CME Group Inc. — 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. The filing is an annual report, not a standalone fourth-quarter filing; it includes unaudited quarterly results.
Business context
CME Group operates futures and options exchanges, clearing houses and related market-data services. Its products span interest rates, equities, foreign exchange, agriculture, energy and metals. Most revenue comes from per-contract clearing and transaction fees; trading volume and the mix of products, venues and customers affect results.
Key financial metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $3,280.6 million | $3,003.7 million | +9% |
| Operating income | $2,021.1 million | $1,831.1 million | +10% |
| Operating margin | 62% | 61% | +1 percentage point |
| Net income attributable to CME Group | $1,812.3 million | $951.4 million | +90% |
| Diluted EPS | $27.15 | $14.31 | +90% |
| Cash from operating activities | $1,346.3 million | $1,356.4 million | -1% |
| Cash and cash equivalents | $1,042.3 million | $855.2 million | +$187.1 million |
| Total debt | $2,106.8 million | $2,525.3 million | Down; no short-term debt at year-end |
| Shareholders’ equity | $21,552.0 million | $20,060.1 million | +7% |
Revenue growth reflected higher contract volume and market-data revenue. Clearing and transaction fees rose 9% to $2,710.9 million as total contract volume increased 10% to 3,386.7 million round turns; average rate per contract declined 1% to $0.800. Market-data and information-services revenue rose 8% to $427.7 million. Operating expenses increased 7% to $1,259.5 million.
Operating cash flow remained strong, but cash from operations was slightly lower despite higher earnings. The company attributed the offset in part to increased restricted cash and other asset movements. Reported cash performance bonds and guaranty fund contributions were $9,333.9 million, matched by an equal liability; these customer-related balances should not be treated as freely available corporate liquidity.
Material changes and unusual items
- Tax-driven earnings increase: The effective tax rate fell to 6.3% from 44.7%. A $646.0 million reduction in the tax provision, largely from revised state tax apportionment and revaluation of deferred tax liabilities, was the main reason net income rose far faster than operating income. A further $48.8 million reduction in valuation allowances also contributed.
- Trading and mix: Average daily volume increased 10% to 13.439 million contracts, with electronic trading at 84% of volume versus 83% in 2010. Interest-rate, equity and agricultural volumes grew; foreign-exchange volume was broadly flat.
- MF Global: The October 2011 bankruptcy of a major clearing firm generated $29.1 million of related expense, including a $21.7 million accounts-receivable write-off. CME transferred more than 30,000 customer accounts and provided a $550 million guarantee to the liquidation trustee to help expedite customer distributions. The company assessed the likelihood of a guarantee payment as remote, but litigation and investigations remained ongoing.
- Q4 2011: Revenue was $736.5 million and operating income was $390.4 million. Net income attributable to CME Group was $745.9 million, materially boosted by a $527.9 million Q4 tax-provision reduction. Q4 diluted EPS was $11.25.
- Capital returns: 2011 dividends were $5.60 per share; CME repurchased 0.8 million shares for $220.4 million. In February 2012, the board raised the dividend target to about 50% of prior-year cash earnings and declared a $2.23 regular quarterly dividend plus a $3.00 variable dividend per share.
Outlook, liquidity and risks
- Management expected existing cash, marketable securities and operating cash flow to meet working-capital and investment needs; it retained access to approximately $1.0 billion of general-purpose borrowing capacity under its revolving facility.
- Expected 2012 capital expenditures were $140–$150 million; a $17.1 million pension contribution was estimated to meet the company’s year-end funding goal.
- Debt consisted of fixed-rate notes due in 2013, 2014 and 2018. The company reported compliance with debt covenants. S&P lowered its long-term rating from AA to AA- in February 2012 and maintained a negative outlook, citing MF Global-related support and potential legal and reputational effects.
- Management cited lower trading volume after year-end through the financial-statement issuance date, associated with lower equity and short-term interest-rate volatility. Results remain sensitive to market activity, volatility, fee and customer mix, and seasonal patterns.
- Key risks include extensive Dodd-Frank and international regulatory changes, potential new customer-protection requirements after MF Global, competition, systems or cyber disruption, clearing-member default and the company’s substantial fixed-cost base.
- The proposed McGraw-Hill index joint venture and sale of CMA were expected to close by June 2012, subject to regulatory approval and customary conditions. CME expected a long-term, ownership-linked exclusive license for S&P index futures and options.
Most important facts for investors to verify
- How much of 2011’s net-income and EPS increase was nonrecurring tax benefit, and what tax rate is sustainable?
- Whether post-year-end trading volume trends persisted and how volume, customer mix and average rate per contract affect revenue.
- The ultimate costs, legal exposure and reputational effects of MF Global, including the $550 million guarantee and customer-fund recovery.
- Progress and economics of the McGraw-Hill transaction, CMA sale and S&P licensing arrangement.
- Whether the higher dividend policy remains supported by operating cash flow, debt obligations and investment requirements.
- Whether regulatory changes, clearing-member concentration and technology or cyber risks alter CME’s costs or clearing safeguards.