MarketAxess Holdings Inc. (NASDAQ:MKTX) Q2 2023 Earnings Call Transcript

MarketAxess Holdings Inc. (NASDAQ:MKTX) Q2 2023 Earnings Call Transcript July 20, 2023

MarketAxess Holdings Inc. beats earnings expectations. Reported EPS is $1.59, expectations were $1.57.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the MarketAxess Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded on July 20, 2023. I would now like to turn the call over to Steve Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir.

Stephen Davidson: Thank you, Sarah. Good morning, and welcome to the MarketAxess second quarter 2023 earnings conference call. For the call, Chris Concannon, Chief Executive Officer, will provide you with a strategic update on the company and provide color on the market outlook; Rich Schiffman, Global Head of Trading Solutions, will update you on our market and how we executed this quarter; and then Chris Gerosa, Chief Financial Officer, will walk you through the financial results for the quarter. Before I turn the call over to Chris Concannon, 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, 2022. I would also direct you read the forward-looking statement disclaimer 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 Chris Concannon.

Chris Concannon: Good morning. I’m very pleased to update you on the significant progress we made in the second quarter to enhance our franchise and drive our long-term growth. First, in terms of the quarter, we generated revenue of $180 million and year-to-date we generated $383 million, 4% above prior year levels. Earnings per share was $1.59 on net income of $60 million. We were not immune to the impact of dramatically lower volatility in the quarter, which impacted trading platforms across fixed income and other asset classes after a very strong first quarter. While our quarterly results will ebb and flow with volatility, we are confident that we have the right long-term strategy and we have made substantial progress this quarter in creating the most comprehensive global fixed income market for the future.

Turning to my strategic update, as you can see on Slide 3, we will now be providing quarterly updates based on 3 new focus areas, which is the framework through which we are managing our growth and how we will communicate our results going forward. First, in terms of innovation, we have now developed and launched unique proprietary data solutions and embedded them in our platform that we believe will help our clients make better trading decisions that achieve better outcomes. We have also launched the first client algorithm, Adaptive Auto-X in the U.S. credit markets with 8 live pilot clients and plans to increase the numbers significantly in the coming months. Next, in terms of integration, we successfully launched our new trading platform last quarter, which integrates our unique data products and our various trading protocols in a single platform.

Contained in that new trading platform is our enhanced portfolio trading functionality with increased capacity for large portfolios and accompanied by our proprietary data analytics that help our clients optimize their portfolios and protocol selections. And last, in terms of execution, we continue to expand our client franchise with record active clients, record traders and record active clients trading three or more products. We continue to grow and set records across various products and new initiatives, and we delivered on our new trading platform, an enhanced portfolio trading solution, and we processed a record single day of trading activity on May 31. In summary, we continued to execute in the quarter, despite the decrease in volatility which dampened activity on our platform.

The initiatives we launched this quarter will be critical in addressing the recent challenges we have faced in growing our estimated market share in U.S. high-grade. While we recognize that our high grade market share can be uniquely impacted by volume and volatility in the ETF markets, we also have felt the impact of new protocols like portfolio trading slowing our market share growth. Slide 4 illustrates how we are innovating with unique proprietary data that powers our new platform and our automation suite. We sit in a privileged position as a leader of the electronic global credit market that generates powerful proprietary data. This proprietary data helps inform our clients on what to trade to achieve their portfolio construction objectives by leveraging our Liquidity Scores, Tradability data and our new Matchability data.

Our unique data like CP Inquiry, CP+ Responder and Tradability, also informs clients how to trade and when to trade by recommending the right protocol to get their best price, how to size their trade, how to reduce their market impact, and informing them what to expect in terms of price outcome. And last, our newly released AI Dealer Direct Data helps inform our clients, who to trade with by leveraging artificial intelligence to determine the best counterparty for a specific trade. On Slide 5, our new trading platform will drive the gathering and directing of client orders to achieve better trading outcomes for clients. We are delivering a high-touch and low-touch trading solutions through our new order centric trading platform powered by our proprietary data and analytics.

