CME Group Inc. — Q2 2014 Form 10-Q
Business and period: CME Group operates derivatives exchanges and clearing services, including CME, CBOT, NYMEX and COMEX. This unaudited report covers the quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods unless stated otherwise. CME Europe launched in Q2 2014.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Change |
|---|---|---|---|
| Revenue | $731.6 million | $816.1 million | -10% |
| Operating expenses | $319.6 million | $308.3 million | +4% |
| Operating income | $412.0 million | $507.8 million | -19% |
| Operating margin | 56.3% | 62.2% | -5.9 percentage points |
| Net income attributable to CME Group | $263.8 million | $311.2 million | -15% |
| Diluted EPS | $0.79 | $0.93 | -15% |
| Effective tax rate | 37.5% | 38.7% | -1.2 percentage points |
Six months ended June 30: Revenue was $1,509.0 million (-2%); operating expenses $642.5 million (+3%); operating income $866.5 million (-5%); operating margin 57.4% versus 59.5%; net income attributable to CME Group $530.6 million (-3%); and diluted EPS $1.58 versus $1.64 (-4%).
- Q2 clearing and transaction fees were $609.3 million (-12%); market data revenue was $89.6 million (+13%). For the six-month period, those amounts were $1,261.5 million (-2%) and $179.0 million (+12%), respectively.
- Q2 total contract volume fell 13% to 796.0 million contracts; average rate per contract was essentially unchanged at $0.749. Six-month volume declined 2% to 1,629.2 million, and the average rate declined 1% to $0.758.
- Operating cash flow for the six months was $554.7 million, down from $768.8 million. Investing activities used $70.3 million; financing activities used $1,916.8 million, including $1,182.1 million of dividends and repayment of $750 million of debt.
- Cash and cash equivalents were $1,037.3 million at June 30, 2014, versus $2,469.7 million at year-end 2013. Total debt was approximately $2.1 billion, all long-term at quarter-end; the $750 million notes due February 2014 were repaid. Shareholders’ equity was $21,465.4 million.
Changes, commentary and outlook
- Management attributed lower revenue mainly to reduced exchange-traded volume, lower other revenue, and less rental income. Market data fee increases and higher OTC contract volumes partly offset the decline. Lower volatility weighed on activity across equity, foreign exchange, energy and metals; interest-rate activity was mixed.
- Expenses increased with higher headcount, product and platform development, acquisition-related costs, contingent consideration and a voluntary exit incentive plan. Offsets included foreign-exchange gains, a $14.5 million MF Global bankruptcy claim recognized as a reduction in other expense, and lower litigation accruals.
- Non-operating results improved, with interest and borrowing costs lower following debt repayments and refinancing. The Q2 tax rate benefited from the domestic production activities deduction.
- No specific earnings or revenue guidance is provided. Management said it expects to maintain an investment-grade credit rating. It reported compliance with debt-facility covenants and no borrowings under its $1.8 billion revolving corporate credit facility; a separate $7.0 billion clearing-house line was available for specified liquidity contingencies.
- On July 30, 2014, CME Group agreed to acquire Trayport and FENICS through a planned merger with GFI Group, expected to close in early 2015 subject to approvals. CME Group shares then valued at approximately $580 million are to be issued; CME Group expects to receive $165 million cash from the sale of GFI’s brokerage business and assume $240 million of debt, which it expects to retire in 2015.
Risks, contingencies and unusual items
- Material operating risks include changes in trading volume and volatility, competition, technology reliability and cybersecurity, regulation, customer concentration, clearing-member defaults, and the company’s ability to control costs and manage debt.
- Patent litigation involving Fifth Market and Technology Research Group remains unresolved; CME Group says it believes the claims are without merit and cannot estimate a reasonably possible loss range. The company also disclosed CFTC litigation against NYMEX and two former employees. Accrued probable and estimable legal and regulatory matters totaled $4.3 million at June 30, 2014.
- CME’s contingent guarantee exposure includes a $460 million letter of credit obligation to Singapore Exchange under a mutual offset agreement. The company considered its guarantee liabilities immaterial and recorded no liability for these guarantees. The filing also describes clearing-house settlement exposures and a farmer/rancher protection fund with $98 million remaining available for claims.
- Cash declined substantially, principally reflecting dividends and debt repayment. The filing says lower operating cash flow also reflected higher payments of accrued expenses and a prior-year cash-collateral item related to a forward-starting interest-rate swap.
Important facts for investors to verify
- Whether trading volumes and clearing fees recover, particularly in foreign exchange, equity, energy and metals, and how volatility affects revenue.
- Whether market-data fee increases can offset subscriber declines, and the effect of customer and reseller concentration.
- Cash generation and capital returns, including the sustainability of dividends after the large first-half financing outflow.
- Costs, financing and regulatory approvals for the proposed Trayport/FENICS-GFI transaction, including assumed debt and expected timing.
- Developments in the patent and regulatory proceedings, clearing-member guarantee exposures, and compliance with applicable liquidity and capital requirements.