MarketAxess Holdings, Inc.
MARKETAXESS HOLDINGS INC (Form: 10-K, Received: 02/24/2011 17:13:43)
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 001-34091
 
MARKETAXESS HOLDINGS INC.
(Exact name of registrant as specified in its charter)
     
Delaware   52-2230784
(State of incorporation)   (IRS Employer Identification No.)
     
299 Park Avenue, New York, New York   10171
(Address of principal executive offices)   (Zip Code)
(212) 813-6000
(Registrant’s telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
     
Title of each class:   Name of each exchange on which registered:
Common Stock, par value $0.003 per share   NASDAQ Global Select Market
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the shares of common stock and non-voting common stock held by non-affiliates of the registrant as of June 30, 2010 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $440.5 million computed by reference to the last reported sale price on the NASDAQ Global Select Market on that date. For purposes of this calculation, affiliates are considered to be officers, directors and holders of 10% or more of the outstanding common stock of the registrant on that date. The registrant had 34,335,481 shares of common stock, 2,393,289 of which were held by affiliates, and 2,585,654 shares of non-voting common stock outstanding on that date.
At February 22, 2011, the aggregate number of shares of the registrant’s common stock and non-voting common stock outstanding was 37,689,747.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for the 2011 Annual Meeting of Stockholders are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K.
 
 

 

 


 

MARKETAXESS HOLDINGS INC.
2010 FORM 10-K ANNUAL REPORT
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  Exhibit 21.1
  Exhibit 23.1
  Exhibit 31.1
  Exhibit 31.2
  Exhibit 32.1
  Exhibit 32.2

 

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PART I
Forward-Looking Statements
This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as “expects,” “intends,” “anticipates,” “plans,” “believes,” “seeks,” “estimates,” “will,” or words of similar meaning and include, but are not limited to, statements regarding the outlook for our future business and financial performance. Forward-looking statements are based on management’s current expectations and assumptions, which are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. It is routine for our internal projections and expectations to change as the year or each quarter in the year progresses, and therefore it should be clearly understood that the internal projections and beliefs upon which we base our expectations may change prior to the end of each quarter or the year. Although these expectations may change, we are under no obligation to revise or update any forward-looking statements contained in this report. Our company policy is generally to provide our expectations only once per quarter, and not to update that information until the next quarter. Actual future events or results may differ, perhaps materially, from those contained in the projections or forward-looking statements. Factors that could cause or contribute to such differences include those discussed below and elsewhere in this report, particularly in Item 1A “Risk Factors.”
Item 1.  
Business.
MarketAxess operates a leading electronic trading platform that allows investment industry professionals to efficiently trade corporate bonds and other types of fixed-income instruments. Our over 800 active institutional investor clients (firms that executed at least one trade in U.S. or European fixed-income securities through our electronic trading platform during 2010) include investment advisers, mutual funds, insurance companies, public and private pension funds, bank portfolios, broker-dealers and hedge funds. Our 78 broker-dealer market-maker clients provide liquidity on the platform and include most of the leading broker-dealers in global fixed-income trading. Through our Corporate BondTicker TM service, we provide fixed-income market data, analytics and compliance tools that help our clients make trading decisions. In addition, we provide FIX (Financial Information eXchange) message management tools, connectivity solutions and ancillary technology services that facilitate the electronic communication of order information between trading counterparties. Our revenues are primarily generated from the trading of U.S. high-grade corporate bonds.
Our multi-dealer trading platform allows our institutional investor clients to simultaneously request competing, executable bids or offers from our broker-dealer clients and execute trades with the broker-dealer of their choice from among those that choose to respond. We offer our broker-dealer clients a solution that enables them to efficiently reach our institutional investor clients for the distribution and trading of bonds. In addition to U.S. high-grade corporate bonds, European high-grade corporate bonds and emerging markets bonds, including both investment-grade and non-investment grade debt, we also offer our clients the ability to trade crossover and high-yield bonds, agency bonds, asset-backed and preferred securities and credit default swaps (“CDS”).
The majority of our revenues are derived from monthly distribution fees and commissions for trades executed on our platform that are billed to our broker-dealer clients on a monthly basis. We also derive revenues from technology products and services, information and user access fees, investment income and other income. Our expenses consist of employee compensation and benefits, depreciation and amortization, technology and communication expenses, professional and consulting fees, occupancy, marketing and advertising and general and administrative expenses.
Traditionally, bond trading has been a manual process, with product and price discovery conducted over the telephone between two or more parties. This traditional process has a number of shortcomings resulting primarily from the lack of a central trading facility for these securities, which creates difficulty matching buyers and sellers for particular issues. Many corporate bond trading participants use e-mail and other electronic means of communication for trading corporate bonds. While this has addressed some of the shortcomings associated with traditional corporate bond trading, we believe that the process is still hindered by limited liquidity, limited price transparency, significant transaction costs, compliance and regulatory challenges, and difficulty in executing numerous trades at one time.
Through our disclosed multi-dealer Request For Quote (“RFQ”) trading functionality, our institutional investor clients can determine prices available for a security, a process called price discovery, as well as trade securities directly with our broker-dealer clients. The price discovery process includes the ability to view indicative prices from the broker-dealer clients’ inventory available on our platform, access to real-time pricing information and analytical tools (including spread-to-Treasury data, search capabilities and independent third-party credit research) available on our Corporate BondTicker TM service and the ability to request executable bids and offers simultaneously from up to 64 of our broker-dealer clients during the trade process. On average, institutional investor clients receive several bids or offers from broker-dealer clients in response to trade inquiries. However, some trade inquiries may not receive any bids or offers.

 

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Our services relating to trade execution include single and multiple-dealer inquiries; list trading, which is the ability to request bids and offers on multiple bonds at the same time; and swap trading, which is the ability to request an offer to purchase one bond and a bid to sell another bond, in a manner such that the two trades will be executed simultaneously, with payment based on the price differential of the bonds. Once a trade is completed on our platform, the broker-dealer client and institutional investor client may settle the trade with the assistance of our automated post-trade messaging, which facilitates the communication of trade acknowledgment and allocation information between our institutional investor and broker-dealer clients.
Typically, we are not a party to the trades that occur on our platform between institutional investor clients and broker-dealer clients; rather, we serve as an intermediary between broker-dealers and institutional investors, enabling them to meet, agree on a price and then transact with each other. However, we also execute certain bond transactions between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller in matching back-to-back trades, which are then settled through a third-party clearing organization. These are primarily voice-assisted trades, a service that we introduced as an adjunct to RFQ trading during late 2008 in response to the adverse effect of the credit crisis on dealer liquidity in corporate bonds. We act as intermediary on a riskless principal basis in these bond transactions by serving as counterparty to the two clients involved.
Our broker-dealer clients accounted for approximately 97% of the underwriting of newly-issued U.S. high-grade corporate bonds and approximately 68% of the underwriting of newly issued European high-grade corporate bonds in 2010. We believe these broker-dealers also represent the principal source of secondary market liquidity in the other markets in which we operate. Secondary market liquidity refers to the ability of market participants to buy or sell a security quickly and in large volume subsequent to the original issuance of the security, without substantially affecting the price of the security. In addition to trading fixed-income securities by traditional means, including the telephone and e-mail, our broker-dealer clients use proprietary single-dealer systems and other trading platforms as well as our electronic trading platform. We believe that the traditional means of trading remain the manner in which the majority of bonds are traded between institutional investors and broker-dealers.
Our volume in U.S. high-grade corporate bonds represented approximately 8.4% of the total U.S. high-grade corporate bond volume, excluding convertible bonds, for 2010 as reported by the Financial Industry Regulatory Authority (“FINRA”) Trade Reporting and Compliance Engine (“TRACE”), which includes inter-dealer and retail trading as well as trading between institutional investors and broker-dealers.
Industry Background
Fixed-income securities are issued by corporations, governments and other entities, and pay a pre-set absolute or relative rate of return. As of September 30, 2010 there were approximately $35.7 trillion of fixed-income securities outstanding in the U.S. market, including $7.4 trillion of U.S. corporate bonds.
The U.S. and European credit markets experienced a period of significant turmoil beginning during the third quarter of 2007, especially in short-term funding and floating rate note instruments. A widespread retrenchment in the credit markets resulted in increased credit spreads and significantly higher credit spread volatility across a wide range of asset classes. The U.S. credit markets demonstrated significant improvement throughout 2009 and 2010, with net inflows to taxable bond funds and corporate and international bond exchange-traded funds, and an increase in the volume of new issues of high-grade corporate bonds compared to the second half of 2008. Credit yield spreads in U.S. corporate bonds declined to 1.1% over U.S. Treasuries as of December 31, 2010 from a peak of 5.4% in December 2008. The trading volume of U.S. high-grade corporate bonds as reported by FINRA Trade Reporting and Compliance Engine (“TRACE”) increased from $2.0 trillion for the year ended December 31, 2008 to $2.9 trillion for each of the years ended December 31, 2009 and 2010. After demonstrating improved conditions during 2009, European credit markets deteriorated throughout 2010 due in part to continuing sovereign debt credit concerns.
U.S. High-Grade Corporate Bond Market
The total amount of U.S. corporate bonds outstanding has grown from $5.3 trillion as of December 31, 2006 to $7.4 trillion as of September 30, 2010. The estimated average daily trading volume of U.S. corporate bonds (investment grade and high yield), as measured by TRACE, has increased from approximately $14.1 billion in 2006 to $16.8 billion in 2010.

 

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The U.S. corporate bond market consists of three broad categories of securities: investment-grade debt (so-called “high-grade”), which typically refers to debt rated BBB- or better by Standard & Poor’s or Baa3 or better by Moody’s Investor Service; debt rated below investment-grade (so-called “high-yield”), which typically refers to debt rated lower than BBB- by Standard & Poor’s or Baa3 by Moody’s Investor Service; and debt convertible into equity (so-called “convertible debt”).
The U.S. high-grade corporate bond market, which represents the largest subset of the U.S. corporate bond market, has undergone significant change over the last decade, which has been driven by a number of factors, including:
   
Improved price transparency — In 2002, FINRA adopted TRACE reporting, which requires FINRA members to report secondary market transactions in certain fixed-income securities to FINRA. The list of TRACE-eligible bonds includes 29,000 unique securities, representing the majority of the daily trading volume of high-grade bonds.
   
Introduction of electronic trading platforms — Electronic trading platforms act as central facilities to bring together buyers and sellers. The actions of participants on these platforms are facilitated by an electronic medium that improves some of the manual processes that might otherwise be required, such as searching for securities with specific characteristics, the coordination of multiple bilateral telephone calls or electronic communications, the sorting and analysis of competing bids or offers, and the entry of orders into the trading system after verbal or e-mail trade agreement. As a result, these platforms typically provide a lower-cost and more efficient means of enhanced distribution and trade execution than previously possible.
   
Introduction of credit derivatives — Credit derivatives can provide increased flexibility and liquidity for investors and lenders to diversify their credit exposures. The notional amount of outstanding CDS transactions grew rapidly between 2002 and 2007. However, activity in the CDS market has since fallen substantially due to concern over the risks associated with these products, in particular the counterparty credit risks, and uncertainty regarding the effect of changes to the market resulting from implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted during 2010.
   
Total amount of debt issued — During 2006 and 2007, the gross amount of new bonds issued averaged approximately $950 billion. During 2008, high-grade corporate bond issuance declined to $664 billion as risk aversion among corporate bond investors limited the ability of issuers across a wide range of industries, in particular the financial services industry, to issue new corporate bonds. The credit markets demonstrated significant improvement throughout 2009 and 2010 and new issues of high-grade corporate bonds increased to approximately $752 billion in 2010.
(BAR GRAPH)

 

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European High-Grade Corporate Bond Market
The European high-grade corporate bond market consists of a broad range of products, issuers and currencies. We define the European high-grade corporate bond market generally to consist of bonds intended to be distributed to European investors, primarily bonds issued by European corporations, excluding bonds that are issued by a corporation domiciled in an emerging markets country and excluding most government bonds that trade in Europe. Examples include:
   
bonds issued by European corporations, denominated in any currency;
   
bonds generally denominated in Euros, U.S. dollars or Pounds Sterling, excluding bonds that are issued by a corporation domiciled in an emerging market;
   
bonds issued by supra-national organizations (entities that include a number of central banks or government financial authorities, such as the World Bank), agencies and governments located in Europe, generally denominated in Euros, U.S. dollars or Pounds Sterling, provided that such currency is not the currency of the country where the bond was issued; and
   
floating-rate notes issued by European corporations.
We believe that the European high-grade corporate bond market is impacted by many of the same factors as the U.S. high-grade corporate bond market. In addition, we believe the following factors are unique to the European high-grade corporate bond market:
   
Sovereign credit issues —The global financial crisis has led to a significant rise in sovereign debt relative to GDP. In the Euro area, gross public sector debt surged to 84% of GDP in 2010 from 66% of GDP in 2007. Increased government deficits and debt levels along with ratings downgrades sparked fears of default among Euro zone nations, leading to increased yields on government bonds, making a more difficult trading environment for European corporate bonds.
   
Regulatory environment — Certain European Union countries have eased restrictions that required institutional investors to invest primarily in domestic securities. This has provided European institutional investors with increased flexibility to invest in securities issued by entities domiciled in other countries within the European Union. In 2007, the Markets in Financial Instruments Directive (“MiFID”) came into effect. MiFID is designed to further harmonize the financial markets of the member states of the European Union and introduces new pre- and post-trade transparency requirements.
   
Common liquidity pool — The larger capital pool created by the common currency and changes in the regulatory environment have facilitated bond issuance by European corporations.
Emerging Markets Bond Market
We define the emerging markets bond market generally to include U.S. dollar, Euro or local currency denominated bonds issued by sovereign entities or corporations domiciled in a developing country. These issuers are typically located in Latin America, Asia, or Central and Eastern Europe. Examples of countries we classify as emerging markets include: Brazil, Colombia, Mexico, Peru, the Philippines, Russia, Turkey and Venezuela.
The institutional investor base for emerging markets bonds includes many crossover investors from the high-yield and high-grade investment areas. Institutional investors have been drawn to emerging markets bonds by their high returns and high growth potential. Demand for emerging markets bonds declined significantly in the fourth quarter of 2008 as the turmoil in the credit markets and the world-wide recession impacted the emerging markets. Emerging markets bond prices as measured by the JPMorgan emerging markets sovereign external debt and corporate bond indices fell steeply in 2008 but demonstrated significant improvement during 2009 and 2010. Emerging markets sovereign external debt and bond indices grew 12.0% and 12.5%, respectively, during 2010.
Crossover and High-Yield Bond Market
We define the high-yield bond market generally to include all debt rated lower than BBB- by Standard & Poor’s or Baa3 by Moody’s Investor Service. We define the crossover market to include any debt issue rated below investment grade by one agency but investment grade by the other. The total amount of high-yield corporate bonds yearly issuance was $146.6 billion for the year ended December 31, 2006 but declined to $43.0 billion during 2008, primarily due to the risk aversion among corporate bond investors that severely limited the ability of high-yield issuers to raise new debt. The high-yield corporate bond markets demonstrated significant improvement throughout 2009 and 2010, with new issuance for the year ended December 31, 2010 increasing to $273.0 billion.

 

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FINRA publicly disseminates real-time price information on approximately 12,000 high-yield corporate bond issues and certain other transactions on a delayed basis. Trades in bonds rated BB and lower are subject to immediate dissemination if the trade size is less than $1 million, or greater than $1 million and trades an average of once or more a day. The average daily trading volume of high-yield bonds reported by FINRA for the year ended December 31, 2010 was $5.2 billion.
Agency Bond Market
We define the agency bond market to include debt issued by a U.S. government-sponsored enterprise. Some prominent issuers of agency bonds are the Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”). The total amount of U.S. agency bonds outstanding was approximately $2.6 trillion as of September 30, 2010. The Federal Reserve Bank of New York reported average daily trading volume for 2010 of $16.8 billion in federal agency and government sponsored enterprise coupon securities (excluding mortgage-backed securities).
Credit Default Swap Market
Credit default swaps are contracts on an underlying asset that transfer risk and return from one party to another without transferring ownership of the underlying asset, allowing market participants to obtain credit protection or assume credit exposure associated with a broad range of issuers of fixed-income securities and other debt obligations. The trading volumes and notional amount outstanding in CDS transactions grew rapidly between 2002 and 2007. Following counterparty credit concerns beginning in 2007, trading activity in the CDS market declined substantially and the industry focused on netting down counterparty positions. The notional amount of CDS outstanding declined to $26.3 trillion as of June 30, 2010 from $62.2 trillion as of December 31, 2007. To address the counterparty credit concerns, structural changes began to occur in the CDS market that included the creation of CDS clearing houses in 2009 that serve as central counterparties for certain CDS transactions. In 2010, in response to the financial crisis, the U.S. Congress passed the Dodd-Frank Act, which is intended to bring comprehensive reform to the regulation of swaps, including CDS. Among the most significant provisions of the derivatives section of the Dodd-Frank Act are: mandatory clearing, through regulated central clearing organizations, of all swaps that the U.S. Commodity Futures Trading Commission (“CFTC”) or the U.S. Securities and Exchange Commission (“SEC”) has determined should be cleared (“clearable swaps”); and mandatory trading of clearable swaps on a board of trade designated as a contract market or a securities exchange or through a “swap execution facility,” or SEF (in each case, subject to certain key exceptions). The Dodd-Frank Act requires the CFTC and SEC to complete the rules to regulate the swaps market place by July 2011. We currently expect to establish and operate a SEF as soon as the process is established. We believe that the introduction of the clearing mandates is likely to result in more standardized contracts and greater price transparency in the CDS markets.
Although the European regulators have not yet introduced legislation concerning regulation of the European derivatives markets, the European Commission has issued three consultation papers intended to help define certain terms in the new OTC derivatives landscape. Our expectation is that the EU will, in line with the U.S., mandate central clearing of standardized CDS contracts and increase transparency through enhanced trade reporting requirements. However, it is not yet clear whether there will be any requirement in the EU to trade standardized CDS contracts on regulated exchanges or trading platforms.
Asset-Backed Securities
Asset-backed securities are ownership interests in a pool of receivables sold by originators into a special purpose vehicle. These securities are typically secured by pools of homogeneous assets with relatively predictable cash flows. The assets are legally separated from the seller, which limits the investor’s exposure to the credit quality of the seller. In 2010, $107 billion in U.S. asset-backed securities were issued, a decrease from $151 billion in 2009. The total amount of U.S. asset-backed securities outstanding at the end of 2010 was $2.2 trillion.
Preferred Securities
Preferred securities are equity ownership securities that carry additional rights above and beyond those conferred by common shares. The additional rights typically include preference in dividends and seniority in assets vis-à-vis common stock in the event of liquidation. Other typical features include convertibility into common stock, callable at the option of the corporation and no voting rights. We estimate that the average daily trading volume of preferred securities was approximately $640 million in 2010.

 

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Our Competitive Strengths
Our electronic trading platform provides solutions to some of the shortcomings of traditional bond trading methods. The benefits of our solution are demonstrable throughout the trading cycle:
   
Pre-trade — gathering real-time and historical pricing information, identifying interested buyers and sellers in a particular security, and obtaining research and analysis;
   
Trade — single and multiple security trade execution; and
   
Post-trade — trade detail matching, account allocation and automated audit trail.
We believe that we are well positioned to strengthen our market position in electronic trading in our existing products and to extend our presence into new products and services by capitalizing on our competitive strengths, including:
Significant Trading Volumes with Participation by Leading Broker-Dealers and Institutional Investors
Our electronic trading platform provides access to the liquidity provided through the participation on our platform of 78 broker-dealer market making clients, including substantially all of the leading broker-dealers in global fixed-income trading, and over 800 active institutional investor firms. We believe these broker-dealers represent the principal source of secondary market liquidity for U.S. high-grade corporate bonds, European high-grade corporate bonds, emerging markets bonds and the other markets in which we operate. Our broker-dealer clients are motivated to continue to utilize our platform due to the presence on the platform of our large network of institutional investor clients. We believe that our net addition of 30 new broker-dealer market making clients during 2009 and 2010 has improved and will continue to improve the liquidity on our electronic trading platform for institutional investors, further motivating them to use our platform. The number of our active institutional investor clients for the past five years has been as follows:
(BAR GRAPH)

 

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Our total trading volume increased from $339.6 billion in 2006 to $402.3 billion in 2010. We believe our trading volumes in 2008 and 2009 reflect the turmoil and resultant lack of liquidity in the credit markets beginning in the third quarter of 2007. Our total trading volume over the past five years is indicated below:
(BAR GRAPH)
Our volume in U.S. high-grade corporate bonds grew from approximately 8.5% of total U.S. high-grade corporate bond volume, excluding convertible bonds, in 2006 as reported by FINRA TRACE, which includes inter-dealer and retail trading as well as trading between institutional investors and broker-dealers, to approximately 9.4% in 2007. However, following the credit market turmoil, our estimated market share declined to approximately 6.2% for the full year 2009. Our volume in U.S. high-grade floating rate note bonds declined from $46.0 billion in 2007 to $6.6 billion in 2009. The U.S. credit markets demonstrated significant improvement throughout 2009 and 2010. Our estimated share of total U.S. high-grade corporate bond volume for 2010 was approximately 8.4%. Our estimated market share from 2006 to 2010 is shown in the chart below:
(BAR GRAPH)

 

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Execution Benefits to Clients
Benefits to Institutional Investor Clients
We believe we provide numerous benefits to our institutional investor clients over traditional fixed-income trading methods, including:
Competitive Prices. By enabling institutional investors to simultaneously request bids or offers from our broker-dealer clients, we believe our electronic trading platform creates an environment that motivates our broker-dealer clients to provide competitive prices and gives institutional investors confidence that they are obtaining a competitive price. For typical MarketAxess multi-dealer corporate bond inquiries, the range of competitive spread-to-Treasury responses is, on average, approximately 10 basis points (a basis point is 1/100 of 1% in yield). As an example of the potential cost savings to institutional investors, a one basis point savings on a $1 million face amount trade of a bond with 10 years to maturity translates to aggregate savings of approximately $775.00.
Transparent Pricing on a Range of Securities. The commingled multi-dealer inventory of bonds posted by our broker-dealer clients on our platform consists of a daily average of more than $70 billion in indicative bids and offers. Subject to applicable regulatory requirements, institutional investors can search bonds in inventory based on any combination of issuer, issue, rating, maturity, spread-to-Treasury, size and dealer providing the listing, in a fraction of the time it takes to do so manually. Institutional investor clients can also request executable bids and offers on our electronic trading platform on any debt security in a database of U.S. and European corporate bonds, although there can be no assurance as to the number of broker-dealers who will choose to provide an executable price. Our platform transmits bid and offer requests in real-time to broker-dealer clients, who may respond with executable prices within a time period specified by the institutional investor. Institutional investors may also elect to display live requests for bids or offers anonymously to all other users of our electronic trading platform, in order to create broader visibility of their inquiry among market participants and increase the likelihood that the request results in a trade. We believe that broader participation in client inquiries will result in more trade matches and lower transaction costs.
Improved Cost Efficiency. We believe that we provide improved efficiency by reducing the time and labor required to conduct broad product and price discovery. Single-security and multi-security (bid or offer lists) inquiries can be efficiently conducted with multiple broker-dealers. In addition, our Corporate BondTicker TM eliminates the need for manually-intensive phone calls or e-mail communication to gather, sort and analyze information concerning historical transaction prices.
Benefits to Broker-Dealer Clients
We also provide substantial benefits to our broker-dealer clients over traditional fixed-income trading methods, including:
Greater Sales Efficiency. We offer our broker-dealer clients broad connectivity with their institutional investor clients. Through this connectivity, our broker-dealer clients are able to efficiently display their indications of interest to buy and sell various securities. We also enable broker-dealers to broaden their distribution by participating in transactions to which they otherwise may not have had access. In addition, the ability to post prices and electronically execute on straightforward trades enables bond sales professionals at broker-dealer firms to focus their efforts on more profitable activities, such as higher value-added trades and more complex transactions.
More Efficient Inventory Management. The posting of inventory to, and the ability to respond to inquiries from, a broad pool of institutional investors, creates an increased opportunity for broker-dealers to identify demand for their inventory, particularly in less liquid securities. As a result, we believe they can achieve enhanced bond inventory turnover, which may limit credit exposure.
Benefits to Both Institutional Investor and Broker-Dealer Clients
We offer additional benefits over traditional fixed-income trading methods that are shared by both institutional investor and broker-dealer clients, including:
Greater Trading Accuracy. Our electronic trading platform includes verification mechanisms at various stages of the execution process which result in greater accuracy in the processing, confirming and clearing of trades between institutional investor and broker-dealer clients. These verification mechanisms are designed to ensure that our broker-dealer and institutional investor clients are sending accurate trade messages by providing multiple opportunities to verify they are trading the correct bond, at the agreed-upon price and size. Our platform assists our institutional investor clients in automating the transmittal of order tickets from the portfolio manager to the trader, and from the trader to back-office personnel. This automation provides more timely execution and a reduction in the likelihood of errors that can result from manual entry of information into different systems.

 

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Efficient Risk Monitoring and Compliance. Institutional investors and their regulators are increasingly focused on ensuring that best execution is achieved for fixed-income trades. Our electronic trading platform offers both institutional investors and broker-dealers an automated audit trail for each stage in the trading cycle. This enables compliance personnel to review information relating to trades more easily and with greater reliability. Trade information including time, price and spread-to-Treasury is stored securely and automatically on our electronic trading platform. This data represents a valuable source of information for our clients’ compliance personnel. Importantly, we believe the automated audit trail, together with the competitive pricing that is a feature of our electronic trading platform, gives fiduciaries the ability to demonstrate that they have achieved best execution on behalf of their clients.
Other Service Offerings
In addition to services directly related to the execution of trades, we offer our clients several other services, including:
Information Services. The information and analytical tools we provide to our clients help them make investment and trading decisions. Our Corporate BondTicker TM provides access to real-time and historical price, yield and MarketAxess estimated spread-to-Treasuries for publicly disseminated FINRA TRACE-eligible bonds. Corporate BondTicker TM combines publicly-available TRACE data with the prices for trades executed on our U.S. high-grade electronic trading platform, integrating the two data sources and providing real-time TRACE data with associated analytical tools that are not otherwise available. Corporate BondTicker TM provides end-of-day CDS pricing data combined with CDS analytics and screening tools that incorporate cash bond and equity market data. In addition, Corporate BondTicker TM provides indicative prices for secondary loans, through arrangements with certain of our broker-dealer clients, and independent third-party credit research. Our electronic trading platform allows institutional investors to compile, sort and use information to discover investment opportunities that might have been difficult or impossible to identify using a manual information-gathering process or other electronic services.
We offer a comprehensive set of reports designed to review and monitor credit trading activity for institutional investor clients. These reports utilize extensive TRACE information and are accessible by means of a flexible interface to run and save reports in a variety of formats for both compliance and management reporting. For example, the best execution report provides a view of the savings generated by trading on our electronic trading platform and offers a quantitative measure of the value of price discovery from multiple dealers. The report allows clients to monitor performance against their own best execution policy. Our compliance product provides a printed history of each inquiry submitted through the MarketAxess trading platform.
Straight-Through Processing. Straight-through processing (“STP”) refers to the integration of systems and processes to automate the trade process from end-to-end — trade execution, confirmation and settlement — without the need for manual intervention. Our electronic trading platform provides broker-dealers and institutional investors with the ability to automate portions of their transaction processing requirements, improving accuracy and efficiency. Through electronic messaging, institutional investors can submit inquiries to, and receive electronic notices of execution from us, in industry standard protocols, complete with all relevant trade details. Institutional investors can download trade messages, allocate trades to sub-accounts on whose behalf the trades were made and send the allocations to broker-dealers for confirmation.
Technology Products and Services. We provide integration, testing and management solutions for FIX-related products and services designed to optimize the electronic trading of fixed-income, equity and other exchange-based products. We also provide technology consulting and customized development services to our clients that leverage our trading technology expertise and our existing technology solutions. In addition, we provide gateway adapters to connect order management and trading systems to fixed-income trading venues.
Robust, Scalable Technology
We have developed proprietary technology that is highly secure, fault-tolerant and provides adequate capacity for our current operations, as well as for substantial growth. Our highly scalable systems are designed to accommodate additional volume, products and clients with relatively little modification and low incremental costs.
Proven Innovator with an Experienced Management Team
Since our inception, we have been an innovator in the fixed-income securities markets. Our management team is comprised of executives with an average of more than 20 years’ experience in the securities industry. We have consistently sought to benefit participants in the markets we serve by attempting to replicate the essential features of fixed-income trading, including the existing relationships between broker-dealers and their institutional investor clients, while applying technology to eliminate weaknesses in traditional trading methods. In 2010, Credit magazine recognized MarketAxess as “Best e-trading platform for corporate bonds and CDS” both in the U.S. and in Europe. MarketAxess was also recognized by Financial News as “Best OTC Trading System” and “Best Fixed-Income Trading Platform” in the Awards for Excellence in Trading & Technology — Europe 2010.