We started our broad rollout in the first quarter of this year, and early client feedback has been overwhelmingly positive. We have transitioned over 30 of our top investor clients, who are now using the platform daily. Turning to Slide 6, our unique data and insights are also powering the first client algorithm, Adaptive Auto-X, designed to better link our liquidity pools. Our Adaptive Auto-X algorithms allow clients to build customized trading algorithms and enhance workflows to handle larger sized trades. Adaptive Auto-X also leverages smart order routing, so we can seamlessly link our liquidity pools and help our clients achieve unique execution outcomes. Slide 7 highlights the expanded addressable market that we have established compared to 2018.

The product set that we had in 2018 gave us access to a total addressable market of approximately $4 billion in revenue. The investments that we have made over the last several years have expanded our total addressable market by $3 billion, for a total addressable market today of $7 billion. We are continuing to invest to capture the tremendous opportunity before us, while integrating the new initiatives we have acquired or built. Slide 8 provides an update on market conditions and U.S. credit. As shown in the upper half of this slide, volatility in the second quarter was down significantly from the prior year impacting activity by select client segments on our platform. ETF market maker activity in the second quarter was down 47% from the first quarter, reflecting decreased opportunities to deploy arbitrage strategies.

In the second quarter, notional volumes and high grade and high yield ETFs decreased 19% and 33%, respectively, compared to the prior year reflecting the impact of reduced volatility on U.S. credit. The decrease in volatility was not unique to fixed income, with realized volatility on the S&P 500 down 52%, FX volatility down 12%, and commodities down 28%. Before I turn the call over to Rich Schiffman, I wanted to provide an update on market trends in July. With 8 important trading days remaining in the month, U.S. high grade estimated market share is running consistent with mid-June levels. U.S. high yield estimated market share, however, has rebounded and is now running above June levels and slightly below prior year July levels. Now, let me turn the call over to Rich Schiffman to provide you with an update on our market.

Richard Schiffman: Thanks, Chris. Slide 10 highlights the strength of our growing client franchise. We had a record 2,083 active client firms trading on our market in the second quarter. As an example of our global strength and diversity, active international client firms represent 51% of total active firms, and the over 5,000 international investor and dealer traders, represent over 40% of total active traders. Trading volume from hedge fund and private bank clients increased 36% year-over-year and represented 17% of total credit volume in the current quarter, up from 12% in the prior year period. A record 1,127 active client firms are trading 3 or more products on our market, which reflects the deep partnership that we have with our clients and the power of our liquidity.

Once clients make the investment to connect to our platform, they want to do more with us, leveraging the power of our market to achieve superior trading results. This reflects the stickiness of MarketAxess in the workflow of our clients. Adoption of our automation suite of products continues to grow, as shown here on Slide 11. What Chris described earlier is playing out exactly as we had expected. Automation tools are only as good as the data that informs and powers the algorithm. Given the breadth of activity on our market, we believe our CP+ data is more accurate than that of our competitors. This is validated by CP+ sales growth over the last several quarters. In the second quarter, there were a record $7.4 million algo responses from dealers, an increase of 31% year-over-year with a 3-year CAGR of 28%.

Adoption of automated tools continues to increase with our investor clients. Once again, we saw record Auto-X trade volume and count in the quarter, with 3-year CAGRs of 32% and 43%, respectively, and a record 146 active client firms leveraging our automation tools. Of these active clients, 32% are top 100 clients in terms of total credit trading volume. Auto-X inquiry sizes are rising, as clients become more comfortable with automation and dealers are increasingly using their algos to handle larger size trades. It’s common for us to see clients start out small and then raise their thresholds as they gain confidence in our services. Responding to client interest, we’ve been steadily raising the maximum automation size, which currently sits at $10 million.

