CME Group Inc. — Q2 2018 Form 10-Q
Business context and reporting period: CME Group operates futures and options exchanges and clearing services, with revenue principally from clearing and transaction fees. This unaudited filing covers the quarter and six months ended June 30, 2018, compared with the same periods in 2017; balance-sheet figures are compared with December 31, 2017.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1,059.6 million | $924.6 million | $2,168.6 million | $1,853.9 million |
| Operating income | $666.9 million | $605.2 million | $1,407.8 million | $1,206.1 million |
| Operating margin | 62.9% | 65.5% | 64.9% | 65.1% |
| Net income | $566.1 million | $415.8 million | $1,164.9 million | $815.6 million |
| Diluted EPS | $1.66 | $1.22 | $3.42 | $2.40 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $1,347.8 million | $783.4 million |
- Revenue drivers: Q2 clearing and transaction fees rose 14% to $906.1 million; market data revenue rose 18% to $113.8 million. For the first half, clearing and transaction fees increased 19% to $1,879.7 million and market data revenue increased 8% to $208.7 million.
- Trading activity: Futures and options contract volume increased 13% in Q2 and 21% in the first half. Average daily volume increased 12% and 21%, respectively. Average rate per contract rose 1% in Q2 but fell 1% in the first half.
- Expenses and profitability: Total expenses rose 23% in Q2 and 17% in the first half, exceeding revenue growth in Q2 and reducing operating margin. Foreign-currency effects, licensing fees, professional fees, bonuses and compensation contributed to higher expenses.
- Taxes and non-operating items: Effective tax rates were 25.2% for Q2 and 24.6% for the first half, down from 34.7% and 39.3%. Management cited the reduction in the federal statutory tax rate. Q2 investment income included $88.2 million of realized and unrealized gains on privately held equity investments; the first-half accounting change recognized a $70.0 million fair-value increase on certain such investments. Other non-operating expense included a $36.9 million loss on foreign-exchange hedge contracts in Q2.
- Cash and liquidity: At June 30, cash and cash equivalents were $1,098.9 million, down from $1,903.6 million at year-end. An additional $1,635.5 million was classified as short-term restricted cash, principally for the proposed NEX acquisition. The reported $1,347.8 million of first-half operating cash flow compares with $1,662.5 million of cash dividends paid.
- Debt: Long-term debt was $3,419.0 million, up from $2,233.1 million at year-end. In June, CME issued $500 million of 3.75% notes due 2028 and $700 million of 4.15% notes due 2048 to help fund the proposed NEX acquisition. It reported no borrowings under its $2.3 billion general-purpose revolving facility or its $7.0 billion clearing liquidity facility.
Material changes, outlook and risks
- Management attributed higher volumes to greater market volatility and uncertainty, including Federal Reserve policy, trade policy, inflation and geopolitical or commodity-market developments. The filing provides no formal earnings or revenue guidance.
- The proposed NEX acquisition was valued at £10 per share, comprising 500 pence in cash and 0.0444 CME Group shares. NEX shareholders had approved it, but regulatory approvals remained pending; management expected closing in the second half of 2018. CME had restricted $1.6 billion of cash for the transaction and maintained a £0.7 billion bridge facility. The filing states the transaction would be subject to a 101%-of-principal repurchase offer for the new notes if it was not completed by June 30, 2019 or the agreement was terminated.
- Currency movements on the restricted British-pound cash generated a $47.3 million Q2 net loss, included in operating expenses. CME also incurred losses on the foreign-exchange option and forward contracts used to mitigate acquisition-related currency exposure.
- CME exited the CDS clearing business in March 2018. The filing identifies competition, technology and cybersecurity, regulation, volume and rate-per-contract variability, clearing-member credit exposure, market conditions and the NEX transaction as relevant risks. Management said there were no material updates to the risk factors in its 2017 Form 10-K.
- Legal matters included a CFTC case concerning alleged disclosure of confidential customer information; CME said it believed it had strong defenses. In a separate antitrust case, the court had preliminarily decided to grant CME and CBOT summary judgment on the antitrust claims; a written decision was pending. No legal accrual was recorded.
Important facts for investors to verify
- Whether and when the NEX acquisition received regulatory approval, closed, and required use of restricted cash, debt proceeds or bridge financing.
- How much of net-income growth is attributable to trading-related operating performance versus investment gains, lower tax expense and acquisition-related foreign-exchange effects.
- Whether higher trading volumes persist and how product mix, member activity, incentives and pricing affect the average rate per contract.
- Whether expense growth, including licensing, professional services and currency-related costs, moderates and supports operating margins.
- Current liquidity and debt levels, dividend funding needs, and developments in the disclosed legal and regulatory matters.