 

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Some of the innovations we have introduced to electronic trading include:
   
the first multi-dealer disclosed trading platform for U.S. high-grade corporate bonds;
   
the first electronic Treasury benchmarking for U.S. high-grade corporate bond trades;
   
Corporate BondTicker TM , our information services product, combining FINRA TRACE bond data with MarketAxess data and analytical tools;
   
bid and offer list technology for corporate bond trading, enabling institutional investors to request executable prices for multiple securities simultaneously;
   
the first disclosed client to multi-dealer trading platform for CDS indices; and
   
public Market Lists for corporate bonds, giving institutional investors the ability to display their bid and offer lists anonymously to the entire MarketAxess trading community.
Our Strategy
Our objective is to provide the leading global electronic trading platform for fixed-income securities, connecting broker-dealers and institutional investors more easily and efficiently, while offering a broad array of information, trading and technology services to market participants across the trading cycle. The key elements of our strategy are:
Enhance the Liquidity of Securities Traded on Our Platform and Broaden Our Client Base in Our Existing Markets
We intend to further enhance the liquidity of securities traded on our leading electronic, multi-dealer to client fixed-income platform. Our ability to innovate and efficiently add new functionality and product offerings to the MarketAxess platform will help us deepen our market share with our existing clients, as well as expand our client base, which we believe will in turn lead to even further increases in the liquidity of the securities provided by our broker-dealer clients and available on our platform. We will seek to increase the number of active European and other international institutional investor clients using our U.S. electronic trading platform, subject to regulatory requirements.
Leverage our Existing Technology and Client Relationships to Expand into New Sectors of the Fixed-Income Securities Market
We intend to leverage our technology, as well as our strong broker-dealer and institutional investor relationships, to deploy our electronic trading platform into additional product segments within the fixed-income securities markets and deliver fixed-income securities-related technical services and products. Due in part to our highly scalable systems, we believe we will be able to enter new markets efficiently. As an example, we have developed technology and trading protocols to trade CDS in anticipation of implementation of the Dodd-Frank Act and, subject to such rulemaking, we currently expect to establish and operate a swap execution facility and/or a security-based swap execution facility.
Leverage our Existing Technology and Client Relationships to Expand into New Client Segments
We intend to leverage our technology and client relationships to deploy our electronic trading platform into new client segments. As an example, we have expanded the base of broker-dealers on our platform to include both regional and diversity dealers.
Continue to Strengthen and Expand our Trade-Related Service Offerings
We plan to continue building our existing service offerings so that our electronic trading platform is more fully integrated into the workflow of our broker-dealer and institutional investor clients. We also plan to continue to add functionality to enhance the ability of our clients to achieve a fully automated, end-to-end straight-through processing solution (automation from trade initiation to settlement). We are continually considering the introduction of new trading techniques.

 

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Expand our Data and Information Services Offerings
We regularly add new content and analytical capabilities to Corporate BondTicker TM in order to improve the value of the information we provide to our clients. We intend to continue to widen the user base of our data products and to continue adding new content and analytical capabilities. As the use of our electronic trading platform continues to grow, we believe that the amount and value of our proprietary trading data will also increase, further enhancing the value of our information services offerings to our clients.
Expand our Technology Services Offerings
We intend to leverage our technology expertise and our client relationships to provide technology solutions to our clients that enhance their electronic trading capabilities and facilitate the electronic communication of order information with their trading counterparties.
Pursue Select Acquisitions and Strategic Alliances
We plan to continue to increase and supplement our internal growth by entering into strategic alliances, or acquiring businesses or technologies, that will enable us to enter new markets, provide new products or services, or otherwise enhance the value of our platform to our clients.
MarketAxess Electronic Trading Platform
Key Trading Functionalities
The key trading functionalities are detailed below.
Single Inquiry Trading Functionality
We currently offer institutional investors the ability to request bids or offers in a single inquiry from up to 50 of our broker-dealer clients for U.S. high-grade corporate bonds, from up to six of our broker-dealer clients for European high-grade corporate bonds and from up to eight of our broker-dealer clients in emerging markets bonds. Institutional investors can obtain bids or offers on any security posted in inventory or included in the database available on our platform.
ASAP and Holding Bin Trading Functionalities
We provide both ASAP (“as soon as possible”) and Holding Bin trading protocols. In the Holding Bin trading protocol, institutional investor clients set the time when they would like all of the broker-dealers’ prices or spreads returned to them, in order to have the ability to see all executable prices available at the same time. In the ASAP trading protocol, institutional investor clients see each broker-dealer’s price or spread as soon as it is entered by the broker-dealer.
List Trading Functionality
We currently offer institutional investors the ability to request bids or offers on a list of up to 40 bonds depending on the market. This facilitates efficient trading for institutional investors such as investment advisors, mutual funds and hedge funds. Institutional investors are able to have multiple lists executable throughout the trading day, enabling them to manage their daily cash flows, portfolio duration, and credit and sector exposure.
Swap Trading Functionality
We currently offer institutional investors the ability to request an offer to purchase one bond and a bid to sell another bond, in a manner such that the two trades will be executed simultaneously, with payment based on the price or yield differential of the securities.

 

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Market Lists
We offer institutional investors the ability to display live requests for bids and offers anonymously to the entire MarketAxess trading community through our Market List functionality, thereby creating broader visibility of their inquiry among market participants and increasing the likelihood that the request results in a trade.
Click-to-Trade
We have enhanced our trading system to provide pre-trade price discovery and fast-track execution for European bonds. Click-to-trade functionality streams attributable pricing in European credit and rates instruments, submitted by our pool of European dealers. Investor clients are able to initiate an inquiry with a single click on the stacks of distinctly displayed dealer bids and offers. Click-to-trade is offered alongside our existing Request for Quote product. Although currently limited to European credit and rate instruments, click-to-trade functionality may be applied to trading of other market sectors.
Markets
U.S. High-Grade Corporate Bonds
Our U.S. high-grade corporate bond business consists of U.S. dollar-denominated investment-grade debt issued by corporations for distribution in the U.S. Both domestic and foreign institutional investors have access to U.S. high-grade corporate bond trading on our electronic trading platform. We use the terms high-grade debt and investment-grade debt interchangeably in this annual report on Form 10-K. Our 2010 trading volume in the U.S. high-grade corporate bond market was $243.4 billion.
In the U.S. high-grade corporate bond market, 61 broker-dealers utilize our platform, including each of the top 20 broker-dealers as ranked by 2010 investment grade new-issue underwriting volume. Our broker-dealer clients accounted for approximately 97% of the underwriting of newly-issued U.S. high-grade corporate bonds in 2010.
We offer our institutional investor clients access to a broad inventory of U.S. high-grade corporate bonds, which is provided and updated daily by our broker-dealer clients. Our electronic trading platform allows institutional investors to view bids and offers from one or more of our broker-dealer clients while permitting each party to know the identity of its counter-party throughout the trading process. Our disclosed inquiry trading functionality combines the strength of existing offline client/dealer relationships with the efficiency and transparency of an electronic trading platform. This enables institutional investors to instantly direct trade inquiries and negotiations to their traditional broker-dealer or to any of the substantial majority of the world’s leading broker-dealers who provide liquidity in these securities. Through our Market List functionality, we also offer institutional investors the ability to display their live requests for bid and offer lists anonymously to the entire MarketAxess trading community as a means of creating broader visibility of their inquiry among market participants and increasing the likelihood that the request results in a trade.
Institutional investors have access to the commingled inventory of our broker-dealer clients, representing indicative bids and offers. Each line item of inventory represents an indicative bid and/or offer on a particular bond issue by a particular broker-dealer client. Institutional investor clients are not restricted to trading only the bonds posted as inventory, although many of the trades conducted on our platform are made from the posted inventory. To transact in a specific bond that does not appear in inventory, institutional investors can easily search our database and submit an online inquiry to their chosen broker-dealers, who can respond with live, executable prices. While, on average, institutional investor clients receive several bids or offers from broker-dealers in response to trade inquiries, some inquiries may not receive any bids or offers.
Eurobonds
MarketAxess Europe Limited, our wholly-owned U.K. subsidiary, offers European secondary trading functionality in U.S. dollar- and Euro-denominated European corporate bonds to our broker-dealer and institutional investor clients. We also offer our clients the ability to trade in other European high-grade corporate bonds, including bonds issued in Pounds Sterling, floating rate notes, European government bonds and bonds denominated in non-core currencies. We offered the first platform in Europe with a multi-dealer disclosed counterparty trading capability for corporate bonds. In 2009, MarketAxess Europe Limited received FSA regulatory approval to trade on a riskless principal basis. In November 2010, we launched a click-to-trade protocol for the European market.

 

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In the Eurobond credit market, defined as including European high-grade, high yield and government bonds, 25 broker-dealers utilize our platform, including 17 of the top 20 broker-dealers as ranked by 2010 European investment grade new-issue underwriting volume. On a typical day, institutional investors on our European corporate bond trading platform have access to over 65,000 lines of streaming pre-trade price indications on over 10,000 individual instruments covered on both the bid and offer side of the market. In a single inquiry, institutional investors can request bids or offers from up to six of the broker-dealers who participate on the European platform. While many of the trades conducted on our platform are made from the posted inventory, institutional investor clients are not restricted to trading only the bonds posted as inventory. To transact in a specific bond that does not appear in inventory, institutional investors can easily search our database and submit an online inquiry to their chosen broker-dealers, who can respond with live, executable prices. While, on average, institutional investor clients receive several bids or offers from broker-dealers in response to trade inquiries, some inquiries may not receive any bids or offers. Our 2010 trading volume in the Eurobond market was $50.3 billion.
Emerging Markets Bonds
Forty-six of our U.S. broker-dealer clients use our platform to trade emerging markets bonds. Three hundred seventy-one active institutional investor clients (firms that executed at least one trade through our electronic trading platform between January 2010 and December 2010) utilize our electronic trading platform to trade emerging markets bonds. These institutional investor clients are located in both the U.S. and Europe. The emerging markets countries whose bonds were most frequently traded on our platform in 2010 were Brazil, Mexico, Venezuela, Argentina and Russia.
In 2007, we introduced local markets emerging market debt trading, which allows our institutional investor clients to transact Euroclear-eligible local currency denominated bonds issued by sovereign entities or corporations in countries that include Mexico, Brazil and Argentina.
Crossover and High-Yield Bonds
Sixty-four of our U.S. broker-dealer clients use our platform to trade crossover and high-yield bonds. Trading in crossover and high-yield bonds uses many of the same features available in our U.S. high-grade corporate bond offering.
Agency Bonds
Thirty-four of our U.S. broker-dealer clients use our platform to trade agency bonds. Trading in agency bonds uses many of the same features available in our U.S. high-grade corporate bond offering.
Credit Default Swaps
We offer CDS index trading on our platform and also offer the capacity to trade lists of single-name CDS. In addition to the trading features, the index trading platform also offers STP connectivity for dealers and institutional investor clients. In 2009, we conformed our platform to the new standardized credit default swap calculation methodologies. Ten of our U.S. broker-dealer clients are activated to use our platform to trade CDS.
Asset-Backed Securities
In January 2011, we introduced trading in consumer asset-backed securities. Consumer asset-backed securities generally consist of credit card, auto and student loan receivables. Fourteen of our U.S. broker-dealer clients use our platform to trade asset-backed securities. Trading in asset-backed securities uses many of the same features available in our U.S. high-grade corporate bond offering.
Preferred Securities
In November 2010, we introduced trading in preferred securities. Fourteen of our U.S. broker-dealer clients use our platform to trade preferred securities. Trading in preferred securities uses many of the same features available in our U.S. high-grade corporate bond offering.

 

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Information and Analytical Tools
Corporate BondTicker TM
Corporate BondTicker TM provides real-time FINRA TRACE data and enhances it with MarketAxess trade data and analytical tools to provide professional market participants with a comprehensive set of corporate bond price information. The data include trade time and sales information, including execution prices, as well as MarketAxess-estimated spread-to-Treasuries, for trades disseminated by the FINRA TRACE system. The data also include actual execution prices and spread-to-Treasury levels for U.S. high-grade corporate bond trades executed on the MarketAxess platform.
Corporate BondTicker TM allows institutional investors to search for and sort bonds based upon specific criteria, such as volume, time/date of transaction, spread change, issuer or security. This search function allows institutional investors to compile information relating to potential securities trades in a fraction of the time that it takes to manually compile this information from disparate sources or other electronic databases, including direct TRACE feeds. Corporate BondTicker TM also offers end-of-day CDS pricing data provided by Credit Market Analysis Ltd. End-of-day screening tools combine the CDS data with market data from cash bonds and equities to provide relative value analysis to our clients. In addition, Corporate BondTicker TM provides independent third-party credit research as well as indicative prices for secondary markets in loans and CDS.
TRACE facilitates the mandatory reporting of over-the-counter secondary market transactions in eligible fixed-income securities. All broker-dealers that are FINRA member firms have an obligation to report transactions in corporate bonds to TRACE under a set of rules approved by the SEC. FINRA then publicly disseminates a portion of this data, which is available free of charge on a delayed basis through the FINRA website or available immediately for a set fee.
Corporate BondTicker TM is integrated directly into the MarketAxess electronic trading platform and can be seamlessly accessed, either when viewing securities inventory or when launching an inquiry. Corporate BondTicker TM is also available through the Internet for non-trading professional market participants, including, among others, research analysts and rating agencies, who can log in and access the information via an easy-to-use browser-based interface.
We provide Corporate BondTicker TM as an ancillary service to our trading clients and also to other industry participants. We derive revenues from our Corporate BondTicker TM service by charging for seat licenses per user at our broker-dealer and institutional investor clients, through distribution agreements with other information service providers and through bulk data sales to third parties. Seat license fees are waived for clients that transact a sufficient volume of trades through MarketAxess.
Additional analytical capabilities of our information services offerings aim to provide clients with more information regarding bond prices and market activity, including asset swap spreads, turnover percentage and liquidity ratios. These statistics measure a security’s trading activity relative to its amount outstanding and relative to the overall market, respectively, providing an additional perspective on relative liquidity. In addition, we provide pricing measures to help institutional investors better assess the relative value of a corporate bond, providing more consistent relative pricing information for institutional investors, such as offering spread data versus the interest rate swap curve and versus the U.S. Treasury curve. Users are also able to download a variety of MarketAxess-compiled trade reports containing a comprehensive review of trading activity. Corporate BondTicker TM is currently the source of corporate bond trading information for The Wall Street Journal.
We also offer a comprehensive set of reports designed to review and monitor credit trading activity for institutional investor clients. It utilizes extensive TRACE information and has a flexible interface to run and save reports in a variety of formats for both compliance and management reporting. For example, the best execution report provides a view of the savings generated by trading on our electronic trading platform and offers a quantitative measure of the value of price discovery from multiple dealers. The report allows clients to monitor performance against their own best execution policy. Our compliance product provides a printed history of each inquiry submitted through the MarketAxess trading platform.
My Portfolio
Institutional investors are able to upload their corporate bond portfolio to our electronic trading platform utilizing the “My Portfolio” trading feature. Institutional investors who utilize “My Portfolio” benefit from the ability to automatically match inventory on our platform to bonds held in their portfolio, allowing them to more efficiently launch an inquiry and transact in these securities. Users of this feature can also directly access Corporate BondTicker TM to obtain the trading history of the securities in their portfolio.

 

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Straight-Through Processing
Straight-through processing refers to the integration of systems and processes to automate the trade process from end-to-end — trade execution, confirmation and settlement — without the need for manual intervention. There are two elements of straight-through processing: internal straight-through processing and external straight-through processing. Internal straight-through processing relates to the trade and settlement processes that are internal to an industry participant. For example, in the case of an institutional investor, this includes authorization of orders, placement of orders with broker-dealers, receipt of execution details and allocation of trades. External straight-through processing refers to connecting seamlessly to all external counterparts in the trading and settlement process.
Automation by way of straight-through processing improves efficiency throughout the trade cycle. We provide broker-dealers and institutional investors with a range of tools that facilitate straight-through processing, including order upload, easy-to-use online allocation tools and pre- and post-trade messaging features that enable institutional investors to communicate electronically between front- and back-office systems, thereby integrating the order, portfolio management and accounting systems of our broker-dealer and institutional investor clients in real time. Our straight-through processing tools can be customized to meet specific needs of clients. We continue to build industry partnerships to assist our clients in creating connectivity throughout the trade cycle. Through these partnerships, we are increasingly providing solutions that can quickly be deployed within our clients’ trading operations.
Usage of our straight-through processing tools increased significantly during the last several years. The number of investor client STP connections increased from 134 as of December 31, 2007 to 245 as of December 31, 2010.
Dealer API
We offer Application Programming Interface (“API”) services to our broker-dealer clients for pre-trade, trade negotiation and post-trade services. This allows for straight-through processing, which improves efficiency and reduces errors in processing.
Technology Services
Through our Greenline subsidiary, we provide integration, testing and management solutions for FIX-related products and services. The FIX protocol is a messaging standard developed specifically for the real-time electronic exchange of securities transaction information. Greenline’s CertiFIX product enables firms to provide a reliable FIX certification environment for their trading counterparties. The VeriFIX product is a testing suite that allows firms to thoroughly test counterparty FIX interfaces, protocol formats and supported messages. Greenline’s MagniFIX product allows firms to monitor their enterprise-wide FIX installations on a real-time basis. In addition, Greenline provides strategic consulting and custom development for its clients.
We also provide technology consulting and customized development services to our clients that leverage our trading technology expertise and our existing technology solutions. Fees for such services are based on the complexity and extent of the services provided. In addition, we provide gateway adapters to connect order management and trading systems to fixed-income trading venues.
Sales and Marketing
We promote our products and services using a variety of direct and indirect sales and marketing strategies. Our sales force is responsible for client acquisition activity and for increasing use of our platform by our existing clients. Their goal is to train and support existing and new clients on how to use the system and to educate them as to the benefits of utilizing an electronic fixed-income trading platform. We employ various strategies, including advertising, direct marketing, promotional mailings and participation in industry conferences, to increase awareness of our brand and our electronic trading platform. For example, we have worked with The Wall Street Journal to establish Corporate BondTicker TM as the source of information for its daily corporate bond and high-yield tables.

 

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Competition
The electronic trading industry is highly competitive and we expect competition to intensify in the future. We face five main areas of competition:
   
Telephone — We compete with bond trading business conducted over the telephone between broker-dealers and their institutional investor clients. Institutional investors have historically purchased fixed-income securities by telephoning bond sales professionals at one or more broker-dealers and inquiring about the price and availability of individual bonds. This remains the manner in which the majority of corporate bonds are still traded between institutional investors and broker-dealers.
   
E-mail — We compete with bond trading business conducted via e-mail between broker-dealers and their institutional investor clients. E-mail provides an efficient means of initiating product and price discovery with a large universe of potential trading partners.
   
Other electronic trading platforms — There are numerous other electronic trading platforms currently in existence. These include: Thomson TradeWeb, a multi-dealer to institutional investor trading platform that has historically focused on government bond trading; Bloomberg, which provides electronic trading functionality; and the New York Stock Exchange. In addition, some broker-dealers operate proprietary electronic trading systems that enable institutional investors to trade directly with a broker-dealer over an electronic medium. We believe that we are currently the only platform primarily focused on multi-party disclosed trading of credit products between broker-dealers and institutional investors, though others have sought or may seek to expand their product offerings to compete in this market. Additionally, as we expand our business into new products, we will likely come into more direct competition with other electronic trading platforms or firms offering traditional services.
   
Market data and information vendors — Several large market data and information providers currently have a data and analytics relationship with virtually every institutional firm. Some of these entities, including Bloomberg, currently offer varying forms of electronic trading of fixed-income securities, mostly on a single-dealer basis. Some of these entities have announced their intention to expand their electronic trading platforms or to develop new platforms. These entities are currently direct competitors to our information services business and already are or may in the future become direct competitors to our electronic trading platform.
   
Technology vendors — We compete with numerous providers of FIX message management tools and connectivity solutions. The market for our technology products and services is fragmented and includes FIX engine providers, testing, monitoring, certification and professional services firms and in-house technology and development groups at virtually every institutional firm.
Competitors, including companies in which some of our broker-dealer clients have invested, have developed electronic trading platforms or have announced their intention to explore the development of electronic trading platforms that compete or will compete with us. Furthermore, our broker-dealer clients have made, and may in the future make investments in or enter into agreements with other businesses that directly or indirectly compete with us.
In general, we compete on the basis of a number of key factors, including:
   
broad network of broker-dealer and institutional investor clients using our electronic trading platform;
   
liquidity provided by the participating broker-dealers;
   
magnitude and frequency of price improvement;
   
enhancing the quality and speed of execution;
   
compliance benefits;

 

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total transaction costs;
   
technology capabilities, including the reliability and ease of use of our electronic trading platform; and
   
range of products and services offered.
We believe that we compete favorably with respect to these factors and continue to proactively build technology solutions that serve the needs of the credit markets.
Our competitive position is also enhanced by the familiarity and integration of our broker-dealer and institutional investor clients with our electronic trading platform and other systems. We have focused on the unique aspects of the credit markets we serve in the development of our platform, working closely with our clients to provide a system that is suited to their needs.
Our broker-dealer clients have invested in building API’s with us for inventory contributions, electronic trading, government bond benchmark pricing and post-trade messaging. We believe that we have successfully built deep roots with our broker-dealer clients, increasing our level of service to them while at the same time increasing their commitment to our services.
Furthermore, 245 of our institutional investor clients have built interfaces to enable them to communicate electronically between our platform and their order, portfolio management and accounting systems. We believe that this increases the reliance of these institutional investor clients on our services and creates significant competitive barriers to entry.
Technology
The design and quality of our technology products are critical to our growth and our ability to execute our business strategy. Our electronic trading platform has been designed with secure, scalable client-server architecture that makes broad use of distributed computing to achieve speed, reliability and fault tolerance. The platform is built on industry-standard technologies and has been designed to handle many multiples of our current trading volume.
All critical server-side components, primarily our networks, application servers and databases, have backup equipment running in the event that the main equipment fails. This offers fully redundant system capacity to maximize uptime and minimize the potential for loss of transaction data in the event of an internal failure. We also seek to minimize the impact of external failures by automatically recovering connections in the event of a communications failure. The majority of our broker-dealer clients have redundant dedicated high-speed communication paths to our network in order to provide fast data transfer. Our security measures include industry-standard communications encryption.
We have designed our application with an easy-to-use, Windows-based interface. Our clients are able to access our electronic trading platform through a secure, single sign-on. Clients are also able to execute transactions over our platform directly from their order management systems. We provide users an automatic software update feature that does not require manual intervention.
Intellectual Property
We rely upon a combination of copyright, patent, trade secret and trademark laws, written agreements and common law to protect our proprietary technology, processes and other intellectual property. Our software code, elements of our electronic trading platform, website and other proprietary materials are protected by copyright laws. We received five patents in 2009 covering our most significant trading protocols and other aspects of our trading system technology, we received two additional patents in 2010 and other patents are pending.
The written agreements upon which we rely to protect our proprietary technology, processes and intellectual property include agreements designed to protect our trade secrets. Examples of these written agreements include third party nondisclosure agreements, employee nondisclosure and inventions assignment agreements, and agreements with customers, contractors and strategic partners. Other written agreements upon which we rely to protect our proprietary technology, processes and intellectual property take many forms and contain provisions related to patent, copyright, trademark and trade secret rights.
We have obtained U.S. federal registration of the MarketAxess ® name and logo, and the same mark and logo have been registered in several foreign jurisdictions. We have pending registrations for the MarketAxess ® name and logo in several other foreign jurisdictions. In addition, we have obtained U.S. federal registration for the marks AutoSpotting ® , BondLink ® , FrontPage ® , Actives ® , DealerAxess ® and associated designs and have a number of other registered trademarks, service marks and trademark applications. Corporate BondTicker TM is a trademark we use, but it has not been registered.

 

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In addition to our efforts to register our intellectual property, we believe that factors such as the technological and creative skills of our personnel, new product and service developments, frequent enhancements and reliability with respect to our services are essential to establishing and maintaining a technology and market leadership position.
Government Regulation
The securities industry and financial markets in the U.S. and elsewhere are subject to extensive regulation. As a matter of public policy, regulatory bodies in the U.S. and the rest of the world are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of investors participating in those markets. Our active broker-dealer subsidiaries fall within the scope of their regulations.
Regulation of the U.S. Securities Industry and Broker-Dealers
In the U.S., the SEC is the governmental agency responsible for the administration of the federal securities laws. One of our U.S. subsidiaries, MarketAxess Corporation, is registered with the SEC as a broker-dealer. It is also a member of FINRA, a self-regulatory organization to which most broker-dealers belong. In addition, MarketAxess Corporation is a member of the Securities Investor Protection Corporation, which provides certain protection for clients’ accounts in the event of a liquidation of a broker-dealer to the extent any such accounts are held by the broker-dealer.
Additionally, MarketAxess Corporation is registered with certain states and the District of Columbia as a broker-dealer. The individual states and the District of Columbia are responsible for the administration of their respective “blue sky” laws, rules and regulations.
On July 21, 2010, the Dodd-Frank Act was signed into law, marking the greatest change to financial supervision since the 1930’s. U.S. financial regulators are in the midst of an intense period of rulemaking that is required to implement the provisions of the Dodd-Frank Act, and market participants will need to make strategic decisions in an environment of regulatory uncertainty. Among the most significant aspects of the derivatives section of the Dodd-Frank Act are mandatory clearing of certain derivatives transactions (“swaps”) through regulated central clearing organizations and mandatory trading of those swaps through either regulated exchanges or swap execution facilities, in each case, subject to certain key exceptions. As with other parts of the Dodd-Frank Act, many of the details of the new regulatory regime relating to swaps are left to the regulators to determine through rulemaking. Subject to such rulemaking, we currently expect to establish and operate a swap execution facility and/or a security-based swap execution facility.
Regulation of the Non-U.S. Securities Industries and Investment Service Providers
The securities industry and financial markets in the U.K., the European Union and elsewhere are subject to extensive regulation. MarketAxess Europe Limited may fall within the scope of those regulations depending on the extent to which it is characterized as providing a regulated investment service.
Our principal regulator in the U.K. is the Financial Services Authority (“FSA”). Our subsidiary, MarketAxess Europe Limited, is registered as a Multilateral Trading Facility (“MTF”) dealer with the FSA.
The securities industry in the member states of the European Union is regulated by agencies in each member state. European Union measures provide for the mutual recognition of regulatory agencies and of prudential supervision making possible the grant of a single authorization for providers of investment services, which, in general, is valid throughout the European Union. As an FSA-approved MTF, MarketAxess Europe Limited receives the benefit of this authorization.
Our Canadian subsidiary, MarketAxess Canada Limited, is registered as an Alternative Trading System dealer under the Securities Act of Ontario and is a member of the Investment Industry Regulatory Organization of Canada.

 

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Employees
As of December 31, 2010, we had 229 employees, 189 of whom were based in the U.S. and 40 of whom were based outside of the U.S., principally in the U.K. None of our employees is represented by a labor union. We consider our relationships with our employees to be good and have not experienced any interruptions of operations due to labor disagreements.
Company Information
Our Internet website address is www.marketaxess.com. Through our Internet website, we will make available, free of charge, the following reports as soon as reasonably practicable after electronically filing them with, or furnishing them to, the SEC: our annual report on Form 10-K; our quarterly reports on Form 10-Q; our current reports on Form 8-K; and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934. Our Proxy Statements for our Annual Meetings are also available through our Internet website. Our Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. You may also obtain copies of our reports without charge by writing to:
MarketAxess Holdings Inc.
299 Park Avenue
New York, NY 10171
Attn: Investor Relations
Our Board of Directors has standing Audit, Compensation, Investment, and Nominating and Corporate Governance Committees. Each of these committees has a written charter approved by our Board of Directors. Our Board of Directors has also adopted a set of Corporate Governance Guidelines. Copies of each committee charter, along with the Corporate Governance Guidelines, are also posted on our website.
You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Room 1580, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an Internet website that contains annual, quarterly and current reports, proxy and information statements and other information that issuers (including the Company) file electronically with the SEC. The SEC’s internet website is www.sec.gov.
We have obtained federal registration of the MarketAxess ® name and logo, as well as for the marks Auto-Spotting ® , BondLink ® , Actives ® , FrontPage ® and DealerAxess ® . We also have a number of other registered trademarks, service mark applications and trademark applications. Other trademarks and service marks appearing in this annual report on Form 10-K are the property of their respective holders.

 

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Item 1A.  
Risk Factors.
Risks Related to Our Business
We face substantial competition that could reduce our market share and harm our financial performance.
The fixed-income securities industry generally, and the electronic financial services markets in which we operate in particular, are highly competitive, and we expect competition to intensify in the future. We will continue to compete with bond trading conducted directly between broker-dealers and their institutional investor clients over the telephone or electronically. In addition, our current and prospective competitors are numerous and include:
   
other multi-dealer trading companies;
   
market data and information vendors;
   
securities and futures exchanges;
   
inter-dealer brokerage firms;
   
electronic communications networks;
   
technology, software, information and media or other companies that have existing commercial relationships with broker-dealers or institutional investors; and
   
other electronic marketplaces that are not currently in the securities business.
Many of our current and potential competitors are more established and substantially larger than we are and have substantially greater market presence, as well as greater financial, technical, marketing and other resources. These competitors may aggressively reduce their pricing to enter into market segments in which we have a leadership position today, potentially subsidizing any losses with profits from trading in other fixed-income or equity securities. In addition, many of our competitors offer a wider range of services, have broader name recognition and have larger customer bases than we do. Some of them may be able to respond more quickly to new or evolving opportunities, technologies and customer requirements than we can and may be able to undertake more extensive promotional activities.
Any combination of our competitors may enter into joint ventures or consortia to provide services similar to those provided by us. Current and new competitors can launch new platforms at a relatively low cost. Others may acquire the capabilities necessary to compete with us through acquisitions. We expect that we will potentially compete with a variety of companies with respect to each product or service we offer. If we are not able to compete successfully in the future, our business, financial condition and results of operations would be adversely affected.
Neither the sustainability of our current level of business nor any future growth can be assured. Even if we do experience growth, we cannot assure you that we will grow profitably.
The success of our business strategy depends, in part, on our ability to maintain and expand the network of broker-dealer and institutional investor clients that use our electronic trading platform. Our business strategy also depends on increasing the use of our platform by these clients. Individuals at broker-dealers or institutional investors may have conflicting interests, which may discourage their use of our platform.
Our growth is also dependent on our ability to diversify our revenue base. We currently derive approximately 57% of our revenues from secondary trading in U.S. high-grade corporate bonds. Our long-term business strategy is dependent on expanding our service offerings and increasing our revenues from other fixed-income products and other sources. We cannot assure you that our efforts will be successful or result in increased revenues or continued profitability. We have experienced significant growth in trading volumes, revenues and profitability over the past two years. We cannot assure you that our business will continue to grow at a similar rate, if at all.