Auto-X trade volume now represents a record 10% of total credit volume and trade count is a record 23% of total credit trades. We believe that Adaptive Auto-X, our new suite of investor client algorithms, will take our automation solutions to a new level by leveraging smart order routing to facilitate access to the MarketAxess ecosystem. Slide 12 provides an update on Open Trading, our market leading all-to-all liquidity pool. Despite the dramatically lower credit spread volatility in the quarter, which reduced price improvement measures, we continue to expand available liquidity with new alternative providers. A record 195 hedge funds provided liquidity on Open Trading in the quarter, an 18% increase from the prior year. The increased alternative liquidity on Open Trading is being driven by better data, which allows hedge funds and systematic investors to deploy trading strategies they have developed in other asset classes.

One of the key drivers of our very strong increase in estimated market share for Eurobonds is the enhanced liquidity offered through Open Trading. We achieved record Eurobond trade volume in the quarter and a record 31% Eurobond Open Trading share. In U.S. high grade, no touch trades executed between Auto-X and a dealer algo represented 19% of trade count in high grade on Open Trading, reflecting the increasing usage of automation tools in leveraging our unique liquidity pool. On Slide 13, we highlight the growing international diversification of our trading business. Second quarter growth in international average daily trade volume and trade count increased 14% and 28%, respectively. This was driven by record Eurobond ADV, up 30% and EM local markets volume, up 11%.

June month end was extremely strong for EM local trading with a record of over US$5 billion equivalent volume traded. This contributed to our second best day on the platform. It included two of our largest trades ever on our market, both around $300 million in size. From a regional perspective, LatAm generated record ADV in the quarter and the second best quarter in terms of revenue. Now, let me turn the call over to Chris Gerosa to review our financial performance.

Christopher Gerosa: Thank you, Rich. On Slide 15, we provide a summary of our quarterly financials. For the quarter, we delivered revenue of $180 million, down slightly from the prior year. Record information services revenue of $12 million, was up 24%. This strong performance was driven by the healthy pipeline of new contracts signed, as we continue to experience strong adoption across our data product suite. Based on the year-to-date progression of information services revenue, we expect to achieve full year revenue growth in the mid-teens. The effective tax rate was 24.2%, slightly lower than prior year, and we reported diluted EPS of $1.59 per share. Excluding the impact of foreign exchange losses and unrealized losses on U.S. Treasury investments in the quarter and the impact of foreign exchange gains in the prior year quarter, all of which are included in other come, diluted EPS would have been down 3% versus the reported 11% decline.

On Slide 16, we provide more detail on our commission revenue and fee capture. Total commission revenue decreased 3% in the quarter and year-to-date is running 3% above prior year levels. Total credit commission revenue was impacted by the dramatically low levels of volatility in the quarter, which reduced trading activity, negatively impacting our trading volumes and estimated U.S. credit market share. This was partially offset by the revenue generated from strong market share gains in Eurobonds, Emerging Markets and Munis. The reduction in total credit fee capture from prior year was driven principally by the lower duration of U.S. high grade bonds traded over our platform. Product mix shift in other credit products, primarily in U.S. high yield and client crossing activity in Eurobonds, which is executed at a lower fee capture rate.

While U.S. high grade fee capture declined year-over-year, duration has remained relatively stable over the last several months, as reflected in the corporate bond duration index. On Slide 17, we provide a summary of our operating expenses. Second quarter expenses increased 7%, driven principally by continued investments to enhance the trading system and our data product offering. Employee compensation and benefits increased $3 million on a 17% increase in headcount, as we continue to add technology and customer facing roles to support revenue growth initiatives. Tech and communications expenses increased $3 million due to higher SaaS, data center and cloud hosting expenses. On Slide 18, we provide an update on our balance sheet, cash flow and capital management.

