CME Group Inc. — Q1 2012 Form 10-Q
Reporting period: Quarter ended March 31, 2012. Unaudited consolidated results; comparisons are with the quarter ended March 31, 2011. CME Group operates futures and options exchanges and clearing services.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $774.6 million | $831.6 million | Down 7% |
| Operating income | $451.2 million | $524.1 million | Down 14% |
| Operating margin | 58% | 63% | Down 5 percentage points |
| Net income attributable to CME Group | $266.6 million | $456.6 million | Down 42% |
| Diluted earnings per share | $4.02 | $6.81 | Down 41% |
| Operating cash flow | $395.6 million | $362.1 million | Up 9% |
| Cash and cash equivalents, quarter end | $1,061.7 million | $1,042.3 million at Dec. 31, 2011 | Up $19.4 million |
| Long-term debt, quarter end | $2,107.2 million | $2,106.8 million at Dec. 31, 2011 | Essentially unchanged |
Clearing and transaction fees were $621.1 million, down 10%; market data revenue rose 7% to $114.2 million, and access and communication revenue rose 72% to $19.7 million. Expenses increased 5% to $323.4 million. The effective tax rate was 38.6%, versus 10.7% a year earlier. Q1 2011 benefited from a $118.1 million tax provision reduction related largely to state tax apportionment and a $48.8 million reduction from releasing valuation allowances.
Operating cash flow exceeded net income, with cash generation affected by working-capital movements, including a $174.9 million increase in income taxes payable. Investing cash outflow was $40.4 million, including a $22.8 million investment in DME Holdings Limited. Financing cash outflow was $335.8 million, primarily reflecting $346.5 million in cash dividends. The balance sheet also included $7,737.8 million of cash performance bonds and guaranty fund contributions, matched by an equal current liability; these balances should not be treated as freely available cash.
Material changes and management commentary
- Total contract volume fell 11% to 763.1 million contracts; average daily volume declined 11% to 12.308 million. Management attributed lower fees primarily to reduced volume, partly offset by a slightly higher average rate per contract.
- Average rate per contract increased to $0.811 from $0.808, reflecting product mix, including a greater share of higher-fee energy contracts.
- Management linked lower activity in several major product groups to reduced volatility, including low short-term interest-rate volatility following the Federal Reserve’s January 2012 commitment to maintain its zero-rate policy through 2014. Equity, foreign exchange, and several agricultural and energy products also had lower volume.
- Expense growth reflected higher compensation, headcount and