 

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Because we operate in a rapidly evolving industry, it is difficult to evaluate our business and prospects.
We face risks and difficulties frequently experienced by companies operating in rapidly evolving industries, such as the electronic financial services industry. These risks and difficulties include, but are not limited to, our ability to:
   
attract and retain broker-dealers and institutional investors on a cost-effective basis;
   
expand and enhance reliable and cost-effective product and service offerings to our clients;
   
respond effectively to competitive pressures;
   
diversify our sources of revenues;
   
maintain adequate control of our expenses;
   
operate, support, expand and develop our operations, website, software, communications and other systems;
   
manage growth in personnel and operations;
   
increase awareness of our brand or market positioning;
   
expand our sales and marketing programs; and
   
respond to regulatory changes or demands.
If we are unsuccessful in addressing these risks or in executing our business strategy, our business, financial condition and results of operations may suffer.
Decreases in trading volumes in the fixed-income markets generally or on our platform would harm our business and profitability.
We have experienced significant decreases in overall trading volume in the past, and may experience decreases in trading volume in the future. Declines in the overall volume of fixed-income securities trading and in market liquidity generally, as well as declines in interest rate volatility, could result in lower revenues from commissions for trades executed on our electronic trading platform and fees generated from related activities.
Likewise, decreases in our share of the segments of the fixed-income trading markets in which we operate, or shifts in trading volume to segments of clients which we have not penetrated, could result in lower trading volume on our platform and, consequently, lower commissions and other revenue. During periods of increased volatility in credit markets, the use of electronic trading platforms by market participants may decrease dramatically as institutional investors seek to obtain additional information during the trade process through conversations with broker-dealers. In addition, during rapidly moving markets, broker-dealers are less likely to post prices electronically.
A decline in trading volumes on our platform for any reason would negatively affect our commission revenue and may have a material adverse effect on our business, financial condition and results of operations.
We may enter into new fee plans, the impact of which may be difficult to evaluate.
From time to time we may introduce new fee plans for the U.S. high-grade corporate bond, Eurobond and other market segments in which we operate. Any new fee plan may include different fee structures or provide volume incentives.
We cannot assure you that any new fee plans will result in an increase in the volume of transactions effected on our platform or that our revenues will increase as a result of the implementation of any such fee plans. Furthermore, resistance to the new fee plans by our broker-dealer or institutional investor clients or a reduction in the number of dealers participating on our platform could have an adverse impact on our distribution fees and otherwise have a material adverse effect on our business, financial condition and results of operations.

 

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We are exposed to risks resulting from non-performance by counterparties to certain transactions executed between our clients in which we act as an intermediary in matching back-to back bond trades .
We execute certain bond transactions between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller in matching back-to-back trades, which are then settled through a third-party clearing organization. MarketAxess Corporation, our U.S. subsidiary, and MarketAxess Europe Limited, our U.K. subsidiary, act as intermediary on a riskless principal basis in these bond transactions by serving as counterparty to the two clients involved. Settlement typically occurs within one to three trading days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded.
We are exposed to credit risk in our role as trading counterparty to our clients executing bond trades on our platform. We are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. Where the unmatched position or failure to deliver is prolonged there may also be regulatory capital charges required to be taken by us. There can be no assurance that the policies and procedures we use to manage this credit risk will effectively mitigate our credit risk exposure.
We are dependent on our broker-dealer clients, who are not restricted from buying and selling fixed-income securities, directly or through their own proprietary or third-party platforms, with institutional investors.
We rely on our broker-dealer clients to provide product and liquidity on our electronic trading platform by posting bond prices on our platform for bonds in their inventory and responding to institutional investor client inquiries. The contractual obligations of our broker-dealer clients to us are minimal, non-exclusive and terminable by such clients. Our broker-dealer clients buy and sell fixed-income securities through traditional methods, including by telephone and e-mail messaging, and through other electronic trading platforms. Some of our broker-dealer clients have developed electronic trading networks that compete with us or have announced their intention to explore the development of such electronic trading networks, and most of our broker-dealer and institutional investor clients are involved in other ventures, including other electronic trading platforms or other distribution channels, as trading participants and/or as investors. These competing trading platforms may offer some features that we do not currently offer. Accordingly, there can be no assurance that such broker-dealers’ primary commitments will not be to one of our competitors.
Any reduction in the use of our electronic trading platform by our broker-dealer clients would reduce the number of different bond issues and the volume of trading in those bond issues on our platform, which could, in turn, reduce the use of our platform by our institutional investor clients. The occurrence of any of the foregoing may have a material adverse effect on our business, financial condition and results of operations.
We could lose significant sources of revenue and trading volume if we lose any of our significant institutional investor clients.
We rely on our institutional investor clients to launch inquiries over our trading platform. A limited number of such clients can account for a significant portion of our trading volume. One institutional investor client accounted for approximately 15.8%, 12.1% and 10.8% of trading volumes during the years ended December 31, 2010, 2009 and 2008, respectively. This institutional investor client also beneficially owns more than 5% of the outstanding shares of our common stock. The contractual obligations of our institutional investor clients to us are minimal, non-exclusive and terminable by such clients. Our institutional investor clients buy and sell fixed-income securities through traditional methods, including by telephone and e-mail messaging, and through other electronic trading platforms.
There can be no assurance that we will be able to retain our major institutional investor clients or that such clients will continue to use our trading platform. The loss of any major institutional investor client or any reduction in the use of our electronic trading platform by such clients could have a material adverse effect on our business, financial condition and results of operations.

 

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If we experience significant fluctuations in our operating results or fail to meet revenue and earnings expectations, our stock price may fall rapidly and without advance notice.
Our revenues and operating results may fluctuate due to a number of factors, including:
   
the unpredictability of the financial services industry;
   
difficulty in quickly adjusting our expense base if revenues fall short of expectations;
   
our ability to retain existing broker-dealer and institutional investor clients and attract new broker-dealer and institutional investor clients;
   
our ability to drive an increase in use of our electronic trading platform by new and existing broker-dealer and institutional investor clients;
   
changes in our pricing policies;
   
the introduction of new features on our electronic trading platform;
   
the effectiveness of our sales force;
   
new product and service introductions by our competitors;
   
fluctuations in overall market trading volume;
   
technical difficulties or interruptions in our service;
   
general economic conditions in our geographic markets;
   
additional investment in our services or operations; and
   
regulatory compliance costs.
As a result, our operating results may fluctuate significantly on a quarterly basis, which could result in decreases in our stock price.
We may not be able to introduce enhanced versions of our electronic trading platform, new services and/or service enhancements in a timely or acceptable manner, which could harm our competitive position.
Our business environment is characterized by rapid technological change, changing and increasingly sophisticated client demands and evolving industry standards. Our future will depend on our ability to develop and introduce new features to, and new versions of, our electronic trading platform. The success of new features and versions depends on several factors, including the timely completion, introduction and market acceptance of the feature or version. In addition, the market for our electronic trading platform may be limited if prospective clients require customized features or functions that we are unable or unwilling to provide. If we are unable to anticipate and respond to the demand for new services, products and technologies and develop new features and enhanced versions of our electronic trading platform that achieve widespread levels of market acceptance on a timely and cost-effective basis, it could have a material adverse effect on our business, financial condition and results of operations.
As we enter new markets, we may not be able to successfully attract clients and adapt our technology and marketing strategy for use in those markets.
Our strategy includes leveraging our electronic trading platform to enter new markets. We cannot assure you that we will be able to successfully adapt our proprietary software and technology for use in other markets. Even if we do adapt our software and technology, we cannot assure you that we will be able to attract clients and compete successfully in any such new markets. We cannot assure you that our marketing efforts or our pursuit of any of these opportunities will be successful. If these efforts are not successful, we may realize less than expected earnings, which in turn could result in a decrease in the market value of our common stock. Furthermore, these efforts may divert management attention or inefficiently utilize our resources.

 

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Rapid market or technological changes may render our technology obsolete or decrease the attractiveness of our products and services to our broker-dealer and institutional investor clients.
We must continue to enhance and improve our electronic trading platform. The electronic financial services industry is characterized by significant structural changes, increasingly complex systems and infrastructures and new business models. If new industry standards and practices emerge, our existing technology, systems and electronic trading platform may become obsolete or our existing business may be harmed. Our future success will depend on our ability to:
   
enhance our existing products and services;
   
develop and/or license new products and technologies that address the increasingly sophisticated and varied needs of our broker-dealer and institutional investor clients and prospective clients; and
   
respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.
Developing our electronic trading platform and other technology entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our electronic trading platform, information databases and network infrastructure to broker-dealer or institutional investor client requirements or emerging industry standards. For example, our electronic trading platform functionality that allows searches and inquiries on bond pricing and availability is a critical part of our service, and it may become out-of-date or insufficient from our broker-dealer clients’ or institutional investor clients’ perspective and in relation to the inquiry functionality of our competitors’ systems. If we face material delays in introducing new services, products and enhancements, our broker-dealer and institutional investor clients may forego the use of our products and use those of our competitors.
Further, the adoption of new Internet, networking or telecommunications technologies may require us to devote substantial resources to modify and adapt our services. We cannot assure you that we will be able to successfully implement new technologies or adapt our proprietary technology and transaction-processing systems to client requirements or emerging industry standards. We cannot assure you that we will be able to respond in a timely manner to changing market conditions or client requirements.
We depend on third-party suppliers for key products and services.
We rely on a number of third parties to supply elements of our trading, information and other systems, as well as computers and other equipment, and related support and maintenance. We cannot assure you that any of these providers will be able to continue to provide these services in an efficient, cost-effective manner, if at all, or that they will be able to adequately expand their services to meet our needs. If we are unable to make alternative arrangements for the supply of critical products or services in the event of a malfunction of a product or an interruption in or the cessation of service by an existing service provider, our business, financial condition and results of operations could be materially adversely affected.
In particular, we depend on a third-party vendor for our corporate bond reference database. Disruptions in the services provided by that third party to us, including as a result of their inability or unwillingness to continue to license products that are critical to the success of our business, could have a material adverse effect on our business, financial condition and results of operations.
We also rely, and expect in the future to continue to rely, on third parties for various computer and communications systems, such as telephone companies, online service providers, data processors, and software and hardware vendors. Other third parties provide, for instance, our data center, telecommunications access lines and significant computer systems and software licensing, support and maintenance services. Any interruption in these or other third-party services or deterioration in their performance could impair the quality of our service. We cannot be certain of the financial viability of all of the third parties on which we rely.
We license software from third parties, much of which is integral to our electronic trading platform and our business. We also hire contractors to assist in the development, quality assurance testing and maintenance of our electronic trading platform and other systems. Continued access to these licensors and contractors on favorable contract terms or access to alternative software and information technology contractors is important to our operations. Adverse changes in any of these relationships could have a material adverse effect on our business, financial condition and results of operations.

 

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We attempt to negotiate favorable pricing, service, confidentiality and intellectual property ownership or licensing and other terms in our contracts with our service providers. These contracts usually have multi-year terms. However, there is no guarantee that these contracts will not terminate and that we will be able to negotiate successor agreements or agreements with alternate service providers on competitive terms. Further, the existing agreements may bind us for a period of time to terms and technology that become obsolete as our industry and our competitors advance their own operations and contracts.
Our success depends on maintaining the integrity of our electronic trading platform, systems and infrastructure; our computer systems may suffer failures, capacity constraints and business interruptions that could increase our operating costs and cause us to lose clients.
In order to be successful, we must provide reliable, real-time access to our electronic trading platform for our broker-dealer and institutional investor clients. If our electronic trading platform is hampered by slow delivery times, unreliable service or insufficient capacity, our broker-dealer and institutional investor clients may decide to stop using our platform, which would have a material adverse effect on our business, financial condition and results of operations.
As our operations grow in both size and scope, we will need to improve and upgrade our electronic trading platform and infrastructure to accommodate potential increases in order message volume and trading volume, the trading practices of new and existing clients, regulatory changes and the development of new and enhanced trading platform features, functionalities and ancillary products and services. The expansion of our electronic trading platform and infrastructure has required, and will continue to require, substantial financial, operational and technical resources. These resources will typically need to be committed well in advance of any actual increase in trading volumes and order messages. We cannot assure you that our estimates of future trading volumes and order messages will be accurate or that our systems will always be able to accommodate actual trading volumes and order messages without failure or degradation of performance. Furthermore, we use new technologies to upgrade our established systems, and the development of these new technologies also entails technical, financial and business risks. We cannot assure you that we will successfully implement new technologies or adapt our existing electronic trading platform, technology and systems to the requirements of our broker-dealer and institutional investor clients or to emerging industry standards. The inability of our electronic trading platform to accommodate increasing trading volume and order messages would also constrain our ability to expand our business.
We cannot assure you that we will not experience systems failures. Our electronic trading platform, computer and communication systems and other operations are vulnerable to damage, interruption or failure as a result of, among other things:
   
irregular or heavy use of our electronic trading platform during peak trading times or at times of unusual market volatility;
   
power or telecommunications failures, hardware failures or software errors;
   
human error;
   
computer viruses, acts of vandalism or sabotage (and resulting potential lapses in security), both internal and external;
   
natural disasters, fires, floods or other acts of God;
   
acts of war or terrorism or other armed hostility; and
   
loss of support services from third parties, including those to whom we outsource aspects of our computer infrastructure critical to our business.

 

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In the event that any of our systems, or those of our third-party providers, fail or operate slowly, it may cause any one or more of the following to occur:
   
unanticipated disruptions in service to our clients;
   
slower response times or delays in our clients’ trade execution;
   
incomplete or inaccurate accounting, recording or processing of trades;
   
financial losses and liabilities to clients;
   
litigation or other claims against us, including formal complaints to industry regulatory organizations; and
   
regulatory inquiries, proceedings or sanctions.
Any system failure that causes an interruption in service or decreases the responsiveness of our service, including failures caused by client error or misuse of our systems, could damage our reputation, business and brand name and lead our broker-dealer and institutional investor clients to decrease or cease their use of our electronic trading platform.
In these circumstances, our redundant systems or disaster recovery plans may not be adequate. Similarly, although many of our contracts with our service providers require them to have disaster recovery plans, we cannot be certain that these will be adequate or implemented properly. In addition, our business interruption insurance may not adequately compensate us for losses that may occur.
We also cannot assure you that we have sufficient personnel to properly respond to system problems. We internally support and maintain many of our computer systems and networks, including those underlying our electronic trading platform. Our failure to monitor or maintain these systems and networks or, if necessary, to find a replacement for this technology in a timely and cost-effective manner would have a material adverse effect on our business, financial condition and results of operations.
If our security measures are breached and unauthorized access is obtained to our electronic trading platform, broker-dealers and institutional investors may become hesitant to use, or reduce or stop their use of, our trading platform.
Our electronic trading platform involves the storage and transmission of our clients’ proprietary information. The secure storage and transmission of confidential information over public networks is a critical element of our operations. Security breaches could expose us to a risk of loss of this information, litigation and possible liability. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to trading or other confidential information, our reputation could be damaged, our business may suffer and we could incur significant liability. Because techniques used to obtain unauthorized access or to sabotage computer systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. If an actual, threatened or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and could cause our broker-dealer and institutional investor clients to reduce or stop their use of our electronic trading platform. We may be required to expend significant resources to protect against the threat of security breaches or to alleviate problems, including reputational harm and litigation, caused by any breaches. Although we intend to continue to implement industry-standard security measures, we cannot assure you that those measures will be sufficient.
We may not be able to protect our intellectual property rights or technology effectively, which would allow competitors to duplicate or replicate our electronic trading platform. This could adversely affect our ability to compete.
Intellectual property is critical to our success and ability to compete, and if we fail to protect our intellectual property rights adequately, our competitors might gain access to our technology. We rely primarily on a combination of patent, copyright, trademark and trade secret laws in the United States and other jurisdictions, as well as license agreements, third-party non-disclosure and other agreements and other contractual provisions and technical measures to protect our intellectual property rights. We attempt to negotiate beneficial intellectual property ownership provisions in our contracts and also require employees, consultants, advisors and collaborators to enter into confidentiality agreements in order to protect the confidentiality of our proprietary information. We have received seven patents and have filed patent applications covering aspects of our technology and/or business, but can give no assurances that any such patents will protect our business and processes from competition or that the patents applied for will be issued.

 

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Additionally, laws and our contractual terms may not be sufficient to protect our technology from use or theft by third parties. For instance, a third party might reverse engineer or otherwise obtain and use our technology without our permission and without our knowledge, thereby infringing our rights and allowing competitors to duplicate or replicate our products. Furthermore, we cannot assure you that these protections will be adequate to prevent our competitors from independently developing technologies that are substantially equivalent or superior to our technology.
We may have legal or contractual rights that we could assert against illegal use of our intellectual property rights, but lawsuits claiming infringement or misappropriation are complex and expensive, and the outcome would not be certain. In addition, the laws of some countries in which we now or in the future provide our services may not protect software and intellectual property rights to the same extent as the laws of the United States.
Defending against intellectual property infringement or other claims could be expensive and disruptive to our business. If we are found to infringe the proprietary rights of others, we could be required to redesign our products, pay royalties or enter into license agreements with third parties.
In the technology industry, there is frequent litigation based on allegations of infringement or other violations of intellectual property rights. As the number of participants in our market increases and the number of patents and other intellectual property registrations increases, the possibility of an intellectual property claim against us grows. Although we have never been the subject of a material intellectual property dispute, we cannot assure you that a third party will not assert in the future that our technology or the manner in which we operate our business violates its intellectual property rights. From time to time, in the ordinary course of our business, we may become subject to legal proceedings and claims relating to the intellectual property rights of others, and we expect that third parties may assert intellectual property claims against us, particularly as we expand the complexity and scope of our business, the number of electronic trading platforms increases and the functionality of these platforms further overlaps. Any claims, whether with or without merit, could:
   
be expensive and time-consuming to defend;
   
prevent us from operating our business, or portions of our business;
   
cause us to cease developing, licensing or using all or any part of our electronic trading platform that incorporates the challenged intellectual property;
   
require us to redesign our products or services, which may not be feasible;
   
result in significant monetary liability;
   
divert management’s attention and resources; and
   
require us to pay royalties or enter into licensing agreements in order to obtain the right to use necessary technologies, which may not be possible on commercially reasonable terms.
We cannot assure you that third parties will not assert infringement claims against us in the future with respect to our electronic trading platform or any of our other current or future products or services or that any such assertion will not require us to cease providing such services or products, try to redesign our products or services, enter into royalty arrangements, if available, or engage in litigation that could be costly to us. Any of these events could have a material adverse effect on our business, financial condition and results of operations.
If we acquire or invest in other businesses, products or technologies, we may be unable to integrate them with our business, our financial performance may be impaired or we may not realize the anticipated financial and strategic goals for any such transactions.
If appropriate opportunities present themselves, we may acquire or make investments in businesses, products or technologies that we believe are strategic. We may not be able to identify, negotiate or finance any future acquisition or investment successfully. Even if we do succeed in acquiring or investing in a business, product or technology, such acquisitions and investments involve a number of risks, including:
   
we may find that the acquired company or assets do not further our business strategy, or that we overpaid for the company or assets, or the economic conditions underlying our acquisition decision may change;
   
we may have difficulty integrating the acquired technologies or products with our existing electronic trading platform, products and services;

 

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we may have difficulty integrating the operations and personnel of the acquired business, or retaining the key personnel of the acquired business;
   
there may be client confusion if our services overlap with those of the acquired company;
   
our ongoing business and management’s attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically or culturally diverse enterprises;
   
we may have difficulty maintaining uniform standards, controls, procedures and policies across locations;
   
an acquisition may result in litigation from terminated employees or third parties; and
   
we may experience significant problems or liabilities associated with product quality, technology and legal contingencies.
These factors could have a material adverse effect on our business, financial condition, results of operations and cash flows, particularly in the case of a larger acquisition or multiple acquisitions in a short period of time. From time to time, we may enter into negotiations for acquisitions or investments that are not ultimately consummated. Such negotiations could result in significant diversion of management time, as well as out-of-pocket costs.
The consideration paid in connection with an investment or acquisition also affects our financial results. If we were to proceed with one or more significant acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash to consummate any acquisition. To the extent we issue shares of capital stock or other rights to purchase capital stock, including options or other rights, existing stockholders may be diluted and earnings per share may decrease. In addition, acquisitions may result in the incurrence of debt, large one-time write-offs, such as of acquired in-process research and development costs, and restructuring charges. They may also result in goodwill and other intangible assets that are subject to impairment tests, which could result in future impairment charges as was the case in 2008 with the write-down of certain TWS-related intangible assets.
We may be limited in our use of our U.S. net operating loss carryforwards.
As of December 31, 2010, we had U.S. net operating loss carryforwards of approximately $29.8 million that will begin to expire in 2021. A net operating loss carryforward enables a company to apply net operating losses incurred during a current period against future periods’ profits in order to reduce tax liability in those future periods.
Section 382 of the Internal Revenue Code provides that when a company undergoes an “ownership change,” that company’s use of its net operating losses is limited annually in each subsequent year. An “ownership change” occurs when, as of any testing date, the sum of the increases in ownership of each shareholder that owns five percent or more of the value of a company’s stock as compared to that shareholder’s lowest percentage ownership during the preceding three-year period exceeds 50 percentage points. For purposes of this rule, certain shareholders who own less than five percent of a company’s stock are aggregated and treated as a single five-percent shareholder.
The issuance or repurchase of a significant number of shares of stock or purchases or sales of stock by significant shareholders could result in an additional “ownership change.” For, example, we may issue a substantial number of shares of our stock in connection with offerings, acquisitions and other transactions in the future and we could repurchase a significant number of shares in connection with a share repurchase program, although no assurance can be given that any such offering, acquisition, other transaction or repurchase program will be undertaken. In addition, the exercise of outstanding options to purchase shares of our common stock may require us to issue additional shares of our common stock. The extent of the actual future use of our U.S. net operating loss carryforwards is subject to inherent uncertainty because it depends on the amount of otherwise taxable income we may earn. We cannot give any assurance that we will have sufficient taxable income in future years to use any of our federal net operating loss carryforwards before they would otherwise expire.

 

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We are dependent on our management team, and the loss of any key member of this team may prevent us from implementing our business plan in a timely manner.
Our success depends largely upon the continued services of our executive officers and other key personnel, particularly Richard M. McVey, Chief Executive Officer and Chairman of our Board of Directors. The terms of Mr. McVey’s employment agreement with us do not require him to continue to work for us and allow him to terminate his employment at any time, subject to certain notice requirements and forfeiture of non-vested equity options, performance shares and restricted stock. Any loss or interruption of Mr. McVey’s services or that of one or more of our other executive officers or key personnel could result in our inability to manage our operations effectively and/or pursue our business strategy.
Because competition for our employees is intense, we may not be able to attract and retain the highly skilled employees we need to support our business.
We strive to provide high-quality services that will allow us to establish and maintain long-term relationships with our broker-dealer and institutional investor clients. Our ability to provide these services and maintain these relationships, as well as our ability to execute our business plan generally, depends in large part upon our employees. We must attract and retain highly qualified personnel. Competition for these personnel is intense, especially for software engineers with extensive experience in designing and developing software and Internet-related services, hardware engineers, technicians, product managers and senior sales executives.
The market for qualified personnel is increasingly competitive as the financial industry continues to recover and as electronic commerce continues to experience growth. Many of the companies with which we compete for experienced personnel have greater resources than we have and are longer established in the marketplace. In addition, in making employment decisions, particularly in the Internet, high-technology and financial services industries, job candidates often consider the total compensation package offered, including the value of the stock-based compensation they are to receive in connection with their employment. Significant volatility in the price of our common stock may adversely affect our ability to attract or retain key employees. The expensing of stock-based compensation may discourage us from granting the size or type of stock-based compensation that job candidates may require to join our company.
We cannot assure you that we will be successful in our efforts to recruit and retain the required personnel. The failure to attract new personnel or to retain and motivate our current personnel may have a material adverse effect on our business, financial condition and results of operations.
Our business is subject to increasingly extensive government and other regulation and our relationships with our broker-dealer clients may subject us to increasing regulatory scrutiny.
The financial industry is extensively regulated by many governmental agencies and self-regulatory organizations, including the SEC and FINRA. As a matter of public policy, these regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets and protecting the interests of investors in those markets. These regulatory bodies have broad powers to promulgate and interpret, investigate and sanction non-compliance with their laws, rules and regulations.
Most aspects of our broker-dealer subsidiaries are highly regulated, including:
   
the way we deal with our clients;
   
our capital requirements;
   
our financial and regulatory reporting practices;
   
required record-keeping and record retention procedures;
   
the licensing of our employees; and
   
the conduct of our directors, officers, employees and affiliates.

 

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We cannot assure you that we and/or our directors, officers and employees will be able to fully comply with these laws, rules and regulations. If we fail to comply with any of these laws, rules or regulations, we may be subject to censure, fines, cease-and-desist orders, suspension of our business, suspensions of personnel or other sanctions, including revocation of our membership in FINRA and registration as a broker-dealer.
We have two major operating subsidiaries, MarketAxess Corporation and MarketAxess Europe Limited. MarketAxess Corporation and MarketAxess Europe Limited are subject to U.S. and U.K. regulations as a registered broker-dealer and as a multilateral trading facility, respectively, which prohibit repayment of borrowings from the Company or affiliates, paying cash dividends, making loans to the Company or affiliates or otherwise entering into transactions that result in a significant reduction in regulatory net capital or financial resources, without prior notification to or approval from such subsidiary’s principal regulator.
In addition, as a result of the global financial crisis and other recent events in the financial industry, there is a greater likelihood of legislative and regulatory action to increase government oversight of the financial services industry. For example, during 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. Among other things, the Dodd-Frank Act creates an entirely new structure for the trading of over-the-counter derivatives, a market in which we currently operate. Changes in laws or regulations or in governmental policies, including the rules relating to the maintenance of specific levels of net capital applicable to our broker-dealer subsidiaries, could have a material adverse effect on our business, financial condition and results of operations. Our industry has been and is subject to continuous regulatory changes and may become subject to new regulations or changes in the interpretation or enforcement of existing regulations, which could require us to incur significant compliance costs or cause the development of affected markets to become impractical. In addition, as we expand our business into new markets, it is likely that we will be subject to additional laws, rules and regulations. We cannot predict the extent to which any future regulatory changes may adversely affect our business and operations.
Our disclosed trading system has not been subjected to regulation as an alternative trading system under Regulation ATS. A determination by the SEC to treat our trading platform as an alternative trading system subject to Regulation ATS would subject us to additional reporting obligations and other limitations on the conduct of our business, many of which could be material. Our anonymous dealer-to-dealer trading service, DealerAxess ® , is regulated as an alternative trading system subject to Regulation ATS.
As an enterprise founded and historically controlled by broker-dealers that compete with each other, we may be subject to ongoing regulatory scrutiny of our business to a degree that is not likely to be experienced by some of our competitors. At any time, the outcome of investigations and other regulatory scrutiny could lead to compulsory changes to our business model, conduct or practices, or our relationships with our broker-dealer clients, or additional governmental scrutiny or private lawsuits against us, any of which could materially harm our revenues, impair our ability to provide access to the broadest range of fixed-income securities and impact our ability to grow and compete effectively, particularly as we implement new initiatives designed to enhance our competitive position.
The activities and consequences described above may result in significant distractions to our management and could have a material adverse effect on our business, financial condition and results of operations.
We expect to continue to expand our operations outside of the United States; however, we may face special economic and regulatory challenges that we may not be able to meet.
We operate an electronic trading platform in Europe and we plan to further expand our operations throughout Europe and other regions. There are certain risks inherent in doing business in international markets, particularly in the financial services industry, which is heavily regulated in many jurisdictions. These risks include:
   
less developed technological infrastructures and generally higher costs, which could result in lower client acceptance of our services or clients having difficulty accessing our trading platform;
   
difficulty in obtaining the necessary regulatory approvals for planned expansion, if at all, and the possibility that any approvals that are obtained may impose restrictions on the operation of our business;
   
the inability to manage and coordinate the various regulatory requirements of multiple jurisdictions that are constantly evolving and subject to unexpected change;

 

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difficulties in staffing and managing foreign operations;
   
fluctuations in exchange rates;
   
reduced or no protection for intellectual property rights;
   
seasonal reductions in business activity; and
   
potentially adverse tax consequences.
Our inability to manage these risks effectively could adversely affect our business and limit our ability to expand our international operations, which could have a material adverse effect on our business, financial condition and results of operations.
We cannot predict our future capital needs or our ability to obtain additional financing if we need it.
Our business is dependent upon the availability of adequate funding and regulatory capital under applicable regulatory requirements. Although we believe that our available cash resources are sufficient to meet our presently anticipated liquidity needs and capital expenditure requirements for at least the next 12 months, we may in the future need to raise additional funds to, among other things:
   
support more rapid growth of our business;
   
develop new or enhanced services and products;
   
fund operating losses;
   
respond to competitive pressures;
   
acquire complementary companies or technologies;
   
enter into strategic alliances;
   
increase the regulatory net capital necessary to support our operations; or
   
respond to unanticipated or changing capital requirements.
We may not be able to obtain additional financing, if needed, in amounts or on terms acceptable to us, if at all. If sufficient funds are not available or are not available on terms acceptable to us, our ability to fund our expansion, take advantage of acquisition opportunities, develop or enhance our services or products, or otherwise respond to competitive pressures would be significantly limited. These limitations could have a material adverse effect on our business, financial condition and results of operations.
We are subject to the risks of litigation and securities laws liability.
Many aspects of our business, and the businesses of our clients, involve substantial risks of liability. Dissatisfied clients may make claims regarding quality of trade execution, improperly settled trades, mismanagement or even fraud against their service providers. We and our clients may become subject to these claims as the result of failures or malfunctions of our electronic trading platform and services provided by us. We could incur significant legal expenses defending claims, even those without merit. An adverse resolution of any lawsuits or claims against us could have a material adverse effect on our business, financial condition and results of operations.