Our balance sheet continues to be solid with cash and investments totaling $506 million and we had no outstanding debt as of June 30. We are actively investing our cash to take advantage of the favorable interest rate environment to continue to deliver strong net interest income in the coming quarters. During the past 12 months, we paid out approximately $107 million in quarterly dividends to our shareholders. Our Board of Directors declared a regularly quarterly cash dividend of $0.72 based on the financial performance of the company. Now, let me turn the call back to Chris for his closing comments.

Chris Concannon: In summary, on Slide 19, we continue to execute very well against our growth strategy. We have launched unique proprietary data solutions and embedded them in our new platform that we believe will help our clients make better trading decisions that achieve better outcomes. We have launched the first client algorithm, Adaptive Auto-X in the U.S. credit markets. We successfully developed and launched our new trading platform, which integrates our unique data products and our various trading protocols in a single platform. We continue to expand our global client franchise and we believe that we are entering a new period of growth in fixed income with higher rates that we expect will make fixed income a very attractive asset class in the years ahead. Now, we would be happy to open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Chris Allen with Citi. Please go ahead.

Christopher Allen: Good morning, everyone. I wanted to ask about Adaptive Auto-X, maybe you can give us a rough timeline in terms of expectations for a broader rollout of the platform, I know, you have 8 live pilot clients and you had your first trade on it. And then maybe you can provide a refresher just in terms of how do you think that’s going to impact client execution quality and the potential cost savings for clients? And how that translates into improved performance longer term?

Chris Concannon: Great. Good morning, Chris. Thanks for that question. Obviously, Adaptive Auto-X is in early stages, as we mentioned, it’s still in pilot. It will remain in pilot through the remainder of the summer. And based on early indications, performance is quite attractive. And as expected, the key thing about Adaptive is it allows a client to submit a larger parent order, which then breaks into what we call child orders, and those orders can be placed across various different protocols. The other unique thing about Adaptive Auto-X, it is pegged to the market, meaning, you can choose your relative price and it will remain pegged to the market and reprice as the market moves throughout the morning or the day. As we mentioned, we have 8 clients in pilot with probably another 3 or 4 in the queue.

All of various shapes and sizes. Some of them are quite large clients, traditional asset managers and some are a number of smaller hedge funds. So we’re trying to do a broad cross section just to complete your question around the performance of Adaptive Auto-X and the goals it’s really to allow clients to outsource their trading strategies into really a very sophisticated AI-driven algorithm. And the unique thing about Adaptive Auto-X and end MarketAxess is that it takes advantage of our Open Trading solutions, both our live markets order book as well as our all-to-all Open Trading solution in RFQ. So it allows clients to actually not cross spread for some portion of their order, which is a substantial improvement in price given the size of spreads in our market.

So it’s a very unique offering that leverages our competitive position in all-to-all trading, that huge liquidity pool that we always talk about Open Trading. Adaptive Auto-X is uniquely designed around that solution. And then, obviously, we plan to roll that out over the course of the fall and into next year. The client feedback thus far has been very positive. We have a number of clients begging to be in the pilot, but we’re trying to keep the pilot at this point small. The other important thing and we rolled out a number of new data products. There’s one product in particular, when combined with Adaptive Auto-X makes it a much more interesting opportunity and that’s called matchability. And matchability predicts the opportunity of a specific bond to find a matching buyer or seller on our platform.

So that combined with Adaptive Auto-X’s increases a client’s likelihood of not crossing spread by being very careful about their bond selection when they’re building their portfolio.

Richard Schiffman: Chris, can I just add to this? Chris, it’s Richard Schiffman here. And just to address the question about execution quality and building on what Chris just said here, it’s really exciting to see what’s going on in the pilot, because this was an example of one of the trades, where we had something that would have been a traditional RFQ and a liquidity taker, paying bid-ask spread and getting quite competitive execution quality on our system. But because they used Adaptive Auto-X, they were able to leave their order resting in our order book live markets, when then someone else came along and executed against them. So as Chris pointed out, crossing bid-ask spread, it’s tying together the different protocols that we have that historically have kind of sat by themselves.