

Thank you, Brian. I'll quickly refer to Slide 11 for a recap. Here is what we have done well this quarter. We achieved organic net revenue growth of 11% for the quarter and 18% year-to-date. We set a record for market share in U.S. options at 11.6%. We remained the number one stock exchange in Europe while increasing our net capture rate. We continue to have success in our ETF trading and listings business, we remained on-track to deliver new products within our U.S. options and global FX businesses. And we've successfully refinanced our debt to improve our ongoing net income and provide more capital allocation flexibility.

While we had another strong quarter, here is where we can do better; first, while we continue to be encouraged at the FX industry as undergoing the structural changes that we anticipated, we continue to be disappointed by our growth of Hotspot revenue in volumes. We plan to change this by focusing on market share growth and increasing our product offering. Second, we have rapidly grown our headcount to 323 people. We now have to ensure that our recently added employees are running at full capacity before we experience additional growth in those areas of our company. We want to avoid a big company mentality and remain nimble and responsive to the market opportunity.

Third, while we remain one of the most efficient exchange operators on the planet, I think we can continue to focus on our expenses and continue to grow the gap between us and our competitors. Finally, with respect to our acquisition of ETF.com, [indiscernible] customs of fully integrating companies that it acquires and we specifically chose not to fully integrate ETF.com, given its business model. However, we need to increase the possibility for revenue synergies in growth strategies between ETF.com and our ETF trading and listing business. I expect more to come from this aspect in the coming year and beyond.

With that, I want to thank you for joining our call today. I will now hand the call back to the operator to begin the Q&A.

Mark Marriott

Thank you. We can begin the Q&A now.

Question-and-Answer Session

Operator

Thank you. At this time we'll be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Rich Repetto from Sandler O'Neill. Please proceed with your question.

Richard Repetto

Good morning, Chris, good morning, Brian. Congrats on the solid quarter here.

Chris Concannon

Thank you, Rich.

Richard Repetto

I'll give you my one question. I think Brian and I think Chris, you also mentioned that a good part of a growth, the year-over-year growth is coming from connectivity somewhere around two-thirds or around here. You also mentioned there was a connectivity charge in 2015. But you're still seeing connectivity revenue improve in equities quarter-over-quarter. I'm just trying to understand what's going on, what are you doing to get this growth in this main driver of your revenue growth quarter-over-quarter as well.

Chris Concannon

Sure, Rich. Great question. First, just to define the area that you're talking about, we think of the world of non-transaction revenue which includes connectivity market data both industry market data, as well as our proprietary market data. We are clearly having success in our proprietary market data. We've also had some success in introducing and fine-tuning our feeds around connectivity over the past year. We'd expect continued growth in what we call non-transaction revenue across all of our asset classes, not just U.S. equities, but Europe, as well as Hotspot which recently introduced non-transaction fees as well. Does that answer your question?

Richard Repetto

Yes, but you are saying in U.S. equity is the biggest, I think, quarter-over-quarter increase on any other segments? I'll just try to zone in there.

Brian Schell

That's correct, Rich and it's not just the -- we're also seeing a portion of that increase is also due to enhanced increased demand, we're seeing basically broader distribution, so not just price. The quarter, I'd say a little bit more than a third of that was actually incremental products coming from increased demand.

Operator

Thank you. Our next question today is coming from Ken Worthington from JPMorgan. Please proceed with your question.

Ken Worthington

Hi, good morning. Thanks for taking my question. In terms of ETFs in the new ETF listings, how integral has the payment for listing program been to your wins this quarter and of the 26 listings, how many are likely to receive payments from you?

Chris Concannon

First, I'll say more broadly while we were certainly being disruptive in our efforts in the ETF space, because we do see it as a huge growth opportunity for us and honestly for the industry, I would say our pricing, that is free first and you can only earn a rebate based on activities of the overall ETF activity. It hasn't really moved issuers to move them – either move their listings or to bring listings to us. Really, the all-end product offering that we have, the quality of our market, the quality of our market makers and the support we get from our market makers in the statistics that we can show, that has really encourage the listings that we've received thus far and really gotten the attention of issuers more so than any rebate because having a rebate flowing to your ETF trust structure can get complicated. Most of our sponsors are very focused on the quality of the markets that we're showing them when you are the largest trading market operator in the ETF; you tend to have some of the best quality markets.

Operator

Thank you. Our next question today is coming from Michael Carrier from Bank of America Merrill Lynch. Please proceed with your question.

Michael Carrier

Thanks, guys. Brian, just on the expense guidance for the rest of the year. I just want to make sure we're looking at the same numbers. For this quarter, the comparable $205 million to $215 million would be like the $50 million, the adjusted expense number. But if I look at that and then where you came in the first quarter, it just seems like there's a decent ramp in the second half. I know you guys have mentioned stuff that you're working on in options and FX, but I just wanted to understand what's driving that. And then Chris, you mentioned just continuing to focus on efficiencies and maybe you see some efficiencies offsets of that growth if you come in at the lower end of that range?

