CME Group Inc. — Q2 2011 Form 10-Q
Business context and reporting period. CME Group operates derivatives exchanges and clearing services, including CME, CBOT, NYMEX and COMEX. This unaudited filing covers the quarter and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods.
Key financial results
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $838.3 million | $813.9 million | $1,669.9 million | $1,507.1 million |
| Operating income | $534.5 million | $515.1 million | $1,058.6 million | $929.8 million |
| Operating margin | 64% | 63% | 63% | 62% |
| Net income attributable to CME Group | $293.7 million | $270.7 million | $750.3 million | $510.9 million |
| Diluted EPS | $4.38 | $4.11 | $11.20 | $7.73 |
Revenue drivers and operating performance. Q2 revenue increased 3%, while six-month revenue rose 11%. Clearing and transaction fees increased 1% in Q2 and 9% for the half year. Q2 total contract volume fell 2% year over year, partly because there was one fewer trading day; average rate per contract rose 2%. Six-month average daily volume increased 9%, led by interest-rate, agricultural and metal products, while equity and foreign-exchange volumes declined. Market data revenue increased 6% in Q2 and 13% for the half year. Q2 included a $9.8 million gain from selling certain Index Services assets.
Expenses rose 2% in Q2 and 6% for the half year, primarily reflecting higher compensation, benefits, legal fees and marketing costs. The six-month comparison also reflects additional Index Services employees. Q2 non-operating expense was $25.2 million, versus $35.0 million a year earlier, mainly due to lower interest costs after debt repayments and maturities.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $576.1 million, down from $649.1 million. The filing cites increased restricted cash and receivables; the $151.7 million reduction in deferred tax liabilities also reduced operating cash flow relative to net income.
- Six-month investing cash outflow was $70.2 million, including $88.4 million of property purchases. Financing cash outflow was $667.5 million, including repayment of a $420.5 million term loan and $187.5 million of dividends.
- Cash and cash equivalents were $693.6 million at June 30, 2011, down from $855.2 million at year-end. This excludes cash performance bonds and guaranty fund contributions, which were $4,241.8 million and are matched by corresponding liabilities.
- Long-term debt was $2,105.8 million; no short-term debt was outstanding after repayment of the term loan. Notes outstanding were $750 million due 2013, $750 million due 2014 and $612.5 million due 2018. The company had no commercial paper outstanding at quarter-end.
- CME Group reported approximately $1.0 billion of excess borrowing capacity for general corporate purposes and compliance with debt covenants. A separate secured clearing-house credit line provides up to $1.0 billion; $3.3 billion of guaranty-fund collateral was available at quarter-end.
Changes, unusual items and outlook
- Six-month net income increased 47%, substantially faster than revenue, reflecting a 26.3% effective tax rate versus 41.8% in 2010. A first-quarter state tax apportionment change reduced tax provision by $118.1 million, and a $48.8 million reduction in valuation allowances also lowered the rate. Q2 effective tax rate was 42.0%, compared with 43.5%.
- The company began marking its BM&FBOVESPA investment to market in February 2011. Its reported fair value was $665.7 million at June 30; six-month unrealized securities gains and currency-related changes materially increased other comprehensive income. These valuation changes are not equivalent to operating earnings.
- Management gave no specific revenue or earnings guidance in the provided filing text. It expects depreciation to increase for the rest of 2011 after approximately $52 million of data-center assets entered service in Q2. CME Group also announced it was pursuing a sale and partial leaseback of its CBOT north and south buildings.
- Standard & Poor’s affirmed an AA rating with a negative outlook; Moody’s affirmed Aa3 with a stable outlook in August 2011. Management expected to maintain investment-grade status.
- Material risks include lower trading volumes or liquidity amid U.S. fiscal and European debt uncertainty, market volatility affecting clearing-member collateral, competition, technology and operational resilience, regulatory changes including Dodd-Frank, and legal proceedings. Several patent disputes remained unresolved; management said it could not estimate reasonably possible losses. Regulatory inquiries could result in sanctions, but management did not expect a material financial impact.
- The SGX mutual-offset agreement was scheduled to run through October 2011, subject to automatic renewal unless terminated. CME reported an $83 million contingent letter-of-credit obligation to SGX and a $15 million standby letter-of-credit guarantee for GFX. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of the six-month earnings increase is attributable to tax benefits and valuation-allowance changes rather than recurring operations.
- Whether trading volumes, product mix and average rates sustain fee revenue, particularly given Q2 declines in equity and foreign-exchange activity.
- Cash generation and capital spending trends, including the effect of restricted cash, receivables and planned building transactions.
- Debt maturities, available credit capacity, credit-rating outlooks and clearing-house liquidity resources.
- Developments in patent litigation, regulatory matters, Dodd-Frank implementation and clearing-member collateral quality.