CME Group Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. CME Group operates futures and options exchanges and clearing services, alongside market data and related businesses. Financial statements are unaudited. Unless stated otherwise, amounts are in U.S. dollars.
Financial performance and condition
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $795.9 million | $838.3 million | $1,570.5 million | $1,669.9 million |
| Operating income | $469.2 million | $534.5 million | $920.4 million | $1,058.6 million |
| Operating margin | 59% | 64% | 59% | 63% |
| Net income attributable to CME Group | $244.9 million | $293.7 million | $511.5 million | $750.3 million |
| Diluted EPS | $0.74 | $0.88 | $1.54 | $2.24 |
| Operating cash flow | Not stated separately | Not stated separately | $657.8 million | $576.1 million |
- Q2 revenue declined 5% and six-month revenue declined 6% year over year. Clearing and transaction fees fell 6% and 8%, respectively, primarily as contract volume decreased. Total contract volume was down 7% in Q2 and 9% for the six-month period; average rate per contract was broadly stable.
- Market data revenue rose 3% in Q2 and 5% year to date, reflecting higher device fees, partly offset by fewer devices. Access and communication revenue increased following the launch of co-location.
- Expenses rose 8% in Q2 and 6% for the six-month period. Higher compensation, transaction-related professional fees, accelerated stock-compensation expense and employee separation costs contributed. Compensation and benefits increased 12% in Q2 and 11% year to date.
- Q2 income tax provision was $257.3 million and the effective tax rate was 50.4%; the six-month provision was $424.4 million and the rate was 45.0%. Venture-related deferred tax liabilities increased the provision by $132.0 million; nonrecurring tax reductions partly offset this. Prior-year rates benefited from state tax and valuation-allowance changes.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $1,293.2 million, compared with $1,042.3 million at year-end 2011. Six-month cash increased $250.9 million. Investing cash flow was positive $71.8 million, including $151.5 million in building-sale proceeds; financing cash flow was negative $478.7 million, principally reflecting $494.2 million in dividends.
- Long-term debt was $2,107.7 million, with fixed-rate notes due in 2013, 2014 and 2018. No commercial paper or revolving-facility borrowings were outstanding. The company reported approximately $1.0 billion of general-purpose revolving capacity and compliance with debt covenants.
- The company also maintained a separate, secured clearing-house credit line of up to $3.0 billion, collateralized by clearing-related assets; guaranty funds available to collateralize it totaled $4.3 billion. These arrangements support clearing liquidity and should not be confused with unrestricted corporate cash.
- Reported current assets and liabilities include equal customer performance-bond and guaranty-fund balances: $6,407.6 million at June 30, versus $9,333.9 million at year-end. These matched balances materially affect headline working-capital comparisons.
Material changes, outlook and risks
- In June, CME Group and McGraw completed formation of S&P/Dow Jones Indices LLC. CME Group reported a 27.0% consolidated interest, accounted for under the equity method, with an aggregate recorded fair value of $923.4 million. The transaction generated an $84.5 million gain on contribution of index assets; the company also recorded a $19.3 million loss on selling Credit Market Analysis Ltd. Together these transactions contributed to reported non-operating income of $65.2 million. Fair value of the venture interest relied on significant unobservable inputs.
- The April sale of the CBOT building towers generated $151.5 million of proceeds and a $20.3 million gain. Because of a leaseback, the gain is recognized as a reduction of operating expenses over 15 years.
- Management gave no specific earnings or revenue guidance in the supplied filing text. It cited market activity, volatility, product mix, competition, regulation, technology execution and economic conditions as factors affecting results. Management attributed weaker interest-rate volumes partly to the Federal Reserve’s stated zero-rate policy through 2014; agricultural volumes benefited from drought-related volatility.
- Legal matters include intellectual-property claims and lawsuits related to MF Global. The company said it believed it had strong defenses; it could not estimate a reasonably possible loss for the early-stage MF Global cases. Accrued legal and regulatory matters were $12.8 million.
- Contingencies include a $550 million guarantee related to certain MF Global customer distributions, which management considered unlikely to require payment, and a $196 million contingent obligation to SGX under a mutual offset agreement. CME established a farmer and rancher protection fund with potential coverage subject to stated per-participant limits and a $100 million aggregate cap. Management considered the related guarantee liabilities immaterial.
- Standard & Poor’s rating outlook was negative; Moody’s outlook was stable. Management expected to maintain investment-grade ratings. The filing reported no material changes in market-risk exposure or risk factors from the prior annual report.
- A five-for-one Class A stock split became effective July 20, 2012; share and EPS figures were retroactively restated. Disclosure controls were assessed as effective, with no material changes in internal control reported.
Important facts for investors to verify
- Whether lower contract volumes persist, particularly in interest-rate products, and how changes in product mix affect average rate per contract.
- How recurring expenses and licensing costs evolve after the McGraw venture, CEO-transition compensation and voluntary exit incentive plan.
- The assumptions and valuation sensitivity underlying the $923.4 million equity-method investment, and the venture’s subsequent contribution to earnings and cash flow.
- The effective tax rate after the unusual venture-related deferred tax effects and nonrecurring tax adjustments.
- Developments in MF Global-related litigation and guarantees, intellectual-property cases, and clearing-house liquidity arrangements.
- Debt maturities in 2013 and 2014, credit-rating outlooks, and the distinction between corporate liquidity and customer/clearing-related funds.