 

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Risks Related to Our Industry
If the use of electronic trading platforms does not increase, we may not be able to achieve our business objectives.
The success of our business plan depends in part on our ability to create an electronic trading platform for a wide range of fixed-income products. Historically, fixed-income securities markets operated through telephone communications between institutional investors and broker-dealers. The utilization of our products and services depends on the acceptance, adoption and growth of electronic means of trading securities. We cannot assure you that the growth and acceptance of electronic means of trading securities will continue.
Economic, political and market factors beyond our control could reduce demand for our services and harm our business, and our profitability could suffer.
The global financial services business is, by its nature, risky and volatile and is directly affected by many national and international factors that are beyond our control. Any one of these factors may cause a substantial decline in the U.S. and/or global financial services markets, resulting in reduced trading volume. These events could have a material adverse effect on our business, financial condition and results of operations. These factors include:
   
economic and political conditions in the United States, Europe and elsewhere;
   
adverse market conditions, including unforeseen market closures or other disruptions in trading;
   
consolidation or contraction in the number of broker-dealers;
   
actual or threatened acts of war or terrorism or other armed hostilities;
   
concerns over inflation and weakening consumer confidence levels;
   
the availability of cash for investment by mutual funds and other wholesale and retail investors;
   
the level and volatility of interest and foreign currency exchange rates; and
   
legislative and regulatory changes.
Any one or more of these factors may contribute to reduced activity and prices in the securities markets generally. Our revenues and profitability are likely to decline significantly during periods of stagnant economic conditions or low trading volume in the U.S. and global financial markets.
Risks Related to Our Common Stock
Market volatility may cause our stock price and the value of your investment to decline.
The market price of our common stock may be significantly affected by volatility in the markets in general. The market price of our common stock likely will continue to fluctuate in response to factors including the following:
   
the other risk factors described in this annual report on Form 10-K;
   
prevailing interest rates;
   
the market for similar securities;
   
additional issuances of common stock;
   
general economic conditions; and
   
our financial condition, performance and prospects, including our ability or inability to meet analyst expectations.

 

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Most of these factors are beyond our control. In addition, the stock markets in general, including the NASDAQ Global Select Market, have experienced and continue to experience significant price and volume fluctuations. These fluctuations have resulted in volatility in the market prices of securities for companies such as ours that often has been unrelated or disproportionate to changes in the operating performance of the affected companies. These broad market and industry fluctuations may affect adversely the market price of our common stock regardless of our operating performance.
We may not pay dividends on our common stock in the future.
We initiated a regular quarterly dividend on our common stock in 2009. However, there is no assurance that we will continue to pay any dividends to holders of our common stock in the future. If we were to cease paying dividends, investors would need to rely on the sale of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.
If securities analysts do not publish research or reports about our business or if they downgrade our common stock, the price of our common stock could decline.
The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about us or our business. These analysts work independently of us. If one or more analysts who cover us downgrade our stock, our stock price could decline rapidly. If one or more of these analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.
Provisions in our stockholders rights plan, organizational documents and Delaware law might discourage, delay or prevent a change of control of our company or changes in our management, and therefore, depress the trading price of our common stock.
Our Board of Directors adopted and our stockholders subsequently ratified a stockholders rights plan, commonly referred to as a “poison pill.” This plan entitles existing stockholders to rights, including the right to purchase shares of common stock, in the event of an acquisition of 20% or more of our outstanding common stock. Our stockholders rights plan could prevent stockholders from profiting from an increase in the market value of their shares as a result of a change of control of us by delaying or preventing a change of control.
In addition, provisions of our certificate of incorporation and bylaws may make it substantially more difficult for a third party to acquire control of us and may prevent changes in our management, including provisions that:
   
prevent stockholders from calling special meetings;
   
allow the directors to amend the bylaws without stockholder approval; and
   
set forth advance notice procedures for nominating directors and submitting proposals for consideration at stockholders’ meetings.
Provisions of Delaware law may also inhibit potential acquisition bids for us or prevent us from engaging in business combinations. In addition, we have severance agreements with several employees and a change of control severance plan that could require an acquiror to pay a higher price. Either collectively or individually, these provisions may prevent holders of our common stock from benefiting from what they may believe are the positive aspects of acquisitions and takeovers, including the potential realization of a higher rate of return on their investment from these types of transactions.
Item 1B.  
Unresolved Staff Comments.
None.
Item 2.  
Properties.
Our corporate headquarters and principal U.S. offices are located at 299 Park Avenue, New York, New York, where we lease 27,900 square feet under sequential leases expiring in February 2022. We also collectively lease approximately 18,300 square feet for our other office locations in the U.S. and the United Kingdom under various leases expiring between September 2013 and November 2020. In addition, we lease another 17,000 square feet at 350 Madison Avenue, New York, New York, which we currently sublet; the lease and sublease expire in April 2011.

 

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Item 3.  
Legal Proceedings.
In January 2007, a former employee of MarketAxess Corporation commenced an arbitration proceeding before FINRA arising out of the May 2006 termination of such individual’s employment with MarketAxess Corporation. This individual subsequently amended his statement of claim to add MarketAxess Holdings Inc. as a party to the arbitration proceeding. FINRA consolidated all of the former employee’s claims into a single proceeding and, by a decision dated July 12, 2010, the FINRA arbitration panel denied the former employee’s claims, totaling approximately $0.9 million, in their entirety. The former employee’s right to appeal the panel’s decision expired in October 2010.
Item 4.  
[Removed and reserved]

 

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PART II
Item 5.  
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Price Range
Our common stock trades on the NASDAQ Global Select Market under the symbol “MKTX”. The range of closing price information for our common stock, as reported by NASDAQ, was as follows:
                 
    High     Low  
2010:
               
January 1, 2010 to March 31, 2010
  $ 16.20     $ 13.25  
April 1, 2010 to June 30, 2010
  $ 17.40     $ 13.45  
July 1, 2010 to September 30, 2010
  $ 17.30     $ 12.39  
October 1, 2010 to December 31, 2010
  $ 20.93     $ 16.93  
 
               
2009:
               
January 1, 2009 to March 31, 2009
  $ 9.02     $ 6.13  
April 1, 2009 to June 30, 2009
  $ 11.07     $ 7.74  
July 1, 2009 to September 30, 2009
  $ 12.10     $ 8.93  
October 1, 2009 to December 31, 2009
  $ 13.90     $ 11.47  
On February 23, 2011, the last reported closing price of our common stock on the NASDAQ Global Select Market was $20.99.
Holders
There were 52 holders of record of our common stock as of February 23, 2011.
Dividend Policy
Prior to 2009, we retained all earnings for investment in our business. In October 2009, our Board of Directors approved a regular quarterly dividend. The first quarterly cash dividend of $0.07 per share was paid to our stockholders in November 2009 and regular quarterly cash dividends have been paid thereafter. In January 2011, our Board of Directors approved an increase in the quarterly cash dividend to $0.09 per share payable on March 2, 2011 to stockholders of record as of the close of business on February 16, 2011. We expect to continue paying regular cash dividends, although there is no assurance as to such dividends. Any future declaration and payment of dividends will be at the sole discretion of our Board of Directors. Our Board of Directors may take into account such matters as general business conditions, our financial results, capital requirements, contractual, legal, and regulatory restrictions on the payment of dividends by us to our stockholders or by our subsidiaries to us and any such other factors as our Board of Directors may deem relevant.
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance Under Equity Compensation Plans
Please see the section entitled “Equity Compensation Plan Information” in Item 12.

 

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Issuer Purchases of Equity Securities
During the quarter ended December 31, 2010, we repurchased the following shares of common stock:
                                 
                    Total Number of     Dollar Value of  
                    Shares Purchased     Shares That May  
    Total Number of     Average Price     as Part of Publicly     Yet Be Purchased  
Period   Shares Purchased     Paid per Share     Announced Plans     Under the Plans  
                      (In thousands)  
October 1, 2010 – October 31, 2010
    359,184     $ 17.47       359,184     $ 466  
November 1, 2010 – November 30, 2010
    25,200       18.45       25,200       1  
December 1, 2010 – December 31, 2010
    32,030       12.77       60       0  
 
                         
 
    416,414     $ 17.17       384,444          
 
                         
In June 2010, the Board of Directors of the Company authorized a share repurchase program for up to $30.0 million of the Company’s common stock. The share repurchase program was completed in December 2010. A total of 1,939,620 shares were repurchased at an aggregate cost of $30.0 million over the life of the repurchase program. Shares repurchased under the program will be held in treasury for future use.
During the three months ended December 31, 2010, a total of 22,868 shares were surrendered by employees to us to satisfy the exercise price and employee withholding tax obligations upon the vesting of restricted shares and exercise of stock options and 9,102 unvested restricted shares were repurchased upon the termination of employment or failure to meet performance conditions.
STOCK PERFORMANCE GRAPH
The following graph shows a comparison from December 31, 2005 through December 31, 2010 of the cumulative total return for (i) our common stock, (ii) the NASDAQ Composite Index and (iii) the Dow Jones US Financial Services Index.
The figures in this graph assume an initial investment of $100 in our common stock and in each index on December 31, 2005, and that all quarterly dividends were reinvested. The returns illustrated below are based on historical results during the period indicated and should not be considered indicative of future stockholder returns.
(BAR CHART)

 

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Item 6.  
Selected Financial Data.
The selected statements of operations data for each of the years ended December 31, 2010, 2009 and 2008 and the selected balance sheet data as of December 31, 2010 and 2009 have been derived from our audited financial statements included elsewhere in this Form 10-K. The selected statements of operations data for the years ended December 31, 2007 and 2006, and the balance sheet data as of December 31, 2008, 2007 and 2006 have been derived from our audited financial statements not included in this Form 10-K.
                                         
    Year Ended December 31,  
    2010     2009     2008     2007     2006  
    (In thousands, except share and per share amounts)  
Statements of Operations Data:
                                       
Revenues
                                       
Commissions
                                       
U.S. high-grade (1)
  $ 83,796     $ 62,557     $ 46,547     $ 52,541     $ 47,752  
Eurobond
    18,656       20,339       18,146       18,828       15,368  
Other (2)
    19,728       13,236       8,835       8,845       8,310  
 
                             
Total commissions
    122,180       96,132       73,528       80,214       71,430  
Technology products and services (3)
    13,648       9,778       8,555       742        
Information and user access fees
    6,681       6,252       6,025       5,877       5,477  
Interest income
    1,192       1,222       3,478       5,242       4,595  
Other (4)
    2,527       1,055       1,499       1,568       1,814  
 
                             
Total revenues
    146,228       114,439       93,085       93,643       83,316  
 
                             
Expenses
                                       
Employee compensation and benefits
    56,446       50,274       43,810       43,051       42,078  
Depreciation and amortization
    6,350       6,790       7,879       7,170       6,728  
Technology and communications
    9,982       8,436       8,311       7,463       7,704  
Professional and consulting fees
    8,503       6,869       8,171       7,639       8,072  
Occupancy
    2,997       3,129       2,891       3,275       3,033  
Marketing and advertising
    3,075       2,882       3,032       1,905       1,769  
General and administrative
    7,965       6,010       6,157       5,889       5,328  
 
                             
Total expenses
    95,318       84,390       80,251       76,392       74,712  
 
                             
Income before income taxes
    50,910       30,049       12,834       17,251       8,604  
Provision for income taxes
    19,482       13,947       4,935       6,931       3,183  
 
                             
Net income
  $ 31,428     $ 16,102     $ 7,899     $ 10,320     $ 5,421  
 
                             
Net income per common share:
                                       
Basic
  $ 0.86     $ 0.44     $ 0.23     $ 0.32     $ 0.18  
Diluted
  $ 0.80     $ 0.42     $ 0.22     $ 0.30     $ 0.15  
Weighted average number of shares of common stock outstanding:
                                       
Basic
    33,159,177       33,263,828       32,830,923       32,293,036       30,563,437  
Diluted
    39,051,186       38,081,980       35,737,379       34,453,195       35,077,348  
 
                                       
Cash dividends per share
  $ 0.28     $ 0.07     $     $     $  

 

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    As of December 31,  
    2010     2009     2008     2007     2006  
    (In thousands)  
Balance Sheet Data:
                                       
Cash and cash equivalents and securities available-for-sale
  $ 197,546     $ 174,338     $ 142,550     $ 124,290     $ 131,015  
Working capital (5)
    191,482       170,060       137,390       120,656       135,268  
Total assets
    299,521       277,286       246,428       198,366       204,278  
     
(1)  
U.S. high-grade commissions include commissions from monthly distribution fees and transactions between institutional investor clients and broker-dealer clients as well as transactions between broker-dealer clients.
 
(2)  
Other commissions consist primarily of commissions from the trading of emerging markets bonds, crossover and high-yield bonds, agency bonds and credit default swaps.
 
(3)  
Technology products and services includes software licenses, maintenance and support services and professional consulting services. Revenues are principally derived from the acquisitions of Greenline in March 2008 and TWS in November 2007.
 
(4)  
Other revenues consist primarily of telecommunications line charges to broker-dealer clients, initial set-up fees and other miscellaneous revenues.
 
(5)  
Working capital is defined as current assets minus current liabilities. Current assets consist of cash and cash equivalents, securities available-for-sale, accounts receivable and prepaid and other expenses. Current liabilities consist of accrued employee compensation, deferred revenue, and accounts payable, accrued expenses and other liabilities.

 

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Item 7.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with “Selected Financial Data” and our consolidated financial statements and related notes included elsewhere in this Form 10-K . In addition to historical information, this discussion and analysis contains forward-looking statements relating to future events and the future performance of MarketAxess that are based on our current expectations, assumptions, estimates and projections about us and our industry. These forward-looking statements involve risks and uncertainties. Our actual results and timing of various events could differ materially from those anticipated in such forward-looking statements as a result of a variety of factors, as more fully described in this section, in “Item 1A. — Risk Factors” and elsewhere in this Form 10-K . We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
Executive Overview
MarketAxess operates a leading electronic trading platform that allows investment industry professionals to efficiently trade corporate bonds and other types of fixed-income instruments. Our over 800 active institutional investor clients (firms that executed at least one trade in U.S. or European fixed-income securities through our electronic trading platform during 2010) include investment advisers, mutual funds, insurance companies, public and private pension funds, bank portfolios, broker-dealers and hedge funds. Our 78 broker-dealer market-maker clients provide liquidity on the platform and include most of the leading broker-dealers in global fixed-income trading. The Company also executes certain bond transactions between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller in matching back-to-back trades, which then settle through a third-party clearing organization. Through our Corporate BondTicker™ service, we provide fixed-income market data, analytics and compliance tools that help our clients make trading decisions. In addition, we provide FIX (Financial Information eXchange) message management tools, connectivity solutions and ancillary technology services that facilitate the electronic communication of order information between trading counterparties. Our revenues are primarily generated from the trading of U.S. high-grade corporate bonds.
Our multi-dealer trading platform allows our institutional investor clients to simultaneously request competing, executable bids or offers from our broker-dealer clients and execute trades with the broker-dealer of their choice from among those that choose to respond. We offer our broker-dealer clients a solution that enables them to efficiently reach our institutional investor clients for the distribution and trading of bonds. In addition to U.S. high-grade corporate bonds, European high-grade corporate bonds and emerging markets bonds, including both investment-grade and non-investment grade debt, we also offer our clients the ability to trade crossover and high-yield bonds, agency bonds, asset-backed and preferred securities and credit default swaps.
The majority of our revenues are derived from monthly distribution fees and commissions for trades executed on our platform that are billed to our broker-dealer clients on a monthly basis. We also derive revenues from technology products and services, information and user access fees, investment income and other income. Our expenses consist of employee compensation and benefits, depreciation and amortization, technology and communication expenses, professional and consulting fees, occupancy, marketing and advertising and other general and administrative expenses.
Our objective is to provide the leading global electronic trading platform for fixed-income securities, connecting broker-dealers and institutional investors more easily and efficiently, while offering a broad array of information, trading and technology services to market participants across the trading cycle. The key elements of our strategy are:
   
to innovate and efficiently add new functionality and product offerings to the MarketAxess platform that we believe will help to increase our market share with existing clients, as well as expand our client base;
   
to leverage our technology, as well as our strong broker-dealer and institutional investor relationships, to deploy our electronic trading platform into additional product segments within the fixed-income securities markets, deliver fixed-income securities-related technical services and products, and deploy our electronic trading platform into new client segments;
   
to continue building our existing service offerings so that our electronic trading platform is fully integrated into the workflow of our broker-dealer and institutional investor clients and to continue to add functionality to allow our clients to achieve a fully automated end-to-end straight-through processing solution (automation from trade initiation to settlement);
   
to add new content and analytical capabilities to Corporate BondTicker™ in order to improve the value of the information we provide to our clients; and
   
to continue to supplement our internal growth by entering into strategic alliances, or acquiring businesses or technologies that will enable us to enter new markets, provide new products or services, or otherwise enhance the value of our platform to our clients.

 

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Critical Factors Affecting Our Industry and Our Company
Economic, Political and Market Factors
The global fixed-income securities industry is risky and volatile and is directly affected by a number of economic, political and market factors that may result in declining trading volume. These factors could have a material adverse effect on our business, financial condition and results of operations. These factors include, among others, credit market conditions, the current interest rate environment, including the volatility of interest rates and investors’ forecasts of future interest rates, economic and political conditions in the United States, Europe and elsewhere, and consolidation or contraction of broker-dealers.
Competitive Landscape
The global fixed-income securities industry generally, and the electronic financial services markets in which we engage in particular, are highly competitive, and we expect competition to intensify in the future. Sources of competition for us will continue to include, among others, bond trading conducted directly between broker-dealers and their institutional investor clients over the telephone or electronically and other multi-dealer trading companies. Competitors, including companies in which some of our broker-dealer clients have invested, have developed electronic trading platforms or have announced their intention to explore the development of electronic platforms that may compete with us.
In general, we compete on the basis of a number of key factors, including, among others, the liquidity provided on our platform, the magnitude and frequency of price improvement enabled by our platform and the quality and speed of execution. We believe that we compete favorably with respect to these factors. We continue to proactively build technology solutions that serve the needs of the credit markets.
Our competitive position is also enhanced by the familiarity and integration of our broker-dealer and institutional investor clients with our electronic trading platform and other systems. We have focused on the unique aspects of the credit markets we serve in the development of our platform, working closely with our clients to provide a system that is suited to their needs.
Regulatory Environment
Our industry has been and is subject to continuous regulatory changes and may become subject to new regulations or changes in the interpretation or enforcement of existing regulations, which could require us to incur significant costs.
Our U.S. subsidiary, MarketAxess Corporation, is a registered broker-dealer with the SEC and is a member of FINRA. Our U.K. subsidiary, MarketAxess Europe Limited, is registered as a multilateral trading facility dealer with the FSA in the U.K. MarketAxess Canada Limited, a Canadian subsidiary, is registered as an Alternative Trading System dealer under the Securities Act of Ontario and is a member of the Investment Industry Regulatory Organization of Canada. Relevant regulations prohibit repayment of borrowings from these subsidiaries or their affiliates, paying cash dividends, making loans to us or our affiliates or otherwise entering into transactions that result in a significant reduction in regulatory net capital or financial resources, without prior notification to or approval from such regulated entity’s principal regulator.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law, marking the greatest change to financial supervision since the 1930’s. U.S. financial regulators are in the midst of an intense period of rulemaking that is required to implement the provisions of the Dodd-Frank Act, and market participants will need to make strategic decisions in an environment of regulatory uncertainty. Among the most significant aspects of the derivatives section of the Dodd-Frank Act are mandatory clearing of certain derivatives transactions (“swaps”) through regulated central clearing organizations and mandatory trading of those swaps through either regulated exchanges or swap execution facilities, in each case, subject to certain key exceptions. As with other parts of the Dodd-Frank Act, many of the details of the new regulatory regime relating to swaps are left to the regulators to determine through rulemaking. Subject to such rulemaking, we currently expect to establish and operate a swap execution facility and/or a security-based swap execution facility.

 

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As a public company listed on the NASDAQ Global Select Market, we are subject to the reporting requirements of the Securities Exchange Act of 1934, the Sarbanes-Oxley Act of 2002 and NASDAQ rules. The requirements of these rules and regulations impose legal and financial compliance costs, make some activities more difficult, time-consuming and/or costly and may also place a strain on our systems and resources. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight are required.
Rapid Technological Changes
We must continue to enhance and improve our electronic trading platform. The electronic financial services industry is characterized by increasingly complex systems and infrastructures and new business models. Our future success will depend on our ability to enhance our existing products and services, develop and/or license new products and technologies that address the increasingly sophisticated and varied needs of our broker-dealer and institutional investor clients and prospective clients and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. We received five patents in 2009 covering our most significant trading protocols and other aspects of our trading system technology, we received two additional patents during 2010 and other patents are pending.
Trends in Our Business
The majority of our revenues are derived from monthly distribution fees and commissions for transactions executed on our platform between our institutional investor and broker-dealer clients. We believe that there are five key variables that impact the notional value of such transactions on our platform and the amount of commissions and distribution fees earned by us:
   
the number of institutional investor clients that participate on the platform and their willingness to originate transactions through the platform;
   
the number of broker-dealer clients on the platform and the frequency and competitiveness of the price responses they provide to the institutional investor clients;
   
the number of markets for which we make trading available to our clients;
   
the overall level of activity in these markets; and
   
the level of commissions that we collect for trades executed through the platform.
We believe that overall corporate bond market trading volume is affected by various factors including the absolute levels of interest rates, the direction of interest rate movements, the level of new issues of corporate bonds and the volatility of corporate bond spreads versus U.S. Treasury securities. Because a significant percentage of our revenue is tied directly to the volume of securities traded on our platform, it is likely that a general decline in trading volumes, regardless of the cause of such decline, would reduce our revenues and have a significant negative impact on profitability.
The U.S. and European credit markets experienced a period of significant turmoil beginning during the third quarter of 2007, especially in short-term funding and floating rate note instruments. A widespread retrenchment in the credit markets resulted in increased credit spreads and significantly higher credit spread volatility across a wide range of asset classes. The U.S. credit markets demonstrated significant improvement throughout 2009 and 2010, with net inflows to taxable bond funds and corporate and international bond exchange-traded funds, and an increase in the volume of new issues of high-grade corporate bonds compared to the second half of 2008. Credit yield spreads in U.S. corporate bonds declined to 1.1% over U.S. Treasuries as of December 31, 2010 from a peak of 5.4% in December 2008. The trading volume of U.S. high-grade corporate bonds as reported by FINRA Trade Reporting and Compliance Engine (“TRACE”) increased from $2.0 trillion for the year ended December 31, 2008 to $2.9 trillion for each of the years ended December 31, 2009 and 2010. After demonstrating improved conditions during 2009, European credit markets deteriorated throughout 2010 due in part to continuing sovereign debt credit concerns.
Commission Revenue
Commissions are generally calculated as a percentage of the notional dollar volume of bonds traded on our platform and vary based on the type, size, yield and maturity of the bond traded. The commission rates are based on a number of factors, including fees charged by inter-dealer brokers in the respective markets, average bid-offer spreads in the products we offer and transaction costs through alternative channels including the telephone. Under our transaction fee plans, bonds that are more actively traded or that have shorter maturities are generally charged lower commissions, while bonds that are less actively traded or that have longer maturities generally command higher commissions.

 

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U.S. High-Grade Corporate Bond Commissions. Our U.S. high-grade corporate bond fee plans for fully electronic trades generally incorporate monthly distribution fees and variable transaction fees billed to our broker-dealer clients on a monthly basis. Certain dealers participate in fee programs that do not contain fixed monthly distribution fees and instead incorporate additional per transaction execution fees and minimum monthly fee commitments. Under the fee plans, we electronically add the transaction fee to the spread quoted by the broker-dealer client. For trades that we execute between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller, we earn our commission through the difference in price between the two back-to-back trades.
Eurobond Commissions. Similar to the U.S. high-grade plans, our European fee plan incorporates monthly distribution fees as well as variable transaction fees. In June 2010, we launched a click-to-trade protocol in the European market. Click-to-trade is offered alongside our request-for-quote product and consists of streamed indicative pricing in credit and rates products. Clients have the ability to request a trade at the displayed price with the indicated dealer. In connection with the launch, the Eurobond fee plan was revised and a standard commission rate was established across most types of bonds. Prior to this change, the variable transaction fee was dependent on the type of bond traded and the maturity of the issue.
Other Commissions. Commissions for other bond and credit default swap trades generally vary based on the type and the maturity of the instrument traded. We generally operate using standard fee schedules that may include both transaction fees and monthly distribution fees that are charged to the participating dealers. For trades that we execute between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller, we earn our commission through the difference in price between the two back-to-back trades.
We anticipate that average fees per million may change in the future. Consequently, past trends in commissions are not necessarily indicative of future commissions.
Other Revenue
In addition to the commissions discussed above, we earn revenue from technology products and services, information services fees paid by institutional investor and broker-dealer clients, income on investments and other income.
Technology Products and Services. Technology products and services includes software licenses, maintenance and support services and professional consulting services.
Information and User Access Fees. We charge information services fees for Corporate BondTicker TM to our broker-dealer clients, institutional investor clients and data-only subscribers. The information services fee is a flat monthly fee, based on the level of service. We also generate information services fees from the sale of bulk data to certain institutional investor clients and data-only subscribers. Institutional investor clients trading U.S. high-grade corporate bonds are charged a monthly user access fee for the use of our platform. The fee, billed quarterly, is charged to the client based on the number of the client’s users. To encourage institutional investor clients to execute trades on our platform, we reduce these information and user access fees for such clients once minimum quarterly trading volumes are attained.
Investment Income. Investment income consists of income earned on our investments.
Other. Other revenues include fees from telecommunications line charges to broker-dealer clients, initial set-up fees and other miscellaneous revenues.