Brian Schell

Good question. So the way to think about that is two things. One is you think about the staffing. We have added a few so we're going to have a little bit of a run rate increase so that the rate is likely to increase a little bit more in the second half versus the first half as we've continued to staff up again to deliver the new products and positioning ourselves for 2017 that we've talked about. So there's a little bit of that that we expect to see. From a structural incentive compensation, it's a little bit more weighed toward the second half of the year as we structure some of our incentives programs. Essentially, they are accrued when delivered and some of our product incentives are weighted in the second half of the year, so we expect to see a slightly higher accrual for some of those things in the second half to get a little bit in the weeds there.

But also, I mentioned the CapEx guidance. We're going to have more assets coming online, again associated with the product development, things that we're talking about. We expect to see a higher depreciation run rate as well for the second half. If you take those into account, we'd like to see the higher [ph], the $50 million run rate that you've seen in the first two quarters.

Operator

Thank you and next question today is coming from Brian Bedell from Deutsche Bank. Please proceed with your question.

Brian Bedell

Hi, good morning, guys.

Chris Concannon

Good morning.

Brian Bedell

Chris, can you talk a little bit about the improvement in capture rates and the sustainability. And I guess I want to focus a little bit more on the U.S. options business and sort of weaving that in with the BAM initiative and then you then going into 2017 in terms of your plans to launch complex orders. How should we be viewing the capture rates within options in that regard and also your market share?

Chris Concannon

Great question. First, I'd say expect fluctuation in capture rates in options when you think about our opportunity in options. It's an opportunity to grow as a percent of the overall market and we're going to be aggressive in how we attack that market and will use price as one of the many different functions of competitions. So I would expect additional fluctuation in capture because that is one of the tools that we use here. But looking forward, we are rolling out new product as you mentioned and that product continues to roll out into 2017.

With respect to the product that we are rolling out, it tends to be offered by our competitors at a higher capture rate. Given where our capture rate is today, we can roll out that product and still be exceptionally competitive in the market that we sit in. I would say expect aggressiveness around capture to continue to increase our market share, but we are headed into an area of product that is tend to be charged at a higher capture rate.

Operator

Thank you. Our next question today is coming from Kyle Voigt form KBW. Please proceed with your question.

Kyle Voigt

Hi, good morning. Thanks for taking my question. I just wanted to talk about some of the pricing changes you made on the non-transaction side. A really high U.S. proprietary market data and the cash equities business, then U.S. options forward fees, both in June; just wondering if it's fair to expect some follow-through from this in the third quarter as we get to the full run rate revenues from the pricing increases. Thank you.

Chris Concannon

From the non-transaction revenue, again, we look at it kind of collectively across. We'd expect a little bit of run rate benefit from the fees, but sometimes it takes a little while for it to catch up. Sometimes you'll see a little bit of attrition immediately as well. We can give a better visibility to that as we roll forward, again looking at as customers continue to make that change. It's something that we'll keep our eye on and we continue to provide some visibility to once we see the stronger performance.

Operator

Thank you. Our final question today is a follow-up from Richard Repetto from Sandler O'Neill. Please proceed with your question.

Richard Repetto

Yes. Hey, Chris, I know auctions is a growth area for you and this box auction mechanism you're going to roll out I guess more towards the year-end, but could you explain what's different about it? I know you have a number of tools in the Optis [ph] market but this functionality, is it different than the other price improvement mechanism out there?

Chris Concannon

First, I love that you get a second question in the queue, Rich. Next time you can just join us here for the call directly.

Richard Repetto

I will be here in Kansas City.

Chris Concannon

But thanks for that question. First, we are very excited about the product that we're rolling out this year. Auctions are not a simple technical delivery on a matching end. So we're excited to get them out the door and out to the clients. They are in demand when you think about the market share across the options industry and the volume in auctions today, it's close to 30% of the overall market. It's quite a healthy part of the options market where investors do risk the price improvement for their orders as they come into the exchange. We're joined here with Bryan Harkins who runs our options and equities business, so I'll let him answer the question on the details of the auction functionality. Brian?

Bryan Harkins

Yes. Hey, Rich. The main difference that we're trying to highlight is the fact that we reward priority quarters. What that means is as market participants in the order book, when they're responding to the auction will actually be given higher priority as a responder to the auction. One of the main reasons why we're doing that is just expect some conversations with the industry about the fact that the growth of auctions in the options industry has had an impact on spreads and spreads are widening. So we're trying to really take steps to reward people being on the MBBO and quoting.

Richard Repetto

Okay.

Operator

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Concannon for any closing remarks.

Chris Concannon

Thank you. I just want to thank everyone for joining our call. Obviously we had a great quarter, but there are so much more to do. The Bats team here is a team that believes the glass is always half-empty, so we will continue to strive to do better. With that, again, thank you for joining the call and we'll end it there.

Operator

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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