CME Group Inc. — Q1 2018 Form 10-Q
Reporting period: Quarter ended March 31, 2018. Unaudited consolidated results compared with Q1 2017; balance-sheet figures compared with December 31, 2017. CME Group operates futures and options exchanges and clearing services, with revenue primarily from clearing and transaction fees.
Financial performance
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Revenue | $1,109.0 million | $929.3 million; up 19% |
| Clearing and transaction fees | $973.6 million | $792.0 million; up 23% |
| Operating expenses | $368.1 million | $328.4 million; up 12% |
| Operating income / margin | $740.9 million / 66.8% | $600.9 million / 64.7% |
| Net income | $598.8 million | $399.8 million; up 50% |
| Diluted EPS | $1.76 | $1.18; up 49% |
| Operating cash flow | $825.0 million | $519.4 million |
| Effective tax rate | 24.1% | 43.5% |
- Futures and options contract volume rose 28% to 1,354.4 million contracts; average daily volume increased 30% to 22.204 million. Electronic trading was 89% of volume, versus 87%.
- Average rate per contract declined 3% to $0.706, reflecting customer and product mix and higher volume incentives. Management estimated volume added $215.1 million to fees, partly offset by a $33.4 million impact from lower average rates.
- Market data revenue was $94.9 million, down 2%; access and communication revenue rose 7% to $26.0 million. Other revenue declined 11% to $14.5 million.
- Investment income increased 13% to $156.4 million, while equity in earnings of unconsolidated subsidiaries rose 30% to $40.1 million. Total non-operating income fell to $47.8 million from $106.1 million, including a $118.6 million other non-operating expense. The filing cites higher distributions of interest earned on reinvested performance-bond collateral; Q1 2017 also included an $86.5 million gain on the sale of BM&FBOVESPA shares.
Financial position and cash flows
- At March 31, cash and cash equivalents were $784.6 million, down from $1,903.6 million at year-end. Cash, cash equivalents and restricted cash totaled $1,278.3 million. Restricted cash included $491.3 million related to the proposed NEX acquisition.
- Performance bonds and guaranty fund contributions were $39.1 billion on both the asset and liability sides of the balance sheet; these customer-related balances are not ordinary corporate liquidity.
- Long-term debt was $2,233.5 million, comprising three $750 million fixed-rate note issues due 2022, 2025 and 2043. No borrowings were outstanding under the $2.3 billion corporate revolving facility or the $7.0 billion clearing liquidity facility. The company reported compliance with debt covenants and approximately $2.3 billion of corporate borrowing capacity.
- Operating cash flow was $825.0 million. Investing activities used $17.4 million; financing activities used $1,435.3 million, including $1,424.8 million of cash dividends paid. The filing does not explain in this excerpt the timing or composition of the cash dividend amount relative to the $0.70 per-share dividend declared for the quarter.
Drivers, outlook and risks
- Management attributed record quarterly average daily volume and revenue growth to elevated volatility across asset classes, amid uncertainty about U.S. interest-rate policy, trade policy, government spending and inflation, as well as commodity-market and weather conditions. These are market-dependent drivers, not assured continuing growth.
- Operating expenses increased, especially licensing and fee-sharing costs, up $15.7 million, and professional fees, up $14.0 million. Management attributed higher professional fees partly to the Eurex litigation and proposed NEX transaction.
- The company agreed to acquire NEX Group for £10 per share, consisting of 500 pence in cash and 0.0444 CME Group shares. The transaction was subject to regulatory and shareholder approvals and was expected to close in the second half of 2018. A £1.6 billion foreign-exchange option was purchased to mitigate currency exposure; its Q1 income-statement impact was immaterial.
- CME exited the CDS clearing business in March 2018. The filing states that there were no material changes in market-risk exposure since year-end and no material updates to the annual-report risk factors. Key ongoing risks include volume and volatility changes, competition, technology and cybersecurity, regulation, customer concentration, clearing-member default exposure, and execution and financing of strategic transactions.
- Legal matters included a CFTC suit concerning disclosure of confidential customer information, for which CME said it had strong defenses. In the Eurex-related litigation, the court had informed the parties of a preliminary decision to grant summary judgment on antitrust claims; a written decision was expected and the trial date had been vacated. No accrual was recorded for legal and regulatory matters considered probable and estimable.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No subsequent events were identified through issuance of the statements.
Accounting and other notable items
- CME adopted the new revenue-recognition standard on January 1, 2018 using the modified retrospective method, reducing opening retained earnings by $8.7 million for deferred revenue, primarily relating to longer-term cleared swaps. Management said ongoing effects were not expected to be material.
- The lower effective tax rate primarily reflected the reduction in the federal statutory rate from 35% to 21% under the 2017 Tax Act; the prior-year rate also reflected tax expense related to the BM&FBOVESPA share sale.
- The company reported a $0.70 per-share common dividend in the equity statement. The filing also reports cash dividends paid of $1,424.8 million in Q1, a figure investors should reconcile to dividend declarations and payment timing.
Most important facts for investors to verify
- Whether unusually high volatility-driven trading volumes and the 30% increase in average daily volume persist, and how lower rates per contract affect fee growth.
- The composition and timing of Q1 cash dividends paid, and the distinction between corporate cash and restricted or customer collateral balances.
- Regulatory and shareholder approvals, financing, currency exposure and closing progress for the proposed NEX acquisition.
- The nature and recurrence of the $118.6 million other non-operating expense and the distribution of interest earned on performance-bond collateral.
- Developments in the CFTC and Eurex litigation, and any resulting financial or operational consequences.