 

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Expenses
In the normal course of business, we incur the following expenses:
Employee Compensation and Benefits. Employee compensation and benefits is our most significant expense and includes employee salaries, stock compensation costs, other incentive compensation, employee benefits and payroll taxes.
Depreciation and Amortization. We depreciate our computer hardware and related software, office hardware and furniture and fixtures and amortize our capitalized software development costs on a straight-line basis over three to seven years. We amortize leasehold improvements on a straight-line basis over the lesser of the life of the improvement or the remaining term of the lease. Intangible assets with definite lives, including purchased technologies, customer relationships and other intangible assets, are amortized over their estimated useful lives, ranging from five to ten years. Intangible assets are assessed for impairment when events or circumstances indicate a possible impairment.
Technology and Communications. Technology and communications expense consists primarily of costs relating to maintenance on software and hardware, our internal network connections, data center hosting costs and data feeds provided by outside vendors or service providers. The majority of our broker-dealer clients have dedicated high-speed communication lines to our network in order to provide fast data transfer. We charge our broker-dealer clients a monthly fee for these connections, which is recovered against the relevant expenses we incur.
Professional and Consulting Fees. Professional and consulting fees consist primarily of accounting fees, legal fees and fees paid to information technology and non-information technology consultants for services provided for the maintenance of our trading platform and information services products.
Occupancy. Occupancy costs consist primarily of office and equipment rent, utilities and commercial rent tax.
Marketing and Advertising. Marketing and advertising expense consists primarily of print and other advertising expenses we incur to promote our products and services. This expense also includes costs associated with attending or exhibiting at industry-sponsored seminars, conferences and conventions, and travel and entertainment expenses incurred by our sales force to promote our trading platform and information services.
General and Administrative. General and administrative expense consists primarily of general travel and entertainment, board of directors expenses, charitable contributions, provision for doubtful accounts, and various state franchise and U.K. value-added taxes.
Expenses may grow in the future, primarily due to investment in new products, notably in employee compensation and benefits, professional and consulting fees, and general and administrative expense. However, we believe that operating leverage can be achieved by increasing volumes in existing products and adding new products without substantial additions to our infrastructure.
Critical Accounting Estimates
This Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States, also referred to as U.S. GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of income and expenses during the reporting periods. We base our estimates and judgments on historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates under varying assumptions or conditions. Note 2 of the Notes to our Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements.
Use of Estimates
On an ongoing basis, management evaluates its estimates and judgments, particularly as they relate to accounting policies that management believes are critical. That is, these accounting policies are most important to the portrayal of our financial condition and results of operations and they require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

 

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Allowance for Doubtful Accounts
All accounts receivable have contractual maturities of less than one year and are derived from trading-related fees and commissions and revenues from products and services. We continually monitor collections and payments from our customers and maintain an allowance for doubtful accounts. The allowance for doubtful accounts is based upon the historical collection experience and specific collection issues that have been identified.
Software Development Costs
We capitalize certain costs associated with the development of internal use software at the point at which the conceptual formulation, design and testing of possible software project alternatives have been completed. We capitalize employee compensation and related benefits and third party consulting costs incurred during the preliminary software project stage. Once the product is ready for its intended use, such costs are amortized on a straight-line basis over three years. We review the amounts capitalized for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable.
Revenue Recognition
The majority of our revenues are derived from monthly distribution fees and commissions for trades executed on our platform that are billed to our broker-dealer clients on a monthly basis. We also derive revenues from technology products and services, information and user access fees, investment income and other income.
Commission revenue. Commissions are generally calculated as a percentage of the notional dollar volume of bonds traded on the platform and vary based on the type and maturity of the bond traded. Under our transaction fee plans, bonds that are more actively traded or that have shorter maturities are generally charged lower commissions, while bonds that are less actively traded or that have longer maturities generally command higher commissions. For trades that we execute between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller, we earn the commission through the difference in price between the two back-to-back trades.
Technology products and services. We generate revenues from technology software licenses, maintenance and support services (referred to as post-contract technical support or “PCS”) and professional consulting services. Revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is considered probable. We generally sell software licenses and services together as part of multiple-element arrangements. We also enter into contracts for technology integration consulting services unrelated to any software product. When we enter into a multiple-element arrangement, the residual method is used to allocate the total fee among the elements of the arrangement. Under the residual method, license revenue is recognized upon delivery when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement.
Each license arrangement requires that we analyze the individual elements in the transaction and estimate the fair value of each undelivered element, which typically includes PCS and professional services. License revenue consists of license fees charged for the use of our products under perpetual and, to a lesser extent, term license arrangements. License revenue from a perpetual arrangement is generally recognized upon delivery while license revenue from a term arrangement is recognized ratably over the duration of the arrangement on a straight-line basis. If the professional services are essential to the functionality of the software product, the license revenue is recognized upon customer acceptance or satisfaction of the service obligation.
Professional services are generally separately priced, are available from a number of suppliers and are typically not essential to the functionality of our software products. Revenues from these services are recognized separately from the license fee. Generally, revenue from time-and-materials consulting contracts is recognized as services are performed.
PCS includes telephone support, bug fixes and unspecified rights to product upgrades and enhancements, and is recognized ratably over the term of the service period, which is generally 12 months. We estimate the fair value of the PCS portion of an arrangement based on the price charged for PCS when sold separately. We sell PCS on a separate, standalone basis when customers renew PCS.
Revenues from contracts for technology integration consulting services are recognized on the percentage-of-completion method. Percentage-of-completion accounting involves calculating the percentage of services provided during the reporting period compared to the total estimated services to be provided over the duration of the contract. If estimates indicate that a contract loss will occur, a loss provision is recorded in the period in which the loss first becomes probable and reasonably estimable. Contract losses are determined to be the amount by which the estimated direct and indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. Revenues recognized in excess of billings are recorded as unbilled services. Billings in excess of revenues recognized are recorded as deferred revenues until revenue recognition criteria are met.

 

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Initial set-up fees. We enter into agreements with our broker-dealer clients pursuant to which we provide access to our platform through a non-exclusive and non-transferable license. Broker-dealer clients may pay an initial set-up fee, which is typically due and payable upon execution of the broker-dealer agreement. The initial set-up fee, if any, varies by agreement. Revenue is recognized over the initial term of the agreement, which is generally two years.
Stock-Based Compensation
We measure and recognize compensation expense for all share-based payment awards based on their estimated fair values measured as of the grant date. These costs are recognized as an expense in the Consolidated Statements of Operations over the requisite service period, which is typically the vesting period, with an offsetting increase to additional paid-in capital.
Income Taxes
Income taxes are accounted for using the asset and liability method. Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized against deferred tax assets if it is more likely than not that such assets will not be realized in future years. We recognize interest and penalties related to unrecognized tax benefits in general and administrative expenses in the Consolidated Statements of Operations.
Business Combinations, Goodwill and Intangibles Assets
Business combinations are accounted for under the purchase method. The total cost of an acquisition is allocated to the underlying net assets based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Determining the fair value of certain assets acquired and liabilities assumed is judgmental in nature and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash flows, discount rates, growth rates and asset lives.
Goodwill and other intangibles with indefinite lives are not amortized. We perform an impairment review of goodwill on an annual basis and more frequently if circumstances change. Intangible assets with definite lives, including purchased technologies, customer relationships and other intangible assets, are amortized on a straight-line basis over their estimated useful lives, ranging from five to ten years. Intangible assets are assessed for impairment when events or circumstances indicate a possible impairment.
Segment Results
As an electronic, multi-dealer platform for trading fixed-income securities, our operations constitute a single business segment. Because of the highly integrated nature of the financial markets in which we compete and the integration of our worldwide business activities, we believe that results by geographic region, products or types of clients are not necessarily meaningful in understanding our business.
Results of Operations
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Overview
Total revenues increased by $31.8 million or 27.8% to $146.2 million for the year ended December 31, 2010 from $114.4 million for the year ended December 31, 2009. This increase in total revenues was primarily due to increases in commissions of $26.0 million and in technology products and services revenues of $3.9 million and other income of $1.5 million.
Total expenses increased by $10.9 million or 12.9% to $95.3 million for the year ended December 31, 2010 from $84.4 million for the year ended December 31, 2009. The increase was primarily due to higher employee compensation and benefits of $6.2 million, general and administrative expense of $2.0 million, professional and consulting fees of $1.6 million and technology and communication costs of $1.5 million.

 

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Income before taxes increased by $20.9 million or 69.4% to $50.9 million for the year ended December 31, 2010 from $30.0 million for the year ended December 31, 2009. Net income increased by $15.3 million or 95.2% to $31.4 million for the year ended December 31, 2010, from $16.1 million for the year ended December 31, 2009.
Revenues
Our revenues for the years ended December 31, 2010 and 2009, and the resulting dollar and percentage changes, were as follows:
                                                 
    Year Ended December 31,  
    2010     2009              
            % of             % of     $     %  
    $     Revenues     $     Revenues     Change     Change  
    ($ in thousands)  
Commissions
  $ 122,180       83.6 %   $ 96,132       84.0 %   $ 26,048       27.1 %
Technology products and services
    13,648       9.3       9,778       8.5       3,870       39.6  
Information and user access fees
    6,681       4.6       6,252       5.5       429       6.9  
Investment income
    1,192       0.8       1,222       1.1       (30 )     (2.5 )
Other
    2,527       1.7       1,055       0.9       1,472       139.5  
 
                                         
Total revenues
  $ 146,228       100.0 %   $ 114,439       100.0 %   $ 31,789       27.8 %
 
                                         
Commissions. Our commission revenues for the years ended December 31, 2010 and 2009, and the resulting dollar and percentage changes, were as follows:
                                 
    Year Ended December 31,  
                    $     %  
    2010     2009     Change     Change  
    ($ in thousands)  
Distribution fees
                               
U.S. high-grade
  $ 37,467     $ 30,831     $ 6,636       21.5 %
Eurobond
    12,693       12,526       167       1.3  
 
                         
Total distribution fees
    50,160       43,357       6,803       15.7  
Variable transaction fees
                               
U.S. high-grade
    46,329       31,726       14,603       46.0  
Eurobond
    5,963       7,813       (1,850 )     (23.7 )
Other
    19,728       13,236       6,492       49.0  
 
                         
Total transaction fees
    72,020       52,775       19,245       36.5  
 
                         
Total commissions
  $ 122,180     $ 96,132     $ 26,048       27.1 %
 
                         
The $6.8 million increase in distribution fees for the year ended December 31, 2010 compared to the year ended December 31, 2009 was due principally to the additional U.S. broker-dealer market makers on the platform.

 

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The following table shows the extent to which the increase in commissions for the year ended December 31, 2010 was attributable to changes in transaction volumes, variable transaction fees per million and monthly distribution fees:
                                 
    Change from Year Ended December 31, 2009  
    U.S.                    
    High-Grade     Eurobond     Other     Total  
            (In thousands)          
Volume increase (decrease)
  $ 11,865     $ (898 )   $ 8,759     $ 19,725  
Variable transaction fee per million increase (decrease)
    2,738       (952 )     (2,267 )     (480 )
Monthly distribution fees increase
    6,636       167             6,803  
 
                       
Total commissions increase (decrease)
  $ 21,239     $ (1,683 )   $ 6,492     $ 26,048  
 
                       
Our trading volume for each of the years presented was as follows:
                                 
    Year Ended December 31,  
                    $     %  
    2010     2009     Change     Change  
Trading Volume Data (in millions)
                               
U.S. high-grade — fixed rate
  $ 235,698     $ 170,519     $ 65,179       38.2 %
U.S. high-grade — floating rate
    7,698       6,629       1,069       16.1  
 
                         
Total U.S. high-grade
    243,396       177,148       66,248       37.4  
Eurobond
    50,251       56,778       (6,527 )     (11.5 )
Other
    108,610       65,360       43,250       66.2  
 
                         
Total
  $ 402,257     $ 299,286     $ 102,971       34.4 %
 
                         
 
                               
Number of U.S. Trading Days
    250       250                  
Number of U.K. Trading Days
    253       253                  
For volume reporting purposes, transactions in foreign currencies are converted to U.S. dollars at average monthly rates.
The 37.4% increase in U.S. high-grade volume was principally due to an increase in the Company’s estimated market share of total U.S. high-grade corporate bond volume as reported by FINRA TRACE from 6.2% for the year ended December 31, 2009 to 8.4% for the year ended December 31, 2010. Estimated FINRA TRACE U.S. high-grade volume increased by less than 1% from $2,865 billion for the year ended December 31, 2009 to $2,886 billion for the year ended December 31, 2010. Eurobond volumes decreased by 11.5% for the year ended December 31, 2010 compared to the year ended December 31, 2009. We believe that the decline in Eurobond volumes was due, in part, to continuing sovereign debt concerns which negatively impacted market conditions. Other volume increased by 66.2% for the year ended December 31, 2010 compared to the year ended December 31, 2009, primarily due to higher agencies and emerging markets volume.
Our average variable transaction fee per million for the years ended December 31, 2010 and 2009 was as follows:
                 
    Year Ended December 31,  
    2010     2009  
Average Variable Transaction Fee Per Million
               
U.S. high-grade — fixed rate
  $ 196     $ 185  
U.S. high-grade — floating rate
    28       24  
Total U.S. high-grade
    190       179  
Eurobond
    119       138  
Other
    182       203  
Total
    179       176  

 

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The U.S. high-grade average variable transaction fee per million improved from $179 per million for the year ended December 31, 2009 to $190 per million for the year ended December 31, 2010, primarily due to the increased participation of new dealers on the platform that pay higher variable fees per million. Eurobond average variable transaction fee per million decreased from $138 per million for the year ended December 31, 2009 to $119 per million for the year ended December 31, 2010. In June 2010, we launched a click-to-trade protocol in the European market. In connection with the launch, the Eurobond fee plan was revised generally downward. Other average variable transaction fee per million decreased from $203 per million for the year ended December 31, 2009 to $182 per million for the year ended December 31, 2010, primarily due to a higher percentage of volume in products that carry lower fees per million, principally agency bonds.
Technology Products and Services. Technology products and services revenues increased by $3.9 million or 39.6% to $13.6 million for the year ended December 31, 2010 from $9.8 million for the year ended December 31, 2009. The increase was primarily a result of higher technology integration consulting services and license fees.
Information and User Access Fees. Information and user access fees increased by $0.4 million or 6.9% to $6.7 million for the year ended December 31, 2010 from $6.3 million for the year ended December 31, 2009.
Investment Income. Investment income was $1.2 million for the each of the years ended December 31, 2010 and December 31, 2009.
Other. Other revenues increased by $1.5 million or 139.5% to $2.5 million for the year ended December 31, 2010 from $1.1 million for the year ended December 31, 2009. The increase was primarily a result of higher initial set-up fees from broker-dealer clients and a gain on the sale of a U.S. Treasury bill investment.
Expenses
Our expenses for the years ended December 31, 2010 and 2009, and the resulting dollar and percentage changes, were as follows:
                                                 
    Year Ended December 31,  
    2010     2009              
            % of             % of     $     %  
    $     Revenues     $     Revenues     Change     Change  
    ($ in thousands)  
Expenses
                                               
Employee compensation and benefits
  $ 56,446       38.6 %   $ 50,274       43.9 %   $ 6,172       12.3 %
Depreciation and amortization
    6,350       4.3       6,790       5.9       (440 )     (6.5 )
Technology and communications
    9,982       6.8       8,436       7.4       1,546       18.3  
Professional and consulting fees
    8,503       5.8       6,869       6.0       1,634       23.8  
Occupancy
    2,997       2.0       3,129       2.7       (132 )     (4.2 )
Marketing and advertising
    3,075       2.1       2,882       2.5       193       6.7  
General and administrative
    7,965       5.4       6,010       5.3       1,955       32.5  
 
                                         
Total expenses
  $ 95,318       65.2 %   $ 84,390       73.7 %   $ 10,928       12.9 %
 
                                         
Employee Compensation and Benefits. Employee compensation and benefits increased by $6.2 million or 12.3% to $56.4 million for the year ended December 31, 2010 from $50.3 million for the year ended December 31, 2009. This increase was primarily attributable to higher incentive compensation of $2.9 million resulting from improved operating performance, salaries of $1.6 million due to increased headcount, and benefits and employment taxes of $1.3 million. The total number of employees increased to 227 as of December 31, 2010 from 212 as of December 31, 2009. As a percentage of total revenues, employee compensation and benefits expense decreased to 38.6% for the year ended December 31, 2010 from 43.9% for the year ended December 31, 2009.
Depreciation and Amortization. Depreciation and amortization expense decreased by $0.4 million or 6.5% to $6.4 million for the year ended December 31, 2010 from $6.8 million for the year ended December 31, 2009. The decrease was primarily due to lower amortization of software development costs of $0.8 million. For the years ended December 31, 2010 and 2009, we capitalized $1.9 million and $1.9 million, respectively, of software development costs, and $5.2 million and $4.9 million, respectively, of equipment and leasehold improvements. The 2010 and 2009 equipment and leasehold improvement expenditures included $3.0 million and $2.2 million, respectively, associated with the move of our corporate offices to new premises in New York City in the first quarter of 2010.

 

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Technology and Communications. Technology and communications expense increased by $1.5 million or 18.3% to $10.0 million for the year ended December 31, 2010 from $8.4 million for the year ended December 31, 2009. The increase was primarily attributable to higher expenses associated with market data of $0.8 million and data center hosting of $0.4 million.
Professional and Consulting Fees. Professional and consulting fees increased by $1.6 million or 23.8% to $8.5 million for the year ended December 31, 2010 from $6.9 million for the year ended December 31, 2009. The increase was principally due to higher technology consulting costs of $0.9 million, recruiting fees of $0.3 million, and legal expense of $0.3 million.
Occupancy. Occupancy costs decreased by $0.1 million or 4.2% to $3.0 million for the year ended December 31, 2010 from $3.1 million for the year ended December 31, 2009.
Marketing and Advertising. Marketing and advertising expense increased by $0.2 million or 6.7% to $3.1 million for the year ended December 31, 2010 from $2.9 million for the year ended December 31, 2009. The increase was principally due to higher travel and entertainment expenses related to sales activities.
General and Administrative. General and administrative expense increased by $2.0 million or 32.5% to $8.0 million for the year ended December 31, 2010 from $6.0 million for the year ended December 31, 2009. The increase was primarily due to higher charitable contributions of $0.3 million, general travel and entertainment expense of $0.3 million, board of directors expenses of $0.3 million and registration fees of $0.3 million.
Provision for Income Tax
We recorded an income tax provision of $19.5 million and $13.9 million for the years ended December 31, 2010 and 2009, respectively. The increase in the tax provision was primarily attributable to the $20.9 million increase in pre-tax income. With the exception of the payment of certain foreign and state and local taxes, the provision for income taxes was a non-cash expense since we had available net operating loss carryforwards and tax credits to offset the cash payment of taxes.
Our consolidated effective tax rate for the year ended December 31, 2010 was 38.3% compared to 46.4% for the year ended December 31, 2009. During 2009, we reduced the tax rates used for recording the deferred tax assets to reflect the tax rates anticipated to be in effect when the temporary differences are expected to reverse, resulting in a decrease in the deferred tax asset and an increase in tax expense of $1.6 million. The 2010 effective tax rate reflects the 2009 refinement in our state and local tax apportionment methodology, which resulted in a lower 2010 state income tax rate. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings and changes in tax legislation and tax rates. Due to our net deferred tax asset balance, a decrease in tax rates results in a reduction in our deferred tax balance and an increase in tax expense.
As of December 31, 2010, we had net operating loss carryforwards of $29.8 million and tax credit carryforwards of $6.0 million for income tax purposes. The net deferred tax asset of $19.8 million at December 31, 2010 includes a valuation allowance of $0.2 million arising from certain tax credit and foreign and state tax loss carryforwards. This valuation allowance was deemed appropriate due to available evidence indicating that some of the deferred tax assets might not be realized in future years.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Overview
Total revenues increased by $21.4 million or 22.9% to $114.4 million for the year ended December 31, 2009 from $93.1 million for the year ended December 31, 2008. This increase in total revenues was primarily due to an increase in commissions of $22.6 million and in technology products and services revenues of $1.2 million, offset by a decrease in investment income of $2.3 million and other income of $0.4 million. Technology products and services revenues reflect the impact of the Greenline acquisition in March 2008. A 15.0% decrease in the average exchange rate of the Pound Sterling compared to the U.S. dollar from the year ended December 31, 2008 to the year ended December 31, 2009 had the effect of reducing European revenues by $3.7 million.

 

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Total expenses increased by $4.1 million or 5.2% to $84.4 million for the year ended December 31, 2009 from $80.3 million for the year ended December 31, 2008. An increase in employee compensation and benefits of $6.5 million was offset by declines in professional and consulting fees of $1.3 million and depreciation and amortization of $1.1 million. The change in the foreign currency rates had the effect of reducing European expenses by $2.2 million. The 2008 results include Greenline expenses from the date of the acquisition.
Income before taxes increased by $17.2 million or 134.1% to $30.0 million for the year ended December 31, 2009 from $12.8 million for the year ended December 31, 2008. Net income increased by $8.2 million or 103.8% to $16.1 million for the year ended December 31, 2009, from $7.9 million for the year ended December 31, 2008.
Revenues
Our revenues for the years ended December 31, 2009 and 2008, and the resulting dollar and percentage changes, were as follows:
                                                 
    Year Ended December 31,  
    2009     2008              
            % of             % of     $     %  
    $     Revenues     $     Revenues     Change     Change  
    ($ in thousands)  
Commissions
  $ 96,132       84.0 %   $ 73,528       79.0 %   $ 22,604       30.7 %
Technology products and services
    9,778       8.5       8,555       9.2       1,223       14.3  
Information and user access fees
    6,252       5.5       6,025       6.5       227       3.8  
Investment income
    1,222       1.1       3,478       3.7       (2,256 )     (64.9 )
Other
    1,055       0.9       1,499       1.6       (444 )     (29.6 )
 
                                         
Total revenues
  $ 114,439       100.0 %   $ 93,085       100.0 %   $ 21,354       22.9 %
 
                                         
Commissions. Our commission revenues for the years ended December 31, 2009 and 2008, and the resulting dollar and percentage changes, were as follows:
                                 
    Year Ended December 31,  
                    $     %  
    2009     2008     Change     Change  
    ($ in thousands)  
Distribution fees
                               
U.S. high-grade
  $ 30,831     $ 30,287     $ 544       1.8 %
Eurobond
    12,526       14,143       (1,617 )     (11.4 )
 
                         
Total distribution fees
    43,357       44,430       (1,073 )     (2.4 )
Variable transaction fees
                               
U.S. high-grade
    31,726       16,260       15,466       95.1  
Eurobond
    7,813       4,003       3,810       95.2  
Other
    13,236       8,835       4,401       49.8  
 
                         
Total transaction fees
    52,775       29,098       23,677       81.4  
 
                         
Total commissions
  $ 96,132     $ 73,528     $ 22,604       30.7 %
 
                         
The change in the average exchange rate of the Pound Sterling compared to the U.S. dollar from the year ended December 31, 2008 to the year ended December 31, 2009 had the effect of reducing Eurobond commission revenues by $3.6 million.

 

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The following table shows the extent to which the increase in commissions for the year ended December 31, 2009 was attributable to changes in transaction volumes, variable transaction fees per million and monthly distribution fees:
                                 
    Change from Year Ended December 31, 2008  
    U.S.                    
    High-Grade     Eurobond     Other     Total  
    (In thousands)  
Volume increase
  $ 5,134     $ 2,348     $ 1,468     $ 8,950  
Variable transaction fee per million increase
    10,332       1,462       2,933       14,727  
Monthly distribution fees increase (decrease)
    544       (1,617 )           (1,073 )
 
                       
Total commissions increase
  $ 16,010     $ 2,193     $ 4,401     $ 22,604  
 
                       
Our trading volume for each of the years presented was as follows:
                                 
    Year Ended December 31,  
                    $     %  
    2009     2008     Change     Change  
Trading Volume Data (in millions)
                               
U.S. high-grade — fixed rate
  $ 170,519     $ 126,569     $ 43,950       34.7 %
U.S. high-grade — floating rate
    6,629       8,068       (1,439 )     (17.8 )
 
                         
Total U.S. high-grade
    177,148       134,636       42,512       31.6  
Eurobond
    56,778       35,788       20,990       58.7  
Other
    65,360       56,047       9,313       16.6  
 
                         
Total
  $ 299,286     $ 226,471     $ 72,815       32.2 %
 
                         
 
                               
Number of U.S. Trading Days
    250       251                  
Number of U.K. Trading Days
    253       254                  
For volume reporting purposes, transactions in foreign currencies are converted to U.S. dollars at average monthly rates. Prior to September 1, 2008, no fees were charged on U.S. high-grade single-dealer inquiries. Such single-dealer inquiry trading volume amounted to $6.3 billion for the year ended December 31, 2008. Effective September 1, 2008, single-dealer inquiry trades are charged commissions in accordance with the U.S. high-grade corporate bond fee plan.
The increase in U.S. high-grade volume was due primarily to an increase in overall market volume as measured by FINRA TRACE, offset by a decline in the Company’s estimated market share of total U.S. high-grade corporate bond volume as reported by FINRA TRACE from 6.6% for the year ended December 31, 2008 to 6.2% for the year ended December 31, 2009. Estimated FINRA TRACE U.S. high-grade volume increased by 41.3% from $2,028 billion for the year ended December 31, 2008 to $2,865 billion for the year ended December 31, 2009. Eurobond volumes increased by 58.7% for the year ended December 31, 2009 compared to the year ended December 31, 2008, primarily due to the improvement in market conditions. Other volume increased by 16.6% for the year ended December 31, 2009 compared to the year ended December 31, 2008, primarily due to higher high-yield and agencies volume, offset by lower credit default swap volume.

 

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Our average variable transaction fee per million for the years ended December 31, 2009 and 2008 was as follows:
                 
    Year Ended December 31,  
    2009     2008  
Average Variable Transaction Fee Per Million
               
U.S. high-grade — fixed rate
  $ 185     $ 127  
U.S. high-grade — floating rate
    24       27  
Total U.S. high-grade
    179       121  
Eurobond
    138       112  
Other
    203       158  
Total
    176       128  
The U.S. high-grade average variable transaction fee per million increased from $121 per million for the year ended December 31, 2008 to $179 per million for the year ended December 31, 2009, primarily due to the introduction of our execution services desk, the introduction of new dealers on the platform that pay higher variable fees per million and the longer maturity of trades executed on the platform, for which we charge higher commissions. Eurobond average variable transaction fee per million increased from $112 per million for the year ended December 31, 2008 to $138 per million for the year ended December 31, 2009, primarily due to a larger percentage of Eurobond volume in products that carry higher fees per million, principally high-yield bonds. Other average variable transaction fee per million increased from $158 per million for the year ended December 31, 2008 to $203 per million for the year ended December 31, 2009, primarily due to a higher percentage of volume in products that carry higher fees per million, principally high-yield bonds.
Technology Products and Services. Technology products and services revenues increased by $1.2 million or 14.3% to $9.8 million for the year ended December 31, 2009 from $8.6 million for the year ended December 31, 2008. The increase was primarily a result of higher technology integration consulting services revenues.
Information and User Access Fees. Information and user access fees increased by $0.2 million or 3.8% to $6.3 million for the year ended December 31, 2009 from $6.0 million for the year ended December 31, 2008.
Investment Income. Investment income decreased by $2.3 million or 64.9% to $1.2 million for the year ended December 31, 2009 from $3.5 million for the year ended December 31, 2008. This decrease was primarily due to lower interest rates.
Other. Other revenues decreased by $0.4 million or 29.6% to $1.1 million for the year ended December 31, 2009 from $1.5 million for the year ended December 31, 2008. The 2008 other revenues included an insurance settlement and other income aggregating $0.4 million.

 

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Expenses
Our expenses for the years ended December 31, 2009 and 2008, and the resulting dollar and percentage changes, were as follows:
                                                 
    Year Ended December 31,  
    2009     2008              
            % of             % of     $     %  
    $     Revenues     $     Revenues     Change     Change  
    ($ in thousands)  
Expenses
                                               
Employee compensation and benefits
  $ 50,274       43.9 %   $ 43,810       47.1 %   $ 6,464       14.8 %
Depreciation and amortization
    6,790       5.9       7,879       8.5       (1,089 )     (13.8 )
Technology and communications
    8,436       7.4       8,311       8.9       125       1.5  
Professional and consulting fees
    6,869       6.0       8,171       8.8       (1,302 )     (15.9 )
Occupancy
    3,129       2.7       2,891       3.1       238       8.2  
Marketing and advertising
    2,882       2.5       3,032       3.3       (150 )     (4.9 )
General and administrative
    6,010       5.3       6,157       6.6       (147 )     (2.4 )
 
                                         
Total expenses
  $ 84,390       73.7 %   $ 80,251       86.2 %   $ 4,139       5.2 %
 
                                         
Employee Compensation and Benefits. Employee compensation and benefits increased by $6.5 million or 14.8% to $50.3 million for the year ended December 31, 2009 from $43.8 million for the year ended December 31, 2008. This increase was primarily attributable to higher incentive compensation of $4.9 million resulting from improved operating performance and stock-based compensation expense of $1.3 million. The total number of employees increased to 212 as of December 31, 2009 from 185 as of December 31, 2008. As a percentage of total revenues, employee compensation and benefits expense decreased to 43.9% for the year ended December 31, 2009 from 47.1% for the year ended December 31, 2008.
Depreciation and Amortization. Depreciation and amortization expense decreased by $1.1 million or 13.8% to $6.8 million for the year ended December 31, 2009 from $7.9 million for the year ended December 31, 2008. The decrease was primarily due to declines in amortization of intangible assets of $0.5 million and software development costs of $0.5 million. The intangible amortization expense reduction was primarily due to a $0.7 million TWS impairment charge recorded in 2008 to reflect negative current period operating results and reduced revenue expectations for connectivity solutions principally delivered to broker-dealers. For the years ended December 31, 2009 and 2008, we capitalized $1.9 million and $2.4 million, respectively, of software development costs, and $4.9 million and $1.7 million, respectively, of equipment and leasehold improvements. The 2009 equipment and leasehold improvement expenditures included $2.2 million associated with the move of our corporate offices to new premises in New York City in the first quarter of 2010.
Technology and Communications. Technology and communications expense increased by $0.1 million or 1.5% to $8.4 million for the year ended December 31, 2009 from $8.3 million for the year ended December 31, 2008.
Professional and Consulting Fees. Professional and consulting fees decreased by $1.3 million or 15.9% to $6.9 million for the year ended December 31, 2009 from $8.2 million for the year ended December 31, 2008. The decrease was principally due to lower legal fees of $0.7 million and information technology consultant costs of $0.3 million.
Occupancy. Occupancy costs increased by $0.2 million or 8.2% to $3.1 million for the year ended December 31, 2009 from $2.9 million for the year ended December 31, 2008. The increase was principally due to additional rental costs associated with new premises leased in New York City in the fourth quarter of 2009.
Marketing and Advertising. Marketing and advertising expense decreased by $0.2 million or 4.9% to $2.9 million for the year ended December 31, 2009 from $3.0 million for the year ended December 31, 2008. Higher travel and entertainment expenses of $0.2 million were more than offset by lower advertising and promotional costs.
General and Administrative. General and administrative expense decreased by $0.1 million or 2.4% to $6.0 million for the year ended December 31, 2009 from $6.2 million for the year ended December 31, 2008. Higher trade settlement costs of $0.4 million were more than offset by lower charges for doubtful accounts of $0.6 million.

