CME Group Inc. — Q3 2012 Form 10-Q
Business context and reporting period. CME Group operates futures and options exchanges and clearing businesses, including CME, CBOT, NYMEX and COMEX. This unaudited filing covers the quarter and nine months ended September 30, 2012; comparisons are with the same periods in 2011 unless noted.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $683.2 million | $874.2 million | $2,253.7 million | $2,544.1 million |
| Operating income | $396.0 million | $572.1 million | $1,316.4 million | $1,630.7 million |
| Operating margin | 58% | 65% | 58% | 64% |
| Net income attributable to CME Group | $218.0 million | $316.1 million | $729.5 million | $1,066.4 million |
| Diluted EPS | $0.66 | $0.95 | $2.20 | $3.19 |
- Q3 revenue fell 22% and nine-month revenue fell 11%. Clearing and transaction fees were $562.2 million in Q3, down 23%, and $1,826.9 million year to date, down 13%. Market data revenue declined 23% in Q3 and 4% year to date. Access and communication fees increased 93% in Q3 and 88% year to date.
- Contract volume was down 27% in Q3 and 16% year to date; average rate per contract rose 6% and 2%, respectively, partly offsetting volume declines. Interest rate and equity volumes were especially weak; agricultural volumes increased.
- Operating expenses declined 5% in Q3 to $287.2 million, but increased 3% year to date to $937.3 million. The effective tax rate was 44.7% for Q3 and 44.9% year to date, versus 42.3% and 31.9% in 2011.
- Operating cash flow was $897.2 million for the first nine months, down 10% from $999.8 million. Investing activities used $49.6 million; financing provided $127.0 million. Cash and equivalents ended at $2,016.9 million, versus $1,042.3 million at year-end 2011.
- At September 30, total assets were $39,858.0 million and total liabilities were $18,069.8 million. Debt carrying value totaled $2,856.0 million: $749.6 million short-term and $2,106.4 million long-term. Cash exceeds reported debt, but includes cash held for clearing-related purposes and should not be treated as wholly available corporate liquidity.
Material changes and unusual items
- Management attributed weaker revenue mainly to lower trading volumes amid reduced market volatility, including subdued interest-rate and equity activity. Drought-related volatility supported agricultural volumes; natural gas activity also increased.
- Operating cost comparisons reflect lower purchased-intangible amortization after contributing Dow Jones index assets to a new venture and selling Credit Market Analysis Ltd. Year-to-date costs also included higher stock compensation, employee separation costs, and expenses related to the venture.
- The June formation of S&P/Dow Jones Indices LLC generated a $79.8 million gain on contribution of assets; the CMA sale generated a $19.9 million loss. Together these transactions produced a reported net gain of $59.9 million. A $5.7 million recovery of a prior impairment also benefited Q3 non-operating results. Q3 equity-method income included $17.4 million from the venture.
- The venture contributed to a $132.0 million non-cash deferred-tax provision in Q2 and a higher year-to-date tax rate; Q3 included an additional $15.7 million tax expense from deferred-tax adjustments. These items materially affect comparisons of reported earnings.
- In September, CME issued $750 million of 3.00% notes due 2022; a swap makes the effective interest rate 3.32%. Proceeds and cash on hand are intended to retire the 5.40% notes due August 2013 at maturity. A $750 million 2013 note is classified as short-term debt.
- Cash dividends paid in the first nine months were $644.3 million. After quarter-end, the board declared a regular $0.45-per-share dividend payable December 26, 2012. In October, CME agreed to acquire the Kansas City Board of Trade, subject to regulatory approval and customary closing conditions.
Outlook, liquidity, risks and contingencies
- The filing provides no quantified revenue or earnings guidance. Management cited volume sensitivity to volatility, economic and political conditions, regulation, and product and customer mix. Management expects to maintain an investment-grade credit rating, citing cash generation, debt repayment capacity, and refinancing ability.
- Available facilities include a $1.0 billion revolving corporate credit facility, with no borrowings outstanding, and a separate committed clearing-house line of credit of up to $3.0 billion, supported by collateral. CME reported compliance with debt covenants and applicable CFTC capital and liquidity requirements. S&P’s long-term rating was AA- with a negative outlook; Moody’s was Aa3 with a stable outlook.
- Material risks include lower trading and clearing activity, competition, technology and operational resilience, regulatory changes, customer concentration, and clearing-member credit exposure. Management reported no material change in market-risk exposure since December 31, 2011, and no material updates to annual-report risk factors.
- Patent litigation remains ongoing; CME stated it believes the claims are without merit. MF Global customer litigation was at an early stage, and the company could not estimate a reasonably possible loss. Accrued legal and regulatory matters totaled $13.3 million.
- CME provided a $550 million guarantee related to certain MF Global customer distributions and said payment was remote. The company recorded a $2.2 million liability for its farmer and rancher fund following the PFG bankruptcy. The filing also describes clearing guarantees and a $196 million contingent obligation under its SGX mutual offset arrangement.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether trading volumes and average rates recover, particularly in interest-rate and equity products, and how that affects transaction-fee revenue.
- The recurring earnings impact of the index venture, asset dispositions, deferred taxes, and other non-recurring items; distinguish reported results from underlying operating trends.
- The timing and funding of the 2013 note retirement, ongoing debt service, dividend capacity, and availability of cash after clearing and regulatory needs.
- Progress, regulatory approval, and financial terms of the planned Kansas City Board of Trade acquisition.
- Developments and potential exposure from MF Global-related claims, patent litigation, clearing guarantees, and other legal or regulatory matters.