CME Group Inc. — Q3 2014 Form 10-Q
Business context and period. CME Group operates futures and options exchanges and clearing businesses, including CME, CBOT, NYMEX and COMEX. This unaudited filing covers the quarter and nine months ended September 30, 2014, compared with the same 2013 periods.
Financial performance
- Revenue: Q3 revenue was $762.4 million, up 7%; nine-month revenue was $2.271 billion, up 1%. Q3 clearing and transaction fees rose 7%, and market data revenue rose 12%. Nine-month clearing and transaction fees were essentially flat, while market data revenue increased 12%.
- Trading activity and pricing: Average daily volume increased 12% in Q3 and 2% for the nine months. Average rate per contract declined 5% and 2%, respectively, reflecting product mix and increased incentives and discounts.
- Profit and margins: Q3 operating income was $430.4 million and net income attributable to CME Group was $290.0 million, up 23%; diluted EPS was $0.86, up 21%. Nine-month operating income was $1.297 billion, down 1%; attributable net income was $820.6 million, up 5%, and diluted EPS was $2.44, up 4%. Operating margin was 56.5% in Q3 versus 56.0%; for the nine months it was 57.1% versus 58.4%.
- Costs and taxes: Expenses increased 6% in Q3 and 4% year to date. The effective tax rate fell to 32.4% from 40.8% in Q3 and to 36.8% from 39.3% for the nine months, with 2014 benefits from state and local apportionment changes and favorable state tax audit settlements.
- Cash flow: Nine-month operating cash flow was $788.9 million, down 12% from $898.6 million. Investing activities used $107.6 million; financing activities used $2.063 billion, including $1.339 billion of cash dividends and repayment of $750 million of debt. Cash and cash equivalents fell to $1.088 billion from $2.470 billion at year-end.
- Debt and liquidity: Long-term debt was $2.108 billion, with no short-term debt outstanding. CME Group reported $1.8 billion of unused capacity under its general-purpose revolving facility and a separate $7.0 billion clearing-house liquidity facility; it was in covenant compliance. Cash and cash equivalents exclude the substantial customer-related performance bond and guaranty fund balances, which are matched by corresponding liabilities.
Changes, outlook, and risks
- Q3 volume growth was led by interest-rate products, up 23%; foreign exchange, energy and metals volumes were weaker year to date. Management attributed activity changes mainly to market volatility, economic and geopolitical conditions, and underlying commodity-market factors.
- Market data revenue benefited from a $15 fee increase for basic real-time services effective in 2014, partly offset by declining subscriber counts. Other revenue fell year to date partly because of prior-year technology-agreement and insurance proceeds and lost rental income after the NYMEX building sale.
- Management disclosed no specific financial guidance. It expected to maintain an investment-grade rating, citing cash generation and debt repayment/refinancing capacity. In October 2014, CME Group announced a reorganization and workforce reduction of about 150 positions; related severance and other costs were expected to affect primarily Q4.
- Unusual expense items included a Q3 $12.8 million net foreign-exchange loss, versus a $12.0 million gain a year earlier. A $5.4 million increase in contingent-consideration fair value was included in other expenses for the nine months. The company also recognized the MF Global bankruptcy claim settlement as a reduction in other expenses in Q2.
- Legal matters include a CFTC suit against NYMEX and two former employees concerning alleged disclosure of confidential customer information; NYMEX’s motion to dismiss was denied on September 30, 2014. The company stated it had strong defenses. Patent matters remain unresolved, and potential losses could not be estimated; accrued probable and estimable legal and regulatory matters totaled $4.3 million at quarter-end.
- Other risks include competition, market activity and rate-per-contract variability, regulation, technology and cybersecurity, clearing-member/default exposure, and litigation. Management reported no material change in market-risk exposure and no material updates to annual-report risk factors. Disclosure controls were deemed effective.
Investor verification priorities
- Confirm the durability of volume growth and whether lower average contract rates continue to offset activity gains.
- Assess the sustainability of market-data revenue growth given subscriber declines and reliance on two resellers for approximately 43% of that revenue.
- Review operating cash-flow conversion, dividend outflows, and cash balances separately from customer collateral and clearing-related funds.
- Track workforce-reorganization costs, proposed GFI transaction-related costs, and other expense volatility.
- Monitor the CFTC and patent litigation, contingent guarantees, and clearing-house liquidity and default exposures.