CME Group Inc. 10-Q Summary: Quarter Ended September 30, 2008
Business Context and Reporting Period
This quarterly report covers the period ended September 30, 2008. The reporting period is significantly impacted by the completion of the merger with NYMEX Holdings, Inc. on August 22, 2008. Financial results include NYMEX operations from August 23, 2008, and CBOT Holdings operations from July 13, 2007. The company operates as a large accelerated filer and is a leading global derivatives marketplace.
Key Financial Metrics
| Metric | Q3 2008 | Q3 2007 | 9 Months 2008 | 9 Months 2007 |
|---|---|---|---|---|
| Total Revenues | $680.95 million | $565.22 million | $1,869.25 million | $1,226.56 million |
| Operating Income | $420.77 million | $345.38 million | $1,164.34 million | $738.56 million |
| Net Income | $168.69 million | $201.57 million | $653.42 million | $457.48 million |
| Diluted EPS | $2.81 | $3.87 | $11.61 | $11.18 |
| Operating Margin | 62% | 61% | 62% | 60% |
| Cash and Equivalents | $582.42 million | $845.31 million (Dec 31, 2007) | N/A | |
| Total Debt (Short + Long Term) | $2.92 billion | $164.44 million (Dec 31, 2007) | N/A | |
| Operating Cash Flow (9 Months) | N/A | $862.71 million | $571.56 million |
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 20% in Q3 and 52% year-to-date (YTD) compared to 2007. This was driven primarily by the inclusion of NYMEX results and increased trading volume in equity and commodity products due to market volatility.
- Net Income Decline (Q3): Despite revenue growth, Q3 net income decreased 16% to $168.7 million from $201.6 million in Q3 2007. This was due to a higher effective tax rate (57.4% vs. 39.7% in Q3 2007) and increased non-operating expenses.
- Expense Increases: Total expenses rose 18% in Q3 and 44% YTD. Key drivers included amortization of purchased intangibles (up 82% in Q3), compensation costs, and impairment charges related to Swapstream operations ($15.1 million total impairment in Q3).
- Debt Expansion: To finance the NYMEX merger, the company significantly increased debt. Total debt rose from $164.4 million at year-end 2007 to $2.92 billion at September 30, 2008, including new floating and fixed-rate notes and credit facilities.
- Impairments: The company recorded $21.7 million in impairment losses on securities lending assets due to defaults by corporate debt issuers and a $2.0 million loss on a derivative hedge with Lehman Brothers following its bankruptcy.
Guidance, Outlook, and Risks
- Integration: Management is focused on integrating NYMEX operations. A restructuring plan for NYMEX is expected to be finalized and initiated in the fourth quarter of 2008.
- Market Volatility: The company notes that unprecedented volatility in capital and credit markets, driven by the global financial crisis, has increased trading volumes in equity and commodity products but reduced volumes in interest rate products (e.g., Eurodollar options down 54% Q3).
- Legal Contingencies: Two class action lawsuits are pending regarding the NYMEX merger (shareholder and member complaints). Additionally, a lawsuit regarding CBOE exercise right privileges (ERPs) reached a settlement in principle, with a maximum potential payment guarantee of $293.0 million.
- Capital Return: The company authorized a $1.1 billion share repurchase program in June 2008. As of September 30, $23.8 million had been spent. A special dividend of $5.00 per share was declared and paid in October 2008.
- Risk Factors: Significant risks include the soundness of clearing firms (exposure to financial institution failures), potential inability to access commercial paper markets, and the impact of the Emergency Economic Stabilization Act of 2008 on financial markets.
Investor Verification Checklist
- NYMEX Integration Costs: Verify the timeline and estimated costs for the NYMEX restructuring plan expected in Q4 2008.
- Securities Lending Exposure: Review the composition of the securities lending portfolio and the extent of exposure to defaulted corporate debt issuers.
- Legal Settlements: Monitor the status of the CBOE ERP settlement and the NYMEX merger class action lawsuits for potential cash outflows.
- Debt Servicing: Assess the impact of rising interest rates on the new floating-rate debt ($1.0 billion variable rate) and the effectiveness of interest rate swap hedges.
- Trading Volume Trends: Track the sustainability of volume increases in equity and commodity products versus the decline in interest rate products amidst ongoing credit market stress.