 

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Provision for Income Tax
We recorded an income tax provision of $13.9 million and $4.9 million for the years ended December 31, 2009 and 2008, respectively. The increase in the tax provision was primarily attributable to the $17.2 million increase in pre-tax income. With the exception of the payment of certain foreign and state and local taxes, the provision for income taxes was a non-cash expense since we had available net operating loss carryforwards and tax credits to offset the cash payment of taxes.
Our consolidated effective tax rate for the year ended December 31, 2009 was 46.4% compared to 38.5% for the year ended December 31, 2008. During 2009, we reduced the tax rates used for recording the deferred tax assets to reflect the tax rates anticipated to be in effect when the temporary differences are expected to reverse, resulting in a decrease in the deferred tax asset and an increase in tax expense of $1.6 million. The 2009 tax rate change reflects a refinement in our state and local tax apportionment methodology. The 2008 effective tax rate reflects a higher portion of earnings generated in lower tax rate jurisdictions. Our consolidated effective tax rate can vary from period to period depending on, among other factors, the geographic and business mix of our earnings and changes in tax legislation and tax rates. Due to our net deferred tax asset balance, a decrease in tax rates results in a reduction in our deferred tax balance and an increase in tax expense.
Quarterly Results of Operations
Our quarterly results have varied significantly as a result of:
   
changes in trading volume due to market conditions, changes in the number of trading days in certain quarters, and seasonality effects caused by slow-downs in trading activity during certain periods;
   
changes in the number of broker-dealers and institutional investors using our trading platform as well as variation in usage by existing clients;
   
expansion of the products we offer to our clients; and
   
variance in our expenses, particularly employee compensation and benefits.
The following table sets forth certain consolidated quarterly income statement data for the eight quarters ended December 31, 2010. In our opinion, this unaudited information has been prepared on a basis consistent with our annual financial statements and includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the unaudited quarterly data. This information should be read in conjunction with our Consolidated Financial Statements and related Notes included in this Annual Report on Form 10-K. The results of operations for any quarter are not necessarily indicative of results that we may achieve for any subsequent periods.

 

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    Three Months Ended  
    Mar 31,     Jun 30,     Sep 30,     Dec 31,     Mar 31,     Jun 30,     Sep 30,     Dec 31,  
    2009     2009     2009     2009     2010     2010     2010     2010  
    (In thousands)  
Revenues
                                                               
Commissions
                                                               
U.S. high-grade (1)
  $ 13,515     $ 13,808     $ 16,306     $ 18,928     $ 19,776     $ 20,249     $ 21,537     $ 22,234  
Eurobond (2)
    4,142       4,712       5,497       5,988       5,492       4,669       4,075       4,420  
Other (3)
    2,789       3,310       3,486       3,651       4,039       4,542       5,540       5,607  
 
                                               
Total commissions
    20,446       21,830       25,289       28,567       29,307       29,460       31,152       32,261  
Technology products and services (4)
    2,023       2,096       2,601       3,058       3,164       3,251       3,455       3,778  
Information and user access fees (5)
    1,655       1,504       1,519       1,574       1,634       1,722       1,603       1,722  
Interest income (6)
    332       234       314       342       291       315       301       285  
Other (7)
    176       175       286       418       488       578       902       559  
 
                                               
Total revenues
    24,632       25,839       30,009       33,959       34,884       35,326       37,413       38,605  
 
                                               
Expenses
                                                               
Employee compensation and benefits
    11,442       11,917       13,127       13,788       13,933       14,189       14,326       13,998  
Depreciation and amortization
    1,791       1,679       1,654       1,666       1,616       1,622       1,560       1,552  
Technology and communications
    2,242       2,120       2,029       2,045       2,417       2,353       2,543       2,669  
Professional and consulting fees
    1,879       1,613       1,645       1,732       2,138       1,990       2,241       2,134  
Occupancy
    676       693       706       1,054       938       707       706       646  
Marketing and advertising
    645       708       651       878       628       759       679       1,009  
General and administrative
    1,226       1,373       1,654       1,757       2,129       1,850       1,834       2,152  
 
                                               
Total expenses
    19,901       20,103       21,466       22,920       23,799       23,470       23,889       24,160  
 
                                               
Income before income taxes
    4,731       5,736       8,543       11,039       11,085       11,856       13,524       14,445  
Provision for income taxes
    1,892       2,549       3,903       5,603       4,384       4,687       4,913       5,498  
 
                                               
Net income
  $ 2,839     $ 3,187     $ 4,640     $ 5,436     $ 6,701     $ 7,169     $ 8,611     $ 8,947  
 
                                               
     
(1)  
Of these amounts, $1,985, $2,039, $2,276, $2,457, $798, $853, $889, and $852, respectively, were from related parties.
 
(2)  
Of these amounts, $783, $933, $1,049, $1,052, $373, $321, $278 and $262, respectively, were from related parties.
 
(3)  
Of these amounts, $302, $378, $363, $486, $187, $207, $201 and $320, respectively, were from related parties.
 
(4)  
Of these amounts, $9, $10, $9, $7, $7, $5, $6 and $0, respectively, were from related parties.
 
(5)  
Of these amounts, $61, $64, $60, $58, $31, $22, $32 and $48, respectively, were from related parties.
 
(6)  
Of these amounts, $90, $58, $36, $30, $23, $33, $33 and $24, respectively, were from related parties.
 
(7)  
Of these amounts, $42, $38, $37, $35, $16, $15, $16 and $16, respectively, were from related parties.

 

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The following tables set forth trading volume and average variable transaction fee per million traded for the eight quarters ended December 31, 2010.
                                                                 
    Three Months Ended  
    Mar 31,     Jun 30,     Sep 30,     Dec 31,     Mar 31,     Jun 30,     Sep 30,     Dec 31,  
    2009     2009     2009     2009     2010     2010     2010     2010  
    (In millions)  
Trading Volume Data
                                                               
U.S. high-grade
  $ 36,839     $ 37,910     $ 47,019     $ 55,381     $ 61,511     $ 58,170     $ 60,387     $ 63,328  
Eurobond
    9,092       13,169       16,580       17,936       16,019       12,739       10,712       10,780  
Other
    14,140       15,742       16,795       18,683       21,672       27,372       29,351       30,215  
 
                                               
Total
  $ 60,071     $ 66,821     $ 80,394     $ 92,000     $ 99,202     $ 98,281     $ 100,450     $ 104,323  
 
                                               
                                                                 
    Three Months Ended  
    Mar 31,     Jun 30,     Sep 30,     Dec 31,     Mar 31,     Jun 30,     Sep 30,     Dec 31,  
    2009     2009     2009     2009     2010     2010     2010     2010  
Variable Transaction Fee Per Million
                                                               
U.S. high-grade
  $ 175     $ 163     $ 186     $ 187     $ 175     $ 189     $ 205     $ 192  
Eurobond
  $ 128     $ 131     $ 145     $ 140     $ 139     $ 130     $ 93     $ 101  
Other
  $ 197     $ 210     $ 208     $ 195     $ 186     $ 166     $ 189     $ 186  
Total
  $ 173     $ 168     $ 182     $ 180     $ 172     $ 175     $ 188     $ 181  
 
                                                               
Number of U.S. trading days
    61       63       64       62       61       63       64       62  
Number of U.K. trading days
    63       61       65       64       63       61       65       64  
Liquidity and Capital Resources
During the past three years, we have met our funding requirements through cash on hand, internally generated funds and the issuance of Series B Preferred Stock. Cash and cash equivalents and securities available-for-sale totaled $197.5 million at December 31, 2010. Other than a capital lease obligation amounting to $0.9 million as of December 31, 2010, we have no long-term or short-term debt and do not maintain bank lines of credit.
Our cash flows were as follows:
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Net cash provided by operating activities
  $ 64,146     $ 43,327     $ 27,634  
Net cash (used in) investing activities
    (7,720 )     (44,165 )     (22,499 )
Net cash (used in) provided by financing activities
    (33,849 )     (2,646 )     30,311  
Effect of exchange rate changes on cash and cash equivalents
    (924 )     (498 )     (834 )
 
                 
Net increase (decrease) for the period
  $ 21,653     $ (3,981 )   $ 34,612  
 
                 
We define free cash flow as cash flow from operating activities less expenditures for furniture, equipment and leasehold improvements and capitalized software development costs. For the years ended December 31, 2010, 2009 and 2008, free cash flow was $57.0 million, $36.5 million and $23.6 million, respectively. Free cash flow is a non-GAAP financial measure. The Company believes that this non-GAAP financial measure, when taken into consideration with the corresponding GAAP financial measures, is important in gaining an understanding of the Company’s financial strength and cash flow generation.

 

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Cash Flows for the Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Net cash provided by operating activities was $64.1 million for the year ended December 31, 2010 compared to $43.3 million for the year ended December 31, 2009. The $20.8 million increase in net cash provided by operating activities was primarily due to an increase in net income of $15.3 million, higher non-cash deferred income taxes of $3.5 million and a decrease in cash used for working capital of $2.3 million.
Net cash used in investing activities was $7.7 million for the year ended December 31, 2010 compared to $44.2 million for the year ended December 31, 2009. The $36.4 million reduction in net cash used in investing activities was principally due to a decrease in net purchases of securities available-for-sale of $34.7 million and a decrease in cash paid for business acquisitions of $1.4 million. During the year ended December 31, 2009, we made a $1.4 million earn-out payment related to the 2008 acquisition of Greenline. Net purchases of securities available-for-sale were $0.6 million for the year ended December 31, 2010 compared to $35.3 million for the year ended December 31, 2009. Capital expenditures were $7.1 million and $6.8 million for the year ended December 31, 2010 and 2009, respectively. Leasehold improvements and equipment expenditures in 2010 and 2009 included $3.0 million and $2.2 million, respectively, associated with the move of our corporate offices to new premises in New York City in the first half of 2010.
Net cash used in financing activities was $33.8 million for the year ended December 31, 2010 compared to $2.6 million for the year ended December 31, 2009. The $31.2 million increase in net cash used in financing activities was principally due to the purchase of 1.9 million shares of our common stock at a cost of $30.0 million under a share repurchase program and an increase in cash dividends paid on common stock and Series B preferred stock of $8.0 million, offset by an increase in net proceeds on the exercise of stock options of $4.5 million and excess tax benefits on stock-based compensation of $1.9 million.
Cash Flows for the Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Net cash provided by operating activities was $43.3 million for the year ended December 31, 2009 compared to $27.6 million for the year ended December 31, 2008. The $15.7 million increase in net cash provided by operating activities was primarily due to an increase in net income of $8.2 million and higher non-cash deferred income taxes of $7.4 million.
Net cash used in investing activities was $44.2 million for the year ended December 31, 2009 compared to $22.5 million for the year ended December 31, 2008. The $21.7 million increase in net cash used in investing activities was principally due to an increase in net purchases of securities available-for-sale of $51.7 million, offset by a decrease in cash paid for business acquisitions. Net purchases of securities available-for-sale were $35.3 million for the year ended December 31, 2009 compared to net proceeds from the sale of securities available-for-sale of $16.3 million for the year ended December 31, 2008. During the year ended December 31, 2008, we paid $34.9 million for the cash portion of the acquisition of Greenline and we made a $1.4 million earn-out payment during the year ended December 31, 2009. Capital expenditures were $6.8 million and $4.0 million for the years ended December 31, 2009 and 2008, respectively. Leasehold improvements and equipment expenditures in 2009 included $2.2 million associated with the move of our corporate offices to new premises in New York City in the first half of 2010.
Net cash used in financing activities was $2.6 million for the year ended December 31, 2009 compared to cash provided by financing activities of $30.3 million for the year ended December 31, 2008. Cash dividends paid in 2009 on common stock and Series B preferred stock was $2.7 million. During the year ended December 31, 2008, the issuance of the Series B Preferred Stock and common stock purchase warrants resulting in net cash proceeds of $33.5 million was offset by $2.8 million expended under a share repurchase program.
Past trends of cash flows are not necessarily indicative of future cash flow levels. A decrease in cash flows may have a material adverse effect on our liquidity, business and financial condition.
Other Factors Influencing Liquidity and Capital Resources
We are dependent on our broker-dealer clients who are not restricted from buying and selling fixed-income securities with institutional investors, either directly or through their own proprietary or third-party platforms. None of our broker-dealer clients is contractually or otherwise obligated to continue to use our electronic trading platform. The loss of, or a significant reduction in the use of our electronic platform by, our broker-dealer clients could reduce our cash flows, affect our liquidity and have a material adverse effect on our business, financial condition and results of operations.

 

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We believe that our current resources are adequate to meet our liquidity needs and capital expenditure requirements for at least the next 12 months. However, our future liquidity and capital requirements will depend on a number of factors, including expenses associated with product development and expansion and new business opportunities that are intended to further diversify our revenue stream. We may also acquire or invest in technologies, business ventures or products that are complementary to our business. In addition, we expect to fully utilize the balance of our unrestricted U.S. net operating loss carryforward during 2011, which would result in an increase in cash paid for income taxes in 2011 and subsequent years. In the event we require any additional financing, it will take the form of equity or debt financing. Any additional equity offerings may result in dilution to our stockholders. Any debt financings, if available at all, may involve restrictive covenants with respect to dividends, issuances of additional capital and other financial and operational matters related to our business.
We have three regulated subsidiaries, MarketAxess Corporation, MarketAxess Europe Limited and MarketAxess Canada Ltd. MarketAxess Corporation is a registered broker-dealer in the U.S., MarketAxess Europe Limited is a registered multilateral trading facility dealer in the U.K. and MarketAxess Canada Ltd. is a registered Alternative Trading System dealer in the Province of Ontario. As such, they are subject to minimum regulatory capital requirements imposed by their respective market regulators that are intended to ensure general financial soundness and liquidity based on certain minimum capital requirements. The relevant regulations prohibit a registrant from repaying borrowings from its parent or affiliates, paying cash dividends, making loans to its parent or affiliates or otherwise entering into transactions that result in a significant reduction in its regulatory net capital position without prior notification to or approval from its principal regulator. The capital structures of our subsidiaries are designed to provide each with capital and liquidity consistent with its business and regulatory requirements. Subject to rulemaking pursuant to the Dodd-Frank Act, we currently expect to establish and operate a swap execution facility and/or a security-based swap execution facility and we will be required to maintain an additional amount of minimum net capital in connection with such facilities. The following table sets forth the capital requirements, as defined, that the Company’s subsidiaries were required to maintain as of December 31, 2010:
                         
    MarketAxess     MarketAxess     MarketAxess  
    Corporation     Europe Limited     Canada Limited  
    (In thousands)  
Net capital
  $ 48,036     $ 24,409     $ 443  
Minimum net capital required
    1,971       3,732       276  
 
                 
Excess net capital
  $ 46,065     $ 20,677     $ 167  
 
                 
We execute certain bond transactions between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller in matching back-to-back trades, which are then settled through a third-party clearing organization. We act as intermediary on a riskless principal basis in these bond transactions by serving as counterparty to the two clients involved. Settlement typically occurs within one to three trading days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded. Under securities clearing agreements with the independent third party, we maintain collateral deposits with the clearing broker in the form of cash or U.S. government securities. As of December 31, 2010, the collateral deposits included in securities and cash provided as collateral in the Consolidated Statements of Financial Condition was $0.9 million. We are exposed to credit risk in the event a counterparty does not fulfill its obligation to complete a transaction. Pursuant to the terms of the securities clearing agreements between us and the independent clearing broker, the clearing broker has the right to charge us for losses resulting from a counterparty’s failure to fulfill its contractual obligations. The losses are not capped at a maximum amount and apply to all trades executed through the clearing broker. At December 31, 2010, we had not recorded any liabilities with regard to this right.
In the ordinary course of business, we enter into contracts that contain a variety of representations, warranties and general indemnifications. Our maximum exposure from any claims under these arrangements is unknown, as this would involve claims that have not yet occurred. However, based on past experience, we expect the risk of loss to be remote.
Prior to 2009, we retained all earnings for investment in our business. In October 2009, our Board of Directors approved a regular quarterly dividend. The first quarterly cash dividend of $0.07 per share was paid to our stockholders in November 2009 and regular quarterly cash dividends have been paid thereafter. In January 2011, our Board of Directors approved an increase in the quarterly cash dividend to $0.09 per share payable on March 2, 2011 to stockholders of record as of the close of business on February 16, 2011. We expect the total amount payable to be approximately $3.4 million. We expect to continue paying regular cash dividends, although there is no assurance as to such dividends. Any future declaration and payment of dividends will be at the sole discretion of our Board of Directors.

 

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Effects of Inflation
Because the majority of our assets are liquid in nature, they are not significantly affected by inflation. However, the rate of inflation may affect our expenses, such as employee compensation, office leasing costs and communications expenses, which may not be readily recoverable in the prices of our services. To the extent inflation results in rising interest rates and has other adverse effects on the securities markets, it may adversely affect our financial position and results of operations.
Contractual Obligations and Commitments
As of December 31, 2010, we had the following contractual obligations and commitments:
                                         
    Payments due by period  
            Less than                     More than  
    Total     1 year     1 - 3 years     3 - 5 years     5 years  
    (In thousands)  
Operating leases
  $ 21,394     $ 1,843     $ 3,595     $ 3,770     $ 12,186  
Capital leases
    1,036       336       658       42        
Foreign currency forward contract
    29,454       29,454                    
 
                             
 
  $ 51,884     $ 31,633     $ 4,253     $ 3,812     $ 12,186  
 
                             
We enter into foreign currency forward contracts with a noncontrolling stockholder broker-dealer client to hedge the exposure to variability in foreign currency cash flows resulting from the net investment in our U.K. subsidiary. As of December 31, 2010, the notional value of the foreign currency forward contract outstanding was $29.1 million and the gross and net fair value liability was $0.3 million.
As of December 31, 2010, we had unrecognized tax benefits of $3.3 million. Due to the nature of the underlying positions, it is not currently possible to schedule the future payment obligations by period.
In January 2011, our board of directors approved a quarterly dividend to be paid to the holders of the outstanding shares of capital stock. A cash dividend of $0.09 per share of voting and non-voting common stock outstanding will be payable on March 2, 2011 to stockholders of record as of the close of business on February 16, 2011. We expect the total amount payable to be approximately $3.4 million.
Recent Accounting Pronouncements
See Note 2 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a discussion of recent accounting pronouncements.
Item 7A.  
Quantitative and Qualitative Disclosures About Market Risk.
Market risk is the risk of the loss resulting from adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates.
Market Risk
The global financial services business is, by its nature, risky and volatile and is directly affected by many national and international factors that are beyond our control. Any one of these factors may cause a substantial decline in the U.S. and global financial services markets, resulting in reduced trading volume and revenues. These events could have a material adverse effect on our business, financial condition and results of operations.
As of December 31, 2010, we had a $72.6 million investment in securities available-for-sale. Adverse movements, such as a 10% decrease in the value of these securities or a downturn or disruption in the markets for these securities, could result in a substantial loss. In addition, principal gains and losses resulting from these securities could on occasion have a disproportionate effect, positive or negative, on our financial condition and results of operations for any particular reporting period.
See also Item 1A . Risk Factors , “Risks Related to Our Industry — Economic, political and market factors beyond our control could reduce demand for our services and harm our business, and our profitability could suffer .”

 

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Interest Rate Risk
Interest rate risk represents our exposure to interest rate changes with respect to the money market instruments, U.S. Treasury obligations and short-term fixed-income securities in which we invest. As of December 31, 2010, our cash and cash equivalents and securities available-for-sale amounted to $197.5 million and were primarily invested in money market instruments, U.S. government obligations and municipal securities. We do not maintain an inventory of bonds that are traded on our platform.
Derivative Risk
Our limited derivative risk stems from our activities in the foreign currency forward contract market. We use this market to mitigate our U.S. dollar versus Pound Sterling exposure that arises from the activities of our U.K. subsidiary. As of December 31, 2010, the notional value of our foreign currency forward contract was $29.1 million. We do not speculate in any derivative instruments.
Credit Risk
We act as a riskless principal through MarketAxess Corporation and MarketAxess Europe Limited in certain transactions that we execute between clients. We act as an intermediary in these transactions by serving as counterparty to both the buyer and the seller in matching back-to-back bond trades, which are then settled through a third-party clearing organization. Settlement typically occurs within one to three trading days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded.
We are exposed to credit risk in our role as trading counterparty to our clients. We are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. Adverse movements in the prices of securities that are the subject of these transactions can increase our risk. Where the unmatched position or failure to deliver is prolonged, there may also be regulatory capital charges required to be taken by us. There can be no assurance that the policies and procedures we use to manage this credit risk will effectively mitigate our credit risk exposure.

 

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Item 8.  
Financial Statements and Supplementary Data.
MARKETAXESS HOLDINGS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
         
    64  
 
       
Audited Consolidated Financial Statements
       
 
       
    65  
 
       
    66  
 
       
    67  
 
       
    68  
 
       
    69  
 
       
    70  
The unaudited supplementary data regarding consolidated quarterly income statement data are incorporated by reference to the information set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in the section captioned “Quarterly Results of Operations.”

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of MarketAxess Holdings Inc. is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework .
Based on our assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2010.
The effectiveness of our internal control over financial reporting as of December 31, 2010 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of MarketAxess Holdings Inc.:
In our opinion, the consolidated financial statements listed in the accompanying index on page 63 present fairly, in all material respects, the financial position of MarketAxess Holdings Inc. and its subsidiaries at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control over Financial Reporting.” Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
         
 
  /s/ PRICEWATERHOUSECOOPERS LLP
 
PRICEWATERHOUSECOOPERS LLP
   
New York, New York
February 24, 2011

 

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MARKETAXESS HOLDINGS INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
                 
    As of December 31  
    2010     2009  
    (In thousands, except share  
    and per share amounts)  
ASSETS
               
Cash and cash equivalents
  $ 124,994     $ 103,341  
Securities available-for-sale
    72,552       70,997  
Securities and cash provided as collateral
    4,939       4,971  
Accounts receivable, including receivables from related parties of $829 and $3,431, respectively, net of allowance of $427 and $859 as of December 31, 2010 and 2009, respectively
    25,682       23,150  
Furniture, equipment and leasehold improvements, net of accumulated depreciation and amortization
    9,448       6,856  
Software development costs, net of accumulated amortization
    3,097       3,420  
Goodwill and intangible assets, net of accumulated amortization
    36,012       37,530  
Prepaid expenses and other assets
    2,984       3,041  
Deferred tax assets, net
    19,813       23,980  
 
           
Total assets
  $ 299,521     $ 277,286  
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Liabilities
               
Accrued employee compensation
  $ 17,791     $ 15,157  
Deferred revenue
    4,571       4,262  
Accounts payable, accrued expenses, and other liabilities, including payables to related parties of $66 and $29 as of December 31, 2010 and 2009, respectively
    12,368       11,050  
 
           
Total liabilities
    34,730       30,469  
 
           
Commitments and Contingencies (Note 14)
               
 
               
Series B Preferred Stock, $0.001 par value, 35,000 shares authorized, issued and outstanding as of December 31, 2010 and 2009, liquidation preference of $1,000 per share
    30,315       30,315  
 
           
 
               
Stockholders’ equity
               
Preferred stock, $0.001 par value, 4,855,000 shares authorized, no shares issued and outstanding as of December 31, 2010 and 2009
           
Series A Preferred Stock, $0.001 par value, 110,000 shares authorized, no shares issued and outstanding as of December 31, 2010 and 2009
           
Common stock voting, $0.003 par value, 110,000,000 shares authorized, 35,945,001 shares and 34,654,957 shares issued and 31,141,261 shares and 31,790,837 shares outstanding as of December 31, 2010 and 2009, respectively
    108       104  
Common stock non-voting, $0.003 par value, 10,000,000 shares authorized, 2,585,654 shares issued and outstanding as of December 31, 2010 and 2009
    9       9  
Additional paid-in capital
    340,615       313,896  
Receivable for common stock subscribed
          (713 )
Treasury stock — Common stock voting, at cost, 4,803,740 shares and 2,864,120 shares as of December 31, 2010 and 2009, respectively
    (70,000 )     (40,000 )
Accumulated deficit
    (34,605 )     (55,403 )
Accumulated other comprehensive loss
    (1,651 )     (1,391 )
 
           
Total stockholders’ equity
    234,476       216,502  
 
           
Total liabilities and stockholders’ equity
  $ 299,521     $ 277,286  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

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MARKETAXESS HOLDINGS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands, except share and per share amounts)  
 
Revenues
                       
Commissions
                       
U.S. high-grade
  $ 83,796     $ 62,557     $ 46,547  
Eurobond
    18,656       20,339       18,146  
Other
    19,728       13,236       8,835  
 
                 
Total commissions
    122,180       96,132       73,528  
Technology products and services
    13,648       9,778       8,555  
Information and user access fees
    6,681       6,252       6,025  
Investment income
    1,192       1,222       3,478  
Other
    2,527       1,055       1,499  
 
                 
Total revenues
    146,228       114,439       93,085  
 
                 
 
                       
Expenses
                       
Employee compensation and benefits
    56,446       50,274       43,810  
Depreciation and amortization
    6,350       6,790       7,879  
Technology and communications
    9,982       8,436       8,311  
Professional and consulting fees
    8,503       6,869       8,171  
Occupancy
    2,997       3,129       2,891  
Marketing and advertising
    3,075       2,882       3,032  
General and administrative
    7,965       6,010       6,157  
 
                 
Total expenses
    95,318       84,390       80,251  
 
                 
Income before income taxes
    50,910       30,049       12,834  
Provision for income taxes
    19,482       13,947       4,935  
 
                 
Net income
  $ 31,428     $ 16,102     $ 7,899  
 
                 
 
                       
Net income per common share
                       
Basic
  $ 0.86     $ 0.44     $ 0.23  
Diluted
  $ 0.80     $ 0.42     $ 0.22  
 
                       
Cash dividends declared per common share
  $ 0.28     $ 0.07     $  
 
                       
Weighted average shares outstanding
                       
Basic
    33,159,177       33,263,828       32,830,923  
Diluted
    39,051,186       38,081,980       35,737,379  
The accompanying notes are an integral part of these consolidated financial statements.

 

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MARKETAXESS HOLDINGS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND ACCUMULATED OTHER COMPREHENSIVE LOSS
                                                                 
                                    Treasury                      
            Common             Receivable     Stock -             Accumulated        
    Common     Stock     Additional     for Common     Common             Other     Total  
    Stock     Non -     Paid-In     Stock     Stock     Accumulated     Comprehen-     Stockholders’  
    Voting     Voting     Capital     Subscribed     Voting     Deficit     sive Loss     Equity  
    (In thousands)  
Balance at December 31, 2007
  $ 99     $ 9     $ 289,988     $ (834 )   $ (37,227 )   $ (76,754 )   $ (884 )   $ 174,397  
Comprehensive income:
                                                               
Net income
                                  7,899             7,899  
Cumulative translation adjustment and foreign currency exchange hedge, net of tax
                                        (410 )     (410 )
Unrealized net loss on securities available-for-sale, net of tax
                                        (26 )     (26 )
 
                                                             
Total comprehensive income
                                                            7,463  
Stock-based compensation
                7,061                               7,061  
Issuance of common stock related to the acquisition of Greenline Financial Technologies, Inc.
    2             5,773                               5,775  
Exercise of stock options and grants of restricted stock, net of withholding tax on stock vesting
    1             (318 )                             (317 )
Decrement in windfall from stock-based compensation
                (191 )                             (191 )
Issuance of common stock purchase warrant
                3,195                               3,195  
Repayment of promissory notes and adjustment of prior year principal and interest balances
                      (117 )                       (117 )
Purchase of treasury stock
                            (2,773 )                 (2,773 )
 
                                               
Balance at December 31, 2008
    102       9       305,508       (951 )     (40,000 )     (68,855 )     (1,320 )     194,493  
 
                                               
Comprehensive income:
                                                               
Net income
                                  16,102             16,102  
Cumulative translation adjustment and foreign currency exchange hedge, net of tax
                                        (331 )     (331 )
Unrealized net gain on securities available-for-sale, net of tax
                                        260       260  
 
                                                             
Total comprehensive income
                                                            16,031  
Stock-based compensation
                8,414                               8,414  
Exercise of stock options and grants of restricted stock, net of withholding tax on stock vesting
    2             240                               242  
Decrement in windfall from stock-based compensation
                (266 )                             (266 )
Repayment of promissory notes
                      238                         238  
Cash dividend on common stock and Series B Preferred Stock
                                  (2,650 )           (2,650 )
 
                                               
Balance at December 31, 2009
    104       9       313,896       (713 )     (40,000 )     (55,403 )     (1,391 )     216,502  
 
                                               
Comprehensive income:
                                                               
Net income
                                  31,428             31,428  
Cumulative translation adjustment and foreign currency exchange hedge, net of tax
                                        (564 )     (564 )
Unrealized net gain on securities available-for-sale, net of tax
                                        304       304  
 
                                                             
Total comprehensive income
                                                            31,168  
Stock-based compensation
                8,969                               8,969  
Exercise of stock options and grants of restricted stock, net of surrender on stock option exercises and withholding tax on stock vesting
    4             4,702                               4,706  
Tax benefit from the exercise of warrants in prior years
                11,429                               11,429  
Excess tax benefits from stock-based compensation
                1,619                               1,619  
Repayment of promissory notes
                      713                         713  
Purchase of treasury stock
                            (30,000 )                 (30,000 )
Cash dividend on common stock and Series B Preferred Stock
                                  (10,630 )           (10,630 )
 
                                               
Balance at December 31, 2010
  $ 108     $ 9     $ 340,615     $     $ (70,000 )   $ (34,605 )   $ (1,651 )   $ 234,476  
 
                                               
The accompanying notes are an integral part of these consolidated financial statements.

 

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MARKETAXESS HOLDINGS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Cash flows from operating activities
                       
Net income
  $ 31,428     $ 16,102     $ 7,899  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    6,350       6,790       7,879  
Stock-based compensation expense
    8,969       8,414       7,061  
Deferred taxes
    15,767       12,255       4,819  
Provision for bad debts
    602       652       1,260  
Gain on sale of securities
    (411 )            
Changes in operating assets and liabilities, net of business acquired:
                       
(Increase) decrease in accounts receivable
    (3,134 )     (10,519 )     5,785  
Decrease (increase) in prepaid expenses and other assets
    57       136       (221 )
Increase (decrease) in accrued employee compensation
    2,634       4,718       (4,228 )
Increase in deferred revenue
    309       1,959       618  
Increase (decrease) in accounts payable, accrued expenses and other liabilities
    1,575       2,820       (3,238 )
 
                 
Net cash provided by operating activities
    64,146       43,327       27,634  
 
                 
Cash flows from investing activities
                       
Acquisition of business, net of cash acquired (Note 7)
          (1,368 )     (34,918 )
Securities available-for-sale:
                       
Proceeds from maturities and sales
    65,365       22,062       46,281  
Purchases
    (66,008 )     (57,406 )     (29,959 )
Securities and cash provided as collateral
    32       (655 )     139  
Purchases of furniture, equipment and leasehold improvements
    (5,205 )     (4,909 )     (1,677 )
Capitalization of software development costs
    (1,904 )     (1,889 )     (2,365 )
 
                 
Net cash (used in) investing activities
    (7,720 )     (44,165 )     (22,499 )
 
                 
Cash flows from financing activities
                       
Issuance of Series B Preferred Stock and common stock purchase warrants
                33,510  
Cash dividend on common stock and Series B Preferred Stock
    (10,630 )     (2,650 )      
Proceeds from exercise of stock options and grants of restricted stock, net of surrenders on stock option exercises and withholding tax on stock vesting
    4,706       242       (317 )
Excess tax benefits (decrements) from stock-based compensation
    1,619       (266 )     (191 )
Purchase of treasury stock — common stock voting
    (30,000 )           (2,773 )
Other
    456       28       82  
 
                 
Net cash (used in) provided by financing activities
    (33,849 )     (2,646 )     30,311  
 
                 
Effect of exchange rate changes on cash and cash equivalents
    (924 )     (498 )     (834 )
 
                 
Cash and cash equivalents
                       
Net increase (decrease) for the period
    21,653       (3,982 )     34,612  
Beginning of period
    103,341       107,323       72,711  
 
                 
End of period
  $ 124,994     $ 103,341     $ 107,323  
 
                 
Supplemental cash flow information:
                       
Cash paid during the year
                       
Cash paid for income taxes
  $ 2,228     $ 837     $ 452  
Non-cash activity
                       
Issuance of common stock in connection with business acquisition
  $     $     $ 5,775  
Capital lease obligation
  $     $ 723     $ 677  
The accompanying notes are an integral part of these consolidated financial statements.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Principal Business Activity
MarketAxess Holdings Inc. (the “Company”) was incorporated in the State of Delaware on April 11, 2000. Through its subsidiaries, the Company operates an electronic trading platform for corporate bonds and other types of fixed-income instruments through which the Company’s institutional investor clients can access the liquidity provided by its broker-dealer clients. The Company’s multi-dealer trading platform allows its institutional investor clients to simultaneously request competitive, executable bids or offers from multiple broker-dealers, and to execute trades with the broker-dealer of their choice. The Company offers its clients the ability to trade U.S. high-grade corporate bonds, European high-grade corporate bonds, credit default swaps, agencies, high yield and emerging markets bonds and asset-backed and preferred securities. The Company also executes certain bond transactions between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller in matching back-to-back trades, which then settle through a third-party clearing organization. Through its Corporate BondTicker™ service, the Company provides fixed-income market data, analytics and compliance tools that help its clients make trading decisions. In addition, the Company provides FIX (Financial Information eXchange) message management tools, connectivity solutions and ancillary technology services that facilitate the electronic communication of order information between trading counterparties.
The Company had one stockholder broker-dealer client for 2010, JPMorgan. For 2009 and 2008, JP Morgan, BNP Paribas and Credit Suisse were considered to be Stockholder Broker-Dealer Clients. These broker-dealer clients constitute related parties of the Company (together, the “Stockholder Broker-Dealer Clients”). See Note 10, “Related Parties.”
2. Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions and balances have been eliminated.
Cash and Cash Equivalents
Cash and cash equivalents include cash maintained at major U.S. and U.K. banks and in money market funds. The Company defines cash equivalents as short-term interest-bearing investments with maturities at the time of purchase of three months or less. Given this concentration, the Company is exposed to certain credit risk.
Securities Available-for-Sale
The Company classifies its marketable securities as available-for-sale securities. Unrealized marketable securities gains and losses, net of taxes, are reflected as a net amount under the caption of accumulated other comprehensive loss on the Consolidated Statements of Financial Condition. Realized gains and losses are recorded in the Consolidated Statements of Operations in other revenues. For the purpose of computing realized gains and losses, cost is determined on a specific identification basis.
The Company assesses whether an other-than-temporary impairment loss on the investments has occurred due to declines in fair value or other market conditions. The portion of an other-than-temporary impairment related to credit loss is recorded as a charge in the Consolidated Statements of Operations. The remainder is recognized in other comprehensive loss if the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security prior to recovery. No charges for other-than-temporary losses were recorded during 2010, 2009 or 2008.
Fair Value Financial Instruments
Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The standard also establishes a three-tiered fair value hierarchy that prioritizes inputs to valuation techniques used in fair value calculations. The three levels of inputs are defined as Level 1 (unadjusted quoted prices for identical assets or liabilities in active markets), Level 2 (inputs that are observable in the marketplace other than those inputs classified in Level 1) and Level 3 (inputs that are unobservable in the marketplace). The Company’s financial assets and liabilities measured at fair value on a recurring basis consist of its securities available-for-sale portfolio and one foreign currency forward contract.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Securities and Cash Provided as Collateral
Securities provided as collateral consist of U.S. government obligations and cash. Collectively, these amounts are used as collateral for standby letters of credit, electronic bank settlements, foreign currency forward contracts to hedge the Company’s net investments in a foreign subsidiary and broker-dealer clearance accounts.
Allowance for Doubtful Accounts
All accounts receivable have contractual maturities of less than one year and are derived from trading-related fees and commissions and revenues from products and services. The Company continually monitors collections and payments from its clients and maintains an allowance for doubtful accounts. The allowance for doubtful accounts is based upon the historical collection experience and specific collection issues that have been identified. Additions to the allowance for doubtful accounts are charged to bad debt expense, which is included in general and administrative expense in the Company’s Consolidated Statements of Operations.
The allowance for doubtful accounts was $0.4 million, $0.9 million and $1.0 million as of December 31, 2010, 2009 and 2008, respectively. The provision for bad debts was $0.6 million, $0.7 million and $1.3 million for the years ended December 31, 2010, 2009 and 2008, respectively. Write-offs and other charges against the allowance for doubtful accounts were $0.7 million, $0.6 million and $0.9 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Depreciation and Amortization
Fixed assets are carried at cost less accumulated depreciation. The Company uses the straight-line method of depreciation over three to seven years. Leasehold improvements are stated at cost and are amortized using the straight-line method over the lesser of the life of the improvement or the remaining term of the lease.
Software Development Costs
The Company capitalizes certain costs associated with the development of internal use software at the point at which the conceptual formulation, design and testing of possible software project alternatives have been completed. The Company capitalizes employee compensation and related benefits and third party consulting costs incurred during the preliminary software project stage. Once the product is ready for its intended use, such costs are amortized on a straight-line basis over three years. The Company reviews the amounts capitalized for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be recoverable.
Foreign Currency Translation and Forward Contracts
Assets and liabilities denominated in foreign currencies are translated using exchange rates at the end of the period; revenues and expenses are translated at average monthly rates. Gains and losses on foreign currency translation are a component of accumulated other comprehensive loss in the Consolidated Statements of Financial Condition. Transaction gains and losses are recorded in general and administrative expense in the Consolidated Statements of Operations.
The Company enters into foreign currency forward contracts to hedge its net investment in its U.K. subsidiary. Gains and losses on these transactions are included in accumulated other comprehensive loss on the Consolidated Statements of Financial Condition.
Revenue Recognition
The majority of the Company’s revenues are derived from monthly distribution fees and commissions for trades executed on its platform that are billed to its broker-dealer clients on a monthly basis. The Company also derives revenues from technology products and services, information and user access fees, investment income and other income.
Commission revenue. Commissions are generally calculated as a percentage of the notional dollar volume of bonds traded on the platform and vary based on the type and maturity of the bond traded. Under the Company’s transaction fee plans, bonds that are more actively traded or that have shorter maturities are generally charged lower commissions, while bonds that are less actively traded or that have longer maturities generally command higher commissions. For trades that the Company executes between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller, the Company earns the commission through the difference in price between the two back-to-back trades.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Technology products and services. The Company generates revenues from technology software licenses, maintenance and support services (referred to as post-contract technical support or “PCS”) and professional consulting services. Revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is considered probable. The Company generally sells software licenses and services together as part of multiple-element arrangements. The Company also enters into contracts for technology integration consulting services unrelated to any software product. When the Company enters into a multiple-element arrangement, the residual method is used to allocate the total fee among the elements of the arrangement. Under the residual method, license revenue is recognized upon delivery when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement.
Each license arrangement requires that the Company analyze the individual elements in the transaction and estimate the fair value of each undelivered element, which typically includes PCS and professional services. License revenue consists of license fees charged for the use of the Company’s products under perpetual and, to a lesser extent, term license arrangements. License revenue from a perpetual arrangement is generally recognized upon delivery while license revenue from a term arrangement is recognized ratably over the duration of the arrangement on a straight-line basis. If the professional services are essential to the functionality of the software product, the license revenue is recognized upon customer acceptance or satisfaction of the service obligation.
Professional services are generally separately priced, are available from a number of suppliers and are typically not essential to the functionality of the Company’s software products. Revenues from these services are recognized separately from the license fee. Generally, revenue from time-and-materials consulting contracts is recognized as services are performed.
PCS includes telephone support, bug fixes and unspecified rights to product upgrades and enhancements, and is recognized ratably over the term of the service period, which is generally 12 months. The Company estimates the fair value of the PCS portion of an arrangement based on the price charged for PCS when sold separately. The Company sells PCS on a separate, standalone basis when customers renew PCS.
Revenues from contracts for technology integration consulting services are recognized on the percentage-of-completion method. Percentage-of-completion accounting involves calculating the percentage of services provided during the reporting period compared to the total estimated services to be provided over the duration of the contract. If estimates indicate that a contract loss will occur, a loss provision is recorded in the period in which the loss first becomes probable and reasonably estimable. Contract losses are determined to be the amount by which the estimated direct and indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. There were no contract loss provisions recorded as of December 31, 2010 and 2009. Revenues recognized in excess of billings are recorded as unbilled services. Billings in excess of revenues recognized are recorded as deferred revenues until revenue recognition criteria are met.
Initial set-up fees. The Company enters into agreements with its broker-dealer clients pursuant to which the Company provides access to its platform through a non-exclusive and non-transferable license. Broker-dealer clients may pay an initial set-up fee, which is typically due and payable upon execution of the broker-dealer agreement. The initial set-up fee, if any, varies by agreement. Revenue is recognized over the initial term of the agreement, which is generally two years.
Stock-Based Compensation
The Company measures and recognizes compensation expense for all share-based payment awards based on their estimated fair values measured as of the grant date. These costs are recognized as an expense in the Consolidated Statements of Operations over the requisite service period, which is typically the vesting period, with an offsetting increase to additional paid-in capital.
Income Taxes
Income taxes are accounted for using the asset and liability method. Deferred income taxes reflect the net tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized against deferred tax assets if it is more likely than not that such assets will not be realized in future years. The Company recognizes interest and penalties related to unrecognized tax benefits in general and administrative expenses in the Consolidated Statements of Operations.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Business Combinations, Goodwill and Intangible Assets
Business acquisitions are accounted for under the purchase method of accounting. The total cost of an acquisition is allocated to the underlying net assets based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Determining the fair value of certain assets acquired and liabilities assumed is judgmental in nature and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash flows, discount rates, growth rates and asset lives.
Goodwill and other intangibles with indefinite lives are not amortized. An impairment review of goodwill is performed on an annual basis and more frequently if circumstances change. Intangible assets with definite lives, including purchased technologies, customer relationships and other intangible assets, are amortized on a straight-line basis over their estimated useful lives, ranging from five to ten years. The Company has no intangibles with indefinite lives. Intangible assets are assessed for impairment when events or circumstances indicate the existence of a possible impairment.
Earnings Per Share
Earnings per share (“EPS”) is calculated using the two-class method. Basic EPS is computed by dividing the net income attributable to common stock by the weighted-average number of shares of common stock outstanding for the period, including consideration of the two-class method to the extent that participating securities were outstanding during the period. Under the two-class method, undistributed net income is allocated to common stock and participating securities based on their respective right to share in dividends. The Series B Preferred Stock is convertible into shares of common stock and also includes a right whereby, upon the declaration or payment of a dividend or distribution on the common stock, a dividend or distribution must also be declared or paid on the Series B Preferred Stock based on the number of shares of common stock into which such securities were convertible at the time. Due to these rights, the Series B Preferred Stock is considered a participating security requiring the use of the two-class method for the computation of basic EPS. On January 24, 2011, all of the shares of the Series B Preferred Stock were mandatorily and automatically converted into 3,499,999 shares of common stock.
Diluted EPS is computed using the more dilutive of the (a) if-converted method or (b) two-class method. Since the Series B Preferred Stock participates equally with the common stock in dividends and unallocated income, diluted EPS under the if-converted method is equivalent to the two-class method. Weighted-average shares outstanding of common stock reflects the dilutive effect that could occur if convertible securities or other contracts to issue common stock were converted into or exercised for common stock.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on revenue recognition. The guidance requires entities to allocate revenue in an arrangement with multiple deliverables using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The guidance eliminates the residual method of revenue allocation and requires revenue to be allocated using the relative selling price method. The guidance also removes tangible products from the scope of software revenue guidance and provides guidance on determining whether software deliverables in an arrangement that includes a tangible product are covered by the scope of the software revenue guidance. Adoption will be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company does not expect adoption of the new revenue recognition guidance to have a material impact on the Company’s Consolidated Financial Statements.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
3. Net Capital Requirements and Customer Protection Requirements
MarketAxess Corporation, a U.S. subsidiary, is a registered broker-dealer with the Securities and Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority (“FINRA”). MarketAxess Corporation claims exemption from SEC Rule 15c3-3, as it does not hold customer securities or funds on account, as defined. Pursuant to the Uniform Net Capital Rule under the Securities Exchange Act of 1934, MarketAxess Corporation is required to maintain minimum net capital, as defined, equal to the greater of $100,000 or 6 2/3% of aggregate indebtedness. MarketAxess Europe Limited, a U.K. subsidiary, is registered as a Multilateral Trading Facility dealer with the Financial Services Authority (“FSA”) in the U.K. MarketAxess Canada Limited, a Canadian subsidiary, is registered as an Alternative Trading System dealer under the Securities Act of Ontario and is a member of the Investment Industry Regulatory Organization of Canada. MarketAxess Europe Limited and MarketAxess Canada Limited are subject to certain financial resource requirements of the FSA and the Ontario Securities Commission, respectively. The following table sets forth the capital requirements, as defined, that the Company’s subsidiaries were required to maintain as of December 31, 2010:
                         
    MarketAxess     MarketAxess     MarketAxess  
    Corporation     Europe Limited     Canada Limited  
    (In thousands)  
Net capital
  $ 48,036     $ 24,409     $ 443  
Minimum net capital required
    1,971       3,732       276  
 
                 
Excess net capital
  $ 46,065     $ 20,677     $ 167  
 
                 
The Company’s regulated subsidiaries are subject to U.S., U.K. and Canadian regulations which prohibit repayment of borrowings from the Company or affiliates, paying cash dividends, making loans to the Company or affiliates or otherwise entering into transactions that result in a significant reduction in regulatory net capital or financial resources, respectively, without prior notification to or approval from such regulated entity’s principal regulator.
4. Fair Value Measurements
The following table summarizes the valuation of the Company’s assets and liabilities measured at fair value as categorized based on the hierarchy described in Note 2.
                                 
    Level 1     Level 2     Level 3     Total  
    (In thousands)  
As of December 31, 2010
                               
Securities available-for-sale
                               
U.S. government obligations
  $     $ 41,351     $     $ 41,351  
Municipal securities
          29,145             29,145  
Corporate bonds
          2,056             2,056  
Foreign currency forward contract
          (337 )           (337 )
 
                       
 
  $     $ 72,215     $     $ 72,215  
 
                       
 
                               
As of December 31, 2009
                               
Securities available-for-sale
                               
U.S. government obligations
  $     $ 40,078     $     $ 40,078  
Municipal securities
          28,873             28,873  
Corporate bonds
          2,046             2,046  
Foreign currency forward contract
          (259 )           (259 )
 
                       
 
  $     $ 70,738     $     $ 70,738  
 
                       

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Securities classified within Level 2 were valued using a market approach utilizing prices and other relevant information generated by market transactions involving comparable assets. The foreign currency forward contract is classified within Level 2 as the valuation inputs are based on quoted market prices. There were no financial assets classified within Level 3 during 2010 and 2009. The following table is a reconciliation of financial assets measured at fair value using significant unobservable inputs (Level 3) for the year ended December 31, 2008:
         
    Year Ended  
    December 31,  
    2008  
 
Balance as of January 1, 2008
  $  
Transfers into Level 3
    6,770  
Redemptions
    (6,770 )
 
     
Balance as of December 31, 2008
  $  
 
     
As of December 31, 2007, the Company had $13.1 million invested in municipal auction rate securities (“MARS”). Liquidity for these securities is typically provided by an auction process that resets the applicable interest rate at pre-determined 35-day intervals. Auctions for six securities with a par value of $11.2 million began to fail in February 2008 and, as a result, the Company had been unable to liquidate these holdings. During 2008, all of the securities were redeemed or had successful auctions at par value. The Company no longer has any investments in MARS.
The Company enters into foreign currency forward contracts with a noncontrolling stockholder broker-dealer client to hedge the exposure to variability in foreign currency cash flows resulting from the net investment in the Company’s U.K. subsidiary. The Company assesses each foreign currency forward contract to ensure that it is highly effective at reducing the exposure being hedged. The Company designates each foreign currency forward contract as a hedge, assesses the risk management objective and strategy, including identification of the hedging instrument, the hedged item and the risk exposure and how effectiveness is to be assessed prospectively and retrospectively. These hedges are for a one-month period and are used to limit exposure to foreign currency exchange rate fluctuations. The gross and net fair value liability of $0.3 million as of both December 31, 2010 and 2009, respectively, is included in accounts payable, in the Consolidated Statements of Financial Condition. Gains or losses on foreign currency forward contracts designated as hedges are included in accumulated other comprehensive loss in the Consolidated Statements of Financial Condition. A summary of the foreign currency forward contracts is as follows:
                 
    As of December 31,  
    2010     2009  
    (In thousands)  
Notional value
  $ 29,117     $ 28,040  
Fair value of notional
    29,454       28,299  
 
           
Gross and net fair value (liability)
  $ (337 )   $ (259 )
 
           

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following is a summary of the Company’s securities available-for-sale:
                                 
            Gross     Gross     Estimated  
    Amortized     unrealized     unrealized     fair  
    cost     gains     losses     value  
    (In thousands)  
As of December 31, 2010
                               
U.S. government obligations
  $ 40,383     $ 968     $     $ 41,351  
Municipal securities
    29,150       14       (19 )     29,145  
Corporate bonds
    2,056                   2,056  
 
                       
Total securities available-for-sale
  $ 71,589     $ 982     $ (19 )   $ 72,552  
 
                       
 
                               
As of December 31, 2009
                               
U.S. government obligations
  $ 39,629     $ 469     $ (20 )   $ 40,078  
Municipal securities
    28,878       4       (9 )     28,873  
Corporate bonds
    2,028       18             2,046  
 
                       
Total securities available-for-sale
  $ 70,535     $ 491     $ (29 )   $ 70,997  
 
                       
The following table summarizes the contractual maturities of securities available-for-sale:
                 
    As of December 31,  
    2010     2009  
    (In thousands)  
Less than one year
  $ 23,593     $ 30,919  
Due in 1 - 5 years
    48,959       40,078  
 
           
Total securities available-for-sale
  $ 72,552     $ 70,997  
 
           
Proceeds from the maturities and sale of securities available-for-sale during 2010, 2009 and 2008 were $65.4 million, $22.1 million and $46.3 million, respectively.
The following table provides fair values and unrealized losses on securities available-for-sale and by the aging of the securities’ continuous unrealized loss position:
                                                 
    Less than Twelve Months     Twelve Months or More     Total  
    Estimated     Gross     Estimated     Gross     Estimated     Gross  
    fair     unrealized     fair     unrealized     fair     unrealized  
    value     losses     value     losses     value     losses  
    (In thousands)  
As of December 31, 2010
                                               
U.S. government obligations
  $     $     $     $     $     $  
Municipal securities
    18,218       (19 )                 18,218       (19 )
Corporate bonds
                                   
 
                                   
Total
  $ 18,218     $ (19 )   $     $     $ 18,218     $ (19 )
 
                                   
 
                                               
As of December 31, 2009
                                               
U.S. government obligations
  $ 9,944     $ (20 )   $     $     $ 9,944     $ (20 )
Municipal securities
    13,644       (9 )                 13,644       (9 )
Corporate bonds
                                   
 
                                   
Total
  $ 23,588     $ (29 )   $     $     $ 23,588     $ (29 )
 
                                   

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
5. Furniture, Equipment and Leasehold Improvements
Furniture, equipment and leasehold improvements, net of accumulated depreciation and amortization, are comprised of the following:
                 
    As of December 31,  
    2010     2009  
    (In thousands)  
Computer hardware and related software
  $ 13,534     $ 14,932  
Office hardware
    1,630       1,417  
Furniture and fixtures
    1,449       2,305  
Leasehold improvements
    4,582       4,008  
Computer hardware under capital lease
    1,419       1,419  
Accumulated depreciation and amortization
    (13,166 )     (17,225 )
 
           
Total furniture, equipment and leasehold improvements, net of accumulated depreciation and amortization
  $ 9,448     $ 6,856  
 
           
During the years ended December 31, 2010, 2009 and 2008, depreciation and amortization expense was $2.6 million, $2.2 million and $2.3 million, respectively.
6. Software Development Costs
During the years ended December 31, 2010, 2009 and 2008, software development costs totaling $1.9 million, $1.9 million and $2.4 million, respectively, were capitalized. Non-capitalized software costs and routine maintenance costs are expensed as incurred and are included in employee compensation and benefits and professional and consulting fees in the Consolidated Statements of Operations. During the years ended December 31, 2010, 2009 and 2008, amortization expense was $2.2 million, $3.0 million and $3.5 million, respectively. Software development costs, net, are comprised of the following:
                 
    As of December 31,  
    2010     2009  
    (In thousands)  
Software development costs
  $ 21,195     $ 19,302  
Accumulated amortization
    (18,098 )     (15,882 )
 
           
Total software development costs, net
  $ 3,097     $ 3,420  
 
           
7. Acquisition
On March 5, 2008, the Company acquired all of the outstanding capital stock of Greenline Financial Technologies, Inc. (“Greenline”), an Illinois-based provider of integration, testing and management solutions for FIX-related products and services designed to optimize electronic trading of fixed-income, equity and other exchange-based products, and approximately ten percent of the outstanding capital stock of TradeHelm, Inc., a Delaware corporation that was spun-out from Greenline immediately prior to the acquisition. The acquisition of Greenline broadens the range of technology services that the Company offers to institutional financial markets, provides an expansion of the Company’s client base, including global exchanges and hedge funds, and further diversifies the Company’s revenues beyond the core electronic credit trading products. The results of operations of Greenline are included in the Consolidated Financial Statements from the date of the acquisition.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The aggregate consideration for the Greenline acquisition was $41.1 million, comprised of $34.7 million in cash, 725,923 shares of common stock valued at $5.8 million and $0.6 million of acquisition-related costs. In addition, the sellers were eligible to receive up to an aggregate of $3.0 million in cash, subject to Greenline attaining certain earn-out targets in 2008 and 2009. A total of $1.4 million was paid to the sellers in 2009 based on the 2008 earn-out target, bringing the aggregate consideration to $42.4 million. The 2009 earn-out target was not met. A total of $2.0 million of the purchase price, which had been deposited into escrow accounts to satisfy potential indemnity claims, was distributed to the sellers in March 2009. The shares of common stock issued to each selling shareholder of Greenline were released in two equal installments on December 20, 2008 and December 20, 2009, respectively. The value ascribed to the shares was discounted from the market value to reflect the non-marketability of such shares during the restriction period. The purchase price allocation is as follows (in thousands):
         
Cash
  $ 6,406  
Accounts receivable
    2,139  
Amortizable intangibles
    8,330  
Goodwill
    29,405  
Deferred tax assets, net
    3,410  
Other assets, including investment in TradeHelm
    1,429  
Accounts payable, accrued expenses and deferred revenue
    (8,701 )
 
     
Total purchase price
  $ 42,418  
 
     
The amortizable intangibles include $3.2 million of acquired technology, $3.3 million of customer relationships, $1.3 million of non-competition agreements and $0.5 million of tradenames. Useful lives of ten years and five years have been assigned to the customer relationships intangible and all other amortizable intangibles, respectively. The identifiable intangible assets and goodwill are not deductible for tax purposes.
The following unaudited pro forma consolidated financial information reflects the results of operations of the Company for the year ended December 31, 2008, as if the acquisition of Greenline had occurred as of the beginning of the period presented, after giving effect to certain purchase accounting adjustments. These pro forma results are not necessarily indicative of what the Company’s operating results would have been had the acquisition actually taken place as of the beginning of the earliest period presented. The pro forma financial information includes the amortization charges from acquired intangible assets, adjustments to interest income and related tax effects (in thousands, except per share amounts).
         
Revenues
  $ 94,676  
Income before income taxes
  $ 13,159  
Net income
  $ 8,105  
Basic net income per common share
  $ 0.23  
Diluted net income per common share
  $ 0.22  
8. Goodwill and Intangible Assets
Goodwill and intangible assets principally relate to the acquisitions of Greenline in 2008 and Trade West Systems, LLC (“TWS”) in 2007. Goodwill was $31.8 million as of both December 31, 2010 and 2009.
                 
    Year Ended December 31,  
    2010     2009  
    (In thousands)  
Greenline acquisition
  $ 29,405     $ 29,405  
TWS acquisition
    2,177       2,177  
Other
    202       202  
 
           
Total
  $ 31,784     $ 31,784  
 
           

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Intangible assets that are subject to amortization, including the related accumulated amortization, are comprised of the following:
                                                 
    December 31, 2010     December 31, 2009  
            Accumulated     Net Carrying             Accumulated     Net Carrying  
    Cost     Amortization     Amount     Cost     Amortization     Amount  
    (In thousands)  
Technology
  $ 4,010     $ (2,505 )   $ 1,505     $ 4,010     $ (1,807 )   $ 2,203  
Customer relationships
    3,530       (1,584 )     1,946       3,530       (1,119 )     2,411  
Non-competition agreements
    1,260       (710 )     550       1,260       (459 )     801  
Tradenames
    590       (363 )     227       590       (259 )     331  
 
                                   
Total
  $ 9,390     $ (5,162 )   $ 4,228     $ 9,390     $ (3,644 )   $ 5,746  
 
                                   
Amortization expense associated with identifiable intangible assets was $1.5 million, $1.6 million and $2.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. Estimated total amortization expense is $1.5 million for 2011, $1.4 million for 2012, $0.5 million for 2013, $0.3 million for 2014 and $0.2 million for 2015.
During the third quarter of 2008, the Company determined that the technology, customer relationships and tradename intangible assets recognized in connection with the TWS acquisition were impaired. A charge of $0.7 million was recorded to reflect negative current period operating results and reduced revenue expectations for connectivity solutions principally delivered to broker-dealers.
9. Income Taxes
The provision for income taxes consists of the following:
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Current:
                       
Federal
  $     $ (308 )   $ 124  
State and local
    355       57       29  
Foreign
    1,348       2,022       253  
 
                 
Total current provision
    1,703       1,771       406  
 
                 
Deferred:
                       
Federal
    14,494       6,763       1,883  
State and local
    3,170       5,014       1,076  
Foreign
    115       399       1,570  
 
                 
Total deferred provision
    17,779       12,176       4,529  
 
                 
Provision for income taxes
  $ 19,482     $ 13,947     $ 4,935  
 
                 
Pre-tax income from U.S. operations was $46.1 million, $21.6 million and $6.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. Pre-tax income from foreign operations was $4.8 million, $8.4 million and $6.1 million for the years ended December 31, 2010, 2009 and 2008, respectively.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The difference between the Company’s reported provision for income taxes and the amount computed by multiplying pre-tax income taxes by the U.S. federal statutory rate of 35% is as follows:
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
U.S. federal tax at statutory rate
  $ 17,819     $ 10,517     $ 4,492  
 
                       
State and local taxes — net of federal benefit
    2,357       1,836       685  
Stock compensation
    (45 )     361       350  
Change in rates for deferred tax assets
    39     1,561       (19 )
Tax-exempt interest income
    (45 )     (175 )     (655 )
Other, net
    (643 )     (153 )     82  
 
                 
Provision for income taxes
  $ 19,482     $ 13,947     $ 4,935  
 
                 
During 2009, the Company reduced the income tax rates used for recording the deferred tax assets to reflect the tax rates anticipated to be in effect when the temporary differences are expected to reverse, resulting in a decrease in the deferred tax assets and an increase in tax expense of $1.6 million. The 2009 tax rate change reflects a refinement in the Company’s state and local tax apportionment methodology. The following is a summary of the Company’s net deferred tax assets:
                 
    As of December 31,  
    2010     2009  
    (In thousands)  
Deferred tax assets
               
U.S net operating loss carryforwards
  $ 6,935     $ 15,975  
Foreign net operating loss carryforwards
    237       403  
Depreciation
    789       754  
Stock compensation expense
    6,945       5,807  
Tax credits
    6,035       3,314  
Other
    1,958       1,891  
 
           
Total deferred tax assets
    22,899       28,144  
Valuation allowance
    (249 )     (666 )
 
           
Net deferred tax assets
    22,650       27,478  
Deferred tax liabilities
               
Capitalized software development costs
    (1,210 )     (1,294 )
Intangible assets
    (1,627 )     (2,204 )
 
           
Deferred tax assets, net
  $ 19,813     $ 23,980  
 
           

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
As of December 31, 2010, the Company has deferred tax assets associated with stock-based compensation of approximately $6.9 million. There is a risk that the ultimate tax benefit realized upon the exercise of stock options or vesting of restricted stock could be less than the tax benefit previously recognized and exhaust the additional-paid-in-capital pool. If this should occur, any excess tax benefit previously recognized would be reversed, resulting in an increase in tax expense. Since the tax benefit to be realized in the future is unknown, it is not currently possible to estimate the impact on the deferred tax balance. As of December 31, 2010, the additional paid-in-capital pool is approximately $15.8 million. The additional paid-in-capital pool is determined under a one pool approach for employee and non-employee awards.
A summary of the Company’s net operating loss and tax credit carryforwards and their expiration dates is as follows:
                 
    Tax operating        
Year of expiration   losses     Tax credits  
    (In thousands)  
U.S. carryforwards:
               
2012 to 2018
  $     $ 193  
2019
          1,393  
2020
          2,043  
2021
    4,392        
2022 to 2027
    10,424       1,577  
2028 to 2030
    14,952       198  
 
           
Total U.S. carryforwards
    29,768       5,404  
Credits with no expiration date
            631  
Foreign carryforwards expiring from 2026 to 2029
    622        
 
           
Total
  $ 30,390     $ 6,035  
 
           
In April 2000, the Board of Directors initiated a warrant program that commenced on February 1, 2001. Under this program, the Company reserved for issuance 5,000,002 shares of common stock. The warrants were issued to holders of Series A, C, E and I redeemable convertible preferred stock (the “Warrant Holders”). The Warrant Holders were entitled to purchase shares of common stock from the Company at an exercise price of $.003 per share. The warrants were issued to the Warrant Holders at the time that they made an equity investment in the Company. Allocations were based on each broker-dealer client’s respective commissions as a percentage of the total commissions from the six participating Warrant Holders, calculated on a quarterly basis. The final share allocations under the warrant program occurred on March 1, 2004. Shares allocated under the warrant program were expensed on a quarterly basis at fair market value. All of the warrants were exercised prior to 2008. Through December 31, 2009, the tax benefit on a portion of the tax deduction generated on the exercise of the warrants had not yet been recorded. During 2010, the Company recognized a portion of the tax benefits amounting to $11.4 million as an increase to additional paid-in-capital due to the expected utilization of the related tax loss carryforwards of $31.0 million. The remaining deferred tax benefit of approximately $4.2 million related to the residual unutilized tax loss carryforward of $10.4 million will be recognized once the tax benefit serves to reduce taxes payable.
In 2000 and 2001, MarketAxess Holdings Inc. and MarketAxess Corporation had an ownership change within the meaning of Section 382 of the Internal Revenue Code. Net operating loss carryforwards relating to the ownership change are $24.0 million as of December 31, 2010. However, only $4.4 million is deemed utilizable and recognized as a net operating loss carryforward. Greenline experienced an ownership change within the meaning of Section 382 of the Internal Revenue Code in 2008. The Company does not believe that this ownership change significantly impacts the ability to utilize acquired net operating loss carryforwards, which amount to $15.0 million as of December 31, 2010. In addition, the Company’s net operating loss and tax credit carryforwards may be subject to additional annual limitations if there is a 50% or greater change in the Company’s ownership, as determined over a rolling three-year period.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. If it is not more likely than not that some portion or all of the gross deferred income tax assets will be realized in future years, a valuation allowance is recorded. As of December 31, 2010, the valuation allowance relates to certain foreign and state tax loss carryforwards that are not expected to be realized. A summary of the changes in the valuation allowance follows:
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Valuation allowance at beginning of year
  $ 666     $ 567     $ 623  
Increase (decrease) to valuation allowance attributable to:
                       
Net operating losses
    (132 )     39       156  
Temporary differences
          186       (212 )
Tax credits
    (285 )     (126 )      
 
                 
Valuation allowance at end of year
  $ 249     $ 666     $ 567  
 
                 
The Company or one of its subsidiaries files U.S. federal, state and foreign income tax returns. No income tax returns have been audited, with the exception of New York city (through 2003) and state (through 2006) and Connecticut state (through 2003) tax returns.
As of December 31, 2010, the Company has unrecognized tax benefits of $3.3 million. If recognized, this entire amount would impact the effective tax rate. The Company currently anticipates the amount of unrecognized tax benefits to increase by approximately $0.3 million by December 31, 2011. A reconciliation of the unrecognized tax benefits is as follows (in thousands):
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Balance at beginning of year
  $ 2,924     $ 2,685     $ 2,685  
Additions for tax positions of prior years
    277       239        
Additions for tax positions of current year
    128              
 
                 
Balance at end of year
  $ 3,329     $ 2,924     $ 2,685  
 
                 

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
10. Related Parties
The Company generates commissions, technology products and services revenues, information and user access fees, investment income and other income and related accounts receivable balances from Stockholder Broker-Dealer Clients or their affiliates. In addition, a Stockholder Broker-Dealer Client acts in an investment advisory, custodial and cash management capacity for the Company. The Company also maintained an account with and paid commissions to this Stockholder Broker-Dealer Client in connection with the Company’s share repurchase program. The Company incurs investment advisory and bank fees in connection with these arrangements. As of the dates and for the periods indicated below, the Company had the following balances and transactions with the Stockholder Broker-Dealer Clients or their affiliates:
                 
    As of December 31,  
    2010     2009  
    (In thousands)  
Cash and cash equivalents
  $ 110,642     $ 101,273  
Securities and cash provided as collateral
    4,049       4,067  
Accounts receivable
    829       3,431  
Accounts payable
    66       29  
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Commissions
  $ 5,541     $ 14,103     $ 12,466  
Technology products and services
    16       35       33  
Information and user access fees
    132       243       276  
Investment income
    113       214       1,165  
Other income
    63       152       169  
General and administrative
    27       79       57  
As of December 31, 2009, the Company had loans and interest receivable due from the Chief Executive Officer of $0.7 million, which are described in more detail in Footnote 11, “Stockholders’ Equity.” The accrued interest on the loans was recorded in accounts receivable and the principal amount was recorded as a receivable for common stock subscribed in stockholders’ equity on the Consolidated Statements of Financial Condition. During both 2009 and 2008, principal and interest payments of $0.3 million were received. In July 2010, the loan and interest receivable were paid in full.
11. Stockholders’ Equity
Common Stock
As of December 31, 2010 and 2009, the Company had 110,000,000 authorized shares of common stock and 10,000,000 authorized shares of non-voting common stock. Common stock entitles the holder to one vote per share of common stock held. Non-voting common stock is convertible on a one-for-one basis into shares of voting common stock at any time subject to a limitation on conversion to the extent such conversion would result in a stockholder, together with its affiliates, owning more than 9.99% of the outstanding shares of common stock.
In October 2006, the Board of Directors of the Company authorized a share repurchase program for up to $40.0 million of common stock. Shares repurchased under the program are held in treasury for future use. During 2008, a total of 221,406 shares were repurchased at a cost of $2.8 million. The share repurchase program was completed in January 2008. A total of 2,864,120 shares were repurchased at an aggregate cost of $40.0 million over the life of the repurchase program.
In June 2010, the Board of Directors of the Company authorized a share repurchase program for up to $30.0 million of the Company’s common stock. Shares repurchased under the program are held in treasury for future use. The share repurchase program was completed in December 2010. A total of 1,939,620 shares were repurchased at an aggregate cost of $30.0 million over the life of the repurchase program.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Common Stock Subscribed
In 2001, the Company awarded 289,581 shares to the Company’s Chief Executive Officer at $3.60 per share, which vested over a three-year period. The common stock subscribed was issued in 2001 in exchange for four eleven-year promissory notes that bore interest at the applicable federal rate and were collateralized by the subscribed shares. In July 2010, the loan and interest receivable were paid in full.
Series B Preferred Stock and Warrants
On June 2, 2008, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with two funds managed by Technology Crossover Ventures (the “Purchasers”), pursuant to which the Company agreed to issue and sell to the Purchasers (i) 35,000 shares of the Company’s Series B Preferred Stock, which shares are convertible into an aggregate of 3,500,000 shares of common stock and (ii) warrants (the “Warrants” and, together with the Series B Preferred Stock, the “Securities”) to purchase an aggregate of 700,000 shares of common stock at an exercise price of $10.00 per share, for an aggregate purchase price of $35.0 million. The Securities were purchased in two tranches on June 3, 2008 and July 14, 2008, with the first tranche representing 28,000 shares of Series B Preferred Stock and Warrants to purchase 560,000 shares of common stock for an aggregate purchase price of $28.0 million, and the second tranche representing the remainder of the Securities for an aggregate purchase price of $7.0 million. The net proceeds, after the placement agent fee and legal fees, were $26.8 million for the first tranche and $6.8 million for the second tranche.
The Purchasers have the right to nominate one director to the Board of Directors of the Company if they beneficially own at least 1,750,000 shares of common stock. The Purchasers also have registration rights that require the Company, within six months after the closing date, to file a registration statement with the SEC to register the resale of the shares of common stock issuable upon conversion of the Series B Preferred Stock and upon exercise of the Warrants (collectively, the “Registrable Shares”), and to cause such registration statement to become effective under the Securities Act of 1933, as amended, no later than 12 months after the closing. On January 22, 2009, a registration statement on Form S-3 registering the resale of the Registrable Shares was declared effective by the SEC. The Company has also agreed to provide the Purchasers with piggyback registration rights on certain public offerings of securities by the Company.
The purchase price of the Series B Preferred Stock was $1,000.00 per share (the “Original Series B Issue Price”). In the event of a Liquidation Event (as such term is defined in the Series B Certificate of Designation), each holder of the Series B Preferred Stock is entitled to receive, prior to any distribution to the holders of the common stock, the greater of (i) an amount per share of Series B Preferred Stock equal to the Original Series B Issue Price, plus any declared but unpaid dividends thereon, and (ii) the amount such holder would have received in connection with the Liquidation Event if the holder held the number of shares of common stock issuable upon conversion of the Series B Preferred Stock then held by such holder.
The shares of Series B Preferred Stock are convertible at any time by the holders thereof at a conversion price of $10.00 per share, subject to anti-dilution adjustments in the event of a stock split, stock dividend, reverse stock split or similar transaction. The Series B Preferred Stock will be automatically converted into shares of common stock at the then-applicable conversion price if at any time after June 3, 2009 (the first anniversary of the original issuance of the Series B Preferred Stock), the closing price of the common stock is at least $17.50 on each trading day for a period of 65 consecutive trading days. On January 24, 2011, all of the shares of the Series B Preferred Stock were manditorily and automatically converted into 3,499,999 shares of common stock.
The Series B Preferred Stock includes a dividend right whereby, upon the declaration or payment of a dividend or distribution on the common stock, a dividend or distribution must also be declared or paid on the Series B Preferred Stock based on the number of shares of common stock into which such shares of Series B Preferred Stock would be convertible at the time. The holders of the Series B Preferred Stock also have voting rights equal to the aggregate number of shares of common stock issuable upon conversion of such holders’ shares of Series B Preferred Stock.
As discussed above, the Warrants entitle the Purchasers to purchase an aggregate of 700,000 shares of common stock at an exercise price of $10.00 per share. The Warrants may be exercised for cash or on a net exercise basis. The Warrants expire on the tenth anniversary of the date they were first issued and are subject to customary anti-dilution adjustments in the event of stock splits, reverse stock splits, stock dividends and similar transactions. The net proceeds from the issuance have been allocated to the Series B Preferred Stock and Warrants based on their relative fair value on the respective closing dates and resulted in $3.2 million being allocated to the Warrants. The fair value of the Warrants was computed using the Black-Scholes option-pricing model.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Series B Preferred Stock does not contain an unconditional obligation requiring the Company to redeem the shares at a specified date or upon the occurrence of an event certain. While liability classification does not apply, there are certain liquidation scenarios not solely within the Company’s control. Therefore, the portion of the net proceeds attributable to the Series B Preferred Stock is not classified as permanent equity. The Series B Preferred Stock is not being accreted to its redemption value since the occurrence of a redemption event is not considered probable.
Dividends
Prior to 2009, the Company retained all earnings for investment in its business. In October 2009, the Company’s Board of Directors approved a regular quarterly dividend. The first quarterly cash dividend of $0.07 per share was paid to holders of common stock outstanding or issuable upon conversion of outstanding shares of non-voting common stock and Series B Preferred Stock in November 2009. In January 2011, the Company’s Board of Directors approved an increase in the quarterly cash dividend to $0.09 per share payable on March 2, 2011 to such stockholders of record as of the close of business on February 16, 2011. Any future declaration and payment of dividends will be at the sole discretion of the Company’s Board of Directors. The Board of Directors may take into account such matters as general business conditions, the Company’s financial results, capital requirements, contractual, legal, and regulatory restrictions on the payment of dividends to the Company’s stockholders or by the Company’s subsidiaries to the parent and any such other factors as the Board of Directors may deem relevant.
Stockholder Rights Agreement
On June 2, 2008, the Board of Directors adopted and the Company’s stockholders subsequently ratified a stockholders rights agreement and declared a distribution of one right (a “Right”) for each outstanding share of common stock and non-voting common stock, to stockholders of record at the close of business on June 20, 2008 and for each share of common stock and non-voting common stock issued by the Company thereafter and prior to the Distribution Date (as defined in the stockholders rights agreement). Each Right entitles the registered holder, subject to the terms of the stockholders rights agreement, to purchase from the Company one one-thousandth of a share of Series A Preferred Stock, par value $0.001 per share (a “Unit), at a price of $40.00 per Unit, subject to adjustment.
12. Stock-Based Compensation Plans
The Company has three stock incentive plans which provide for the grant of stock options, stock appreciation rights, restricted stock, performance shares, performance units, or other stock-based awards as incentives and rewards to encourage employees, consultants and non-employee directors to participate in the long-term success of the Company. As of December 31, 2010, there were 4,303,905 shares available for grant under the stock incentive plans.
Total stock-based compensation expense was as follows:
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands)  
Employee:
                       
Stock options
  $ 1,728     $ 2,858     $ 3,757  
Restricted stock and performance shares
    6,588       5,040       2,832  
 
                 
 
    8,316       7,898       6,589  
 
                 
Non-employee directors:
                       
Stock options
    83       143       139  
Restricted stock
    570       373       333  
 
                 
 
    653       516       472  
 
                 
Total stock-based compensation
  $ 8,969     $ 8,414     $ 7,061  
 
                 
The Company records stock-based compensation expense for employees in employee compensation and benefits and for non-employee directors in general and administrative expenses in the Consolidated Statements of Operations.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Stock Options
The exercise price of each option granted is equal to the market price of the Company’s common stock on the date of grant. Generally, option grants have provided for vesting over a three-year period. Options expire ten years from the date of grant. The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables, including the expected stock price volatility over the term of the awards, the risk-free interest rate and the expected term. Expected volatilities are based on historical volatility of the Company’s stock and a peer group. The risk-free interest rate is based on U.S. Treasury securities with a maturity value approximating the expected term of the option. The expected term represents the period of time that options granted are expected to be outstanding based on actual and projected employee stock option exercise behavior.
The weighted-average fair value for options granted during 2010, 2009 and 2008 was $5.45, $4.60 and $4.51, respectively. The following table represents the assumptions used for the Black-Scholes option-pricing model to determine the per share weighted-average fair value for options granted for the three years ended December 31, 2010:
                         
    2010     2009     2008  
Expected life (years)
    5.0       5.4       6.1  
Risk-free interest rate
    2.2 %     2.4 %     3.1 %
Expected volatility
    50.0 %     49.8 %     37.6 %
Expected dividend yield
    2.0 %     0.0 %     0.0 %
The following table reports stock option activity during the three years ended December 31, 2010 and the intrinsic value as of December 31, 2010:
                                 
                    Remaining        
    Number of     Weighted-Average     Contractual        
    Shares     Exercise Price     Term     Intrinsic Value  
                      (In thousands)  
Outstanding at December 31, 2007
    5,026,892     $ 9.05                  
Granted
    851,620     $ 10.77                  
Canceled
    (516,408 )   $ 11.60                  
Exercised
    (74,929 )   $ 2.93                  
 
                             
Outstanding at December 31, 2008
    5,287,175     $ 9.17                  
Granted
    140,239     $ 9.66                  
Canceled
    (199,932 )   $ 11.07                  
Exercised
    (60,924 )   $ 9.54                  
 
                             
Outstanding at December 31, 2009
    5,166,558     $ 9.10                  
Granted
    8,239     $ 14.10                  
Canceled
    (12,575 )   $ 13.85                  
Exercised
    (758,660 )   $ 9.17             $ 5,861  
 
                             
Outstanding at December 31, 2010
    4,403,562     $ 9.09       4.4     $ 51,631  
 
                             
Exercisable at December 31, 2010
    4,034,463     $ 8.95       4.2     $ 47,841  
 
                             
The intrinsic value is the amount by which the closing price of the Company’s common stock on December 31, 2010 of $20.81 or the price on the day of exercise exceeds the exercise price of the stock options multiplied by the number of shares. As of December 31, 2010, there was $0.5 million of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over a weighted-average period of 0.7 years.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Restricted Stock and Performance Shares
Shares of restricted stock generally vest over a period of three years. Compensation expense is measured at the grant date and recognized ratably over the vesting period. Performance share awards are granted to certain senior managers. Each performance share award is earned or forfeited based on the level of achievement by the Company of pre-tax operating income on a per share basis before performance share and cash bonus expense. The pay-out ranges from zero to 150% of the performance share award. For each performance share earned, a participant is awarded an equal number of shares of restricted stock. Any restricted stock awarded to a participant vests and ceases to be restricted stock in two equal installments on each of the second and third anniversaries of the date of grant of the applicable performance share award. Compensation expense for performance shares is measured at the grant date and recognized on a graded basis over the vesting period. For 2010 and 2009, the pay-out achievement was 150% of the performance award. The Company failed to meet the pre-tax operating income per share target for 2008 and, accordingly, all of the performance share awards were forfeited. The following table reports performance share activity for the three years ended December 31, 2010:
                         
Performance year   2010     2009     2008  
Share pay-out at plan
    87,035       137,778       177,680  
Actual share pay-out in following year
    130,552       206,664       0  
Fair value per share on grant date
  $ 14.29     $ 7.94     $ 10.93  
The following table reports restricted stock and performance share activity during the three years ended December 31, 2010:
                 
            Weighted-Average  
    Number of     Grant Date Fair  
    Restricted Shares     Value  
Outstanding at December 31, 2007
    707,003     $ 12.69  
Granted
    151,915          
Canceled
    (6,967 )        
Vested
    (203,957 )        
 
             
Outstanding at December 31, 2008
    647,994     $ 12.14  
Granted
    659,520          
Canceled
    (500 )        
Vested
    (272,875 )        
 
             
Outstanding at December 31, 2009
    1,034,139     $ 9.64  
Granted
    549,264          
Performance share pay-out
    206,664          
Canceled
    (71,152 )        
Vested
    (474,051 )        
 
             
Outstanding at December 31, 2010
    1,244,864     $ 11.23  
 
             
As of December 31, 2010, there was $9.0 million of total unrecognized compensation expense related to non-vested restricted stock and performance shares. That cost is expected to be recognized over a weighted-average period of 1.7 years.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
13. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per common share:
                         
    Year Ended December 31,  
    2010     2009     2008  
    (In thousands, except share and per share amounts)  
Basic EPS
                       
Net income
  $ 31,428     $ 16,102     $ 7,899  
Amount allocable to common shareholders
    90.5 %     90.5 %     94.3 %
 
                 
Net income applicable to common stock
  $ 28,427     $ 14,569     $ 7,449  
 
                       
Common stock — voting
    30,573,523       30,678,174       30,245,269  
Common stock — non-voting
    2,585,654       2,585,654       2,585,654  
 
                 
Basic weighted average shares outstanding
    33,159,177       33,263,828       32,830,923  
 
                 
Basic earnings per share
  $ 0.86     $ 0.44     $ 0.23  
 
                 
 
                       
Diluted EPS
                       
Net income
  $ 31,428     $ 16,102     $ 7,899  
 
                       
Basic weighted average shares outstanding
    33,159,177       33,263,828       32,830,923  
Effect of dilutive shares:
                       
Series B Preferred Stock
    3,500,000       3,500,000       1,983,334  
Stock options, restricted stock and warrants
    2,392,009       1,318,151       923,122  
 
                 
Diluted weighted average shares outstanding
    39,051,186       38,081,980       35,737,379  
 
                 
Diluted earnings per share
  $ 0.80     $ 0.42     $ 0.22  
 
                 
Stock options, restricted stock and warrants totaling 446,187 shares, 3,647,376 shares and 4,718,939 shares for the years ended December 31, 2010, 2009 and 2008, respectively, were excluded from the computation of diluted earnings per share because their effect would have been antidilutive. The computation of diluted shares can vary among periods due, in part, to the change in the average price of the Company’s common stock.
14. Commitments and Contingencies
The Company leases office space and equipment under non-cancelable lease agreements expiring at various dates through 2022. Office space leases are subject to escalation based on certain costs incurred by the landlord. Minimum rental commitments as of December 31, 2010 under such operating and capital leases, net of future sublease income of $0.3 million in 2011, were as follows:
                 
    Operating     Capital  
Year Ending December 31,   Leases     Leases  
    (In thousands)  
2011
  $ 1,843     $ 336  
2012
    1,805       336  
2013
    1,790       322  
2014
    1,756       42  
2015
    2,014        
2016 and thereafter
    12,186        
 
           
Minimum lease payments
    21,394       1,036  
Less amount representing interest
          110  
 
           
 
  $ 21,394     $ 926  
 
           

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Rental expense for the years ended December 31, 2010, 2009 and 2008 was $2.7 million, $2.7 million and $2.2 million, respectively, and is included in occupancy expense in the Consolidated Statements of Operations. Rental expense has been recorded based on the total minimum lease payments after giving effect to rent abatement and concessions, which are being amortized on a straight-line basis over the life of the lease, and sublease income.
The Company has entered into a sublease agreement on one of its leased properties through the April 2011 lease termination date. In May 2008, the Company assigned the lease agreement on another leased property to a third party. The Company is contingently liable should the assignee default on future lease obligations through the November 2015 lease termination date. The aggregate amount of future lease obligations under these two arrangements is $2.1 million as of December 31, 2010.
The Company is contingently obligated for standby letters of credit that were issued to landlords for office space. The Company uses a U.S. government obligation as collateral for these standby letters of credit. This collateral is included with securities and cash provided as collateral in the Consolidated Statements of Financial Condition and had a fair market value as of December 31, 2010 and 2009 of $3.5 million.
The Company, through two regulated subsidiaries, executes certain bond transactions between and among institutional investor and broker-dealer clients on a riskless principal basis by serving as counterparty to both the buyer and the seller in matching back-to-back trades, which are then settled through a third-party clearing organization. The Company acts as intermediary on a riskless principal basis in these bond transactions by serving as counterparty to the two clients involved. Settlement typically occurs within one to three trading days after the trade date. Cash settlement of the transaction occurs upon receipt or delivery of the underlying instrument that was traded. Under securities clearing agreements with the independent third party, the Company maintains a collateral deposit with the clearing broker in the form of cash. As of December 31, 2010, the collateral deposit included in securities and cash provided as collateral in the Consolidated Statements of Financial Condition was $0.9 million. The Company is exposed to credit risk in the event a counterparty does not fulfill its obligation to complete a transaction. Pursuant to the terms of the securities clearing agreements between the Company and the independent clearing broker, the clearing broker has the right to charge the Company for losses resulting from a counterparty’s failure to fulfill its contractual obligations. The losses are not capped at a maximum amount and apply to all trades executed through the clearing broker. At December 31, 2010, the Company had not recorded any liabilities with regard to this right.
In the normal course of business, the Company enters into contracts that contain a variety of representations, warranties and general indemnifications. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not yet occurred. However, based on experience, the Company expects the risk of loss to be remote.
In January 2007, a former employee of MarketAxess Corporation commenced an arbitration proceeding before FINRA arising out of the May 2006 termination of such individual’s employment with MarketAxess Corporation. This individual subsequently amended his statement of claim to add MarketAxess Holdings Inc. as a party to the arbitration proceeding. FINRA consolidated all of the former employee’s claims into a single proceeding and, by a decision dated July 12, 2010, the FINRA arbitration panel denied the former employee’s claims, totaling approximately $0.9 million, in their entirety. The former employee’s right to appeal the panel’s decision expired in October 2010.
15. Segment Information
As an electronic multi-dealer platform for the trading of fixed-income securities, the Company’s operations constitute a single business segment. Because of the highly integrated nature of the financial markets in which the Company competes and the integration of the Company’s worldwide business activities, the Company believes that results by geographic region or client sector are not necessarily meaningful in understanding its business.
16. Retirement Savings Plans
The Company, through its U.S. and U.K. subsidiaries, offers its employees the opportunity to invest in defined contribution plans. For the years ended December 31, 2010, 2009 and 2008, the Company contributed $0.9 million, $0.6 million and $0.4 million, respectively, to the plans.

 

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MARKETAXESS HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
17. Customer Concentration
During the years ended December 31, 2010, 2009 and 2008, no single client accounted for more than 10% of total revenue. One institutional investor client accounted for approximately 15.8%, 12.1% and 10.8% of trading volumes during the years ended December 31, 2010, 2009 and 2008, respectively. This institutional investor client also beneficially owns more than 5% of the outstanding shares of the Company’s common stock.
18. Subsequent Events
The Company has performed an evaluation of subsequent events through the date of issuance of the accompanying Consolidated Financial Statements.

 

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Item 9.  
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.  
Controls and Procedures.
(a)  Evaluation of Disclosure Controls and Procedures. Our management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures,” as that term is defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of December 31, 2010. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to ensure that information required to be disclosed by MarketAxess in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to ensure that information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
(b)  Management’s Annual Report on Internal Control Over Financial Reporting. See Item 8 of this Annual Report on Form 10-K.
(c)  Attestation Report of the Independent Registered Public Accounting Firm. See Report of Independent Registered Public Accounting Firm included in Item 8 of this Annual Report on Form 10-K.
(d)  Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act) during the quarter ended December 31, 2010 identified in connection with the evaluation thereof by our management, including the Chief Executive Officer and Chief Financial Officer, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.  
Other Information.
None.

 

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PART III
Item 10.  
Directors, Executive Officers and Corporate Governance.
The information required by this item is incorporated herein by reference to the sections entitled “Proposal 1 — Election of Directors,” “Corporate Governance and Board Matters,” “Executive Officers” and “Other Matters — Section 16(a) beneficial ownership reporting compliance” in the Company’s definitive Proxy Statement (the “Proxy Statement”) for the Annual Meeting of Stockholders to be held in the second quarter of 2011. The Company intends to file the Proxy Statement within 120 days after the end of its fiscal year (i.e., on or before April 30, 2011). The Company’s Code of Conduct applicable to directors and all employees, including senior financial officers, is available on the Company’s website at www.marketaxess.com . If the Company makes any amendments to its Code of Conduct that is required to be disclosed pursuant to the Exchange Act, the Company will make such disclosures on its website.
Item 11.  
Executive Compensation.
The information required by this item is incorporated herein by reference to the sections entitled “Compensation Discussion and Analysis,” “Report of the Compensation Committee of the Board of Directors,” “Executive Compensation” and “Corporate Governance and Board Matters — Directors’ compensation” in the Company’s Proxy Statement.