CME Group Inc. — Q1 2017 Form 10-Q
Business context and reporting period. CME Group operates derivatives exchanges and clearing businesses, including CME, CBOT, NYMEX and COMEX. This unaudited quarterly report covers the three months ended March 31, 2017; comparisons are with Q1 2016 unless otherwise noted. Quarterly results are not necessarily indicative of future periods.
Financial performance and liquidity
- Revenue: $929.3 million, down 1%. Clearing and transaction fees were $792.0 million (down 1%); market data revenue was $96.8 million (down 5%).
- Profitability: Operating income was $601.2 million, up 5%; operating margin was 64.7%, versus 61.4%. Net income was $399.8 million, up 9%, and diluted EPS was $1.18, up 8%.
- Cash flow: Operating cash flow was $518.7 million, compared with $530.0 million. Investing activities provided $224.2 million, including $244.0 million from the sale of the remaining BM&FBOVESPA shares. Financing activities used $1,323.7 million, including $1,322.6 million in cash dividends. Cash and cash equivalents ended at $1,287.8 million, down from $1,868.6 million at year-end 2016.
- Debt and liquidity: Long-term debt was $2,231.6 million carrying value ($2.25 billion par). No borrowings were outstanding under the $2.3 billion corporate revolving facility or the $7.0 billion secured clearing facility. The company reported compliance with debt covenants and approximately $2.3 billion of general-purpose borrowing capacity.
- Balance sheet: Total assets were $75.5 billion and shareholders’ equity was $20.6 billion. Performance-bond and guaranty-fund assets and liabilities were each approximately $44.4 billion; these customer-related balances materially inflate reported current assets and liabilities and should not be treated as ordinary corporate liquidity.
- Tax: The effective tax rate rose to 43.5% from 36.4%, principally due to tax expense reclassified from accumulated other comprehensive income upon the final BM&FBOVESPA share sale.
Changes versus Q1 2016
- Total contract volume increased 3% to 1,060.1 million contracts, but average rate per contract declined 3% to $0.731; the rate decline more than offset the volume benefit, reducing futures and options clearing and transaction fees by $6.4 million.
- Average daily volume was nearly flat overall, up 1% to 17.1 million contracts. Interest-rate volume rose 11%, while equity volume fell 22%; electronic trading remained 87% of volume.
- Operating expenses fell 9% to $328.1 million. The comparison benefited from the prior-year $28.6 million datacenter-related loss and legal fees, partly offset by higher compensation and other items.
- Net income increased despite slightly lower revenue, aided by higher non-operating income. Investment income included an $86.5 million net gain on the BM&FBOVESPA sale; it also reflected higher interest earned on reinvested collateral. Higher tax expense tempered the benefit.
Outlook, risks and unusual items
- The filing provides no quantitative earnings or revenue guidance. Management said trading activity is affected by volatility, economic and political conditions, regulation, competition, product mix and pricing.
- Management attributed higher interest-rate trading to uncertainty around Federal Reserve policy and other political developments; lower equity and foreign-exchange volumes were associated with lower volatility. Agricultural, metals and selected energy products had differing volume drivers.
- Revenue concentration: one clearing firm represented 13% and another 12% of clearing and transaction fees. The two largest market-data resellers represented approximately 40% of market-data revenue. Management considered the risk of losing this revenue limited, but these are notable dependencies.
- In April 2017, CME Group announced its intention to close CME Clearing Europe and CME Europe by the end of 2017. This was a subsequent event; the filing does not quantify its financial effects.
- A CFTC lawsuit against NYMEX and two former employees concerning alleged disclosure of confidential customer information remained pending. Management reported strong factual and legal defenses; no accrual was recorded for legal and regulatory matters considered probable and estimable.
- Other stated risks include competition, technology reliability and cybersecurity, regulatory changes, market-volume declines, clearing-member credit exposure, and legal proceedings. Management reported no material change in market-risk exposure since year-end 2016 and effective disclosure controls.
Important facts for investors to verify
- How much of the earnings increase is sustainable apart from the BM&FBOVESPA sale gain and other investment-income effects, and how the related tax reclassification affects comparability.
- Whether lower average rates per contract and market-data revenue continue, and how product/customer mix and incentives affect monetization of volume.
- The implications, costs and timing of the planned CMECE and CME Europe closures.
- Clearing-firm and market-data reseller concentration, collateral reinvestment income and related distribution expense, and the adequacy of clearing safeguards.
- The outcome and potential consequences of the pending CFTC litigation and the effect of new accounting standards, especially revenue recognition, once implementation assessments are completed.