CME GROUP INC. quarterly report, Q3 FY2013

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CME Group Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2013. Financial statements are unaudited. Comparisons are with the corresponding 2012 periods unless noted.

Business context and results

CME Group operates futures and options exchanges and clearing businesses, including CME, CBOT, NYMEX, COMEX and KCBT. Revenue is driven primarily by clearing and transaction fees, which depend on trading volume, product mix and average rate per contract.

  • Third quarter: Revenue was $714.6 million, up 5%; operating income was $400.5 million, up 1%; operating margin was 56%, versus 58%. Net income attributable to CME Group was $236.7 million, up 9%; diluted EPS was $0.71, up 8%.
  • Nine months: Revenue was $2.249 billion, essentially flat; operating income was $1.314 billion, essentially flat; operating margin was 58%, unchanged. Net income attributable to CME Group was $783.7 million, up 7%; diluted EPS was $2.35, up 7%.
  • Revenue mix: Q3 clearing and transaction fees were $597.9 million, up 6%; market data revenue was $78.6 million, down 5%. For nine months, clearing and transaction fees rose 3% to $1.884 billion, while market data revenue fell 22% to $238.9 million.
  • Trading activity: Average daily volume increased 11% in Q3 and 9% for nine months. Interest-rate volume rose 29% and 20%, respectively. Agricultural volume fell 14% and 10%. Average rate per contract declined 7% in Q3 and 6% for nine months, partly reflecting product mix and energy-contract incentives.

Cash flow, liquidity and debt

  • Nine-month operating cash flow was $898.6 million, broadly unchanged from $897.2 million. Investing activities provided $33.0 million; financing activities used $471.3 million. Cash and cash equivalents rose to $2.065 billion from $1.605 billion at year-end 2012.
  • At September 30, total debt carrying value was approximately $2.857 billion: $749.7 million short-term and $2.107 billion long-term. CME issued $750 million of 5.30% notes due 2043 and intended to use proceeds and cash to retire $750 million of 5.75% notes due February 2014 at maturity.
  • The company reported no borrowings under its $1.8 billion revolving senior credit facility and approximately $1.8 billion of excess borrowing capacity for general corporate purposes. Its separate clearing-house line provided up to $5.0 billion at September 30; the limit was increased to $7.0 billion effective November 2013, with an option to request up to $10.0 billion.
  • Cash performance bonds and guaranty fund contributions were $16.193 billion on both the asset and liability sides. These clearing-related balances are not equivalent to freely available corporate cash. The company reported compliance with debt covenants and regulatory capital requirements.

Changes, management commentary and outlook

  • Higher Q3 revenue reflected increased contract volume, partly offset by the lower average rate per contract. Growth in interest-rate activity was associated with changing Federal Reserve expectations and higher long-term rate volatility; OTC clearing mandates also supported interest-rate-swap revenue.
  • Nine-month market data revenue declined partly because the index business was contributed to S&P/Dow Jones Indices and Credit Market Analysis was sold in 2012; the company attributed $52.7 million of the decline to those changes. Subscriber reductions and customer cost-cutting also weighed on market data revenue.
  • Q3 expenses rose 9% to $314.1 million, mainly from higher compensation, headcount and bonuses, professional fees, and licensing fees. Nine-month expenses were essentially flat at $935.5 million, with savings associated with the 2012 business changes offsetting other increases.
  • Nine-month non-operating results shifted to a $19.8 million expense from $23.5 million of income, reflecting the absence of prior-year transaction-related gains and higher interest expense, partly offset by greater equity income from S&P/Dow Jones Indices. The effective tax rate fell to 40.8% for Q3 and 39.3% for nine months, with the filing citing tax deductions and differences from 2012 tax effects.
  • The filing gives no specific earnings or revenue guidance. Management cites competition, regulation, trading activity and volatility, technology and cybersecurity, customer concentration, clearing-member credit risk, and the ability to manage costs and debt among key risks. Management cautions that quarterly results may not indicate future results.

Contingencies and unusual items

  • Legal and regulatory accruals were $13.3 million at September 30. The company described several patent disputes and a CFTC suit involving NYMEX and former employees; it said it intended to defend the matters and could not estimate potential losses for the patent cases.
  • On November 6, 2013, CME announced an agreement in principle concerning MF Global customer litigation: CME would assert a $29.0 million claim against the trustee and deliver $14.5 million of the resulting distribution to customer representatives. The agreements require court approval.
  • Gross unrecognized tax-benefit liabilities, including related interest and penalties, increased to $231.6 million from $57.8 million at year-end, due to additions based on current- and prior-year tax positions.
  • Other notable nine-month items included $8.8 million of technology-agreement fees and $5.1 million of Hurricane Sandy business-interruption insurance proceeds. A $0.45 regular quarterly dividend was declared after quarter-end, payable December 26, 2013.

Investor verification priorities

  • Assess whether higher trading volumes can persist and whether product mix and incentives will continue to pressure average rate per contract.
  • Separate recurring market-data performance from the effects of the index-business contribution and CMA sale; monitor subscriber trends and the planned basic-service price increase to $85 per device per month effective January 1, 2014.
  • Review debt refinancing, interest costs, liquidity availability and the terms of the expanded clearing-house credit line.
  • Track the MF Global settlement approval and developments in patent and regulatory matters, including potential financial exposure that the filing says cannot be estimated.
  • Evaluate the rise in unrecognized tax-benefit liabilities and the effect of tax-rate changes on earnings.