CME

CME Group Inc. 10-Q Summary: Period Ended June 30, 2003

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2003, for Chicago Mercantile Exchange Holdings Inc. (CME). CME operates a global derivatives exchange, offering futures and options on futures contracts across interest rates, equity indexes, foreign exchange, and commodities. The company utilizes the GLOBEX electronic trading platform and provides clearing services. As of June 30, 2003, the company had approximately 1,185 employees and 70 clearing firms.

Key Financial Metrics

Trading Volume: Total volume for the six months ended June 30, 2003, was 315.0 million contracts (average daily volume of 2.5 million), a 21.5% increase over the prior year. Electronic trading via GLOBEX represented 42.3% of total volume.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 28.7% year-over-year. This was driven primarily by a 34.6% increase in clearing and transaction fees, resulting from higher trading volumes and a shift toward higher-fee equity products and electronic trading.
• Expense Increases: Total operating expenses rose 15.6% to $165.3 million. Key drivers included a $11.1 million increase in compensation and benefits (due to headcount growth, bonuses, and salary increases) and a $4.2 million increase in marketing expenses related to a brand advertising campaign.
• Securities Lending: Net revenue from securities lending declined significantly due to lower interest rates and a strategic change in the timing of daily offerings, reducing the return on average daily balance from 0.26% in 2002 to 0.11% in 2003.
• Capital Structure: The company completed a secondary public offering of Class A common stock in June 2003. CME Holdings did not receive proceeds from this offering as shares were sold by existing shareholders.

Outlook, Risks, and Management Commentary

• Fee Adjustments: Management announced upcoming fee reductions effective September 2, 2003, for GLOBEX electronic trading customer fees on E-mini stock index "rolls" and for Eurodollar contracts. A new market maker program for Eurodollar futures during non-floor hours will also be established.
• Market Risk: The company faces interest rate risk regarding short-term investments and derivatives trading risk via its subsidiary GFX. GFX maintains net position limits of $12.0 million in aggregate notional value. As of June 30, 2003, GFX held futures positions with a notional value of $206.2 million, largely offset by spot and forward positions.
• Legal Contingencies: A former employee filed lawsuits alleging retaliatory discharge and racial discrimination, seeking damages in excess of $3 million. Management believes the claims are without merit and intends to defend them vigorously.
• Guarantees: CME guarantees the principal of the Interest Earning Facility (IEF) for clearing firms, totaling $231.9 million at June 30, 2003. Management concluded no significant liability needs to be recorded under FIN No. 45.
• Capital Expenditures: Anticipated capital expenditures for the second half of 2003 include approximately $9 million for lobby and office improvements.

Investor Verification Checklist

• Verify the sustainability of the 21.5% trading volume growth, particularly the shift to electronic trading (GLOBEX) which drives higher average rates per contract.
• Assess the impact of the announced fee reductions (effective Sept 2003) on future clearing and transaction fee margins.
• Monitor the resolution of the pending employment litigation and potential financial exposure.
• Review the performance of the Interest Earning Facility (IEF) and the associated guarantee liability of $231.9 million.
• Confirm the execution of the clearing services agreement with the Chicago Board of Trade (CBOT), scheduled to begin in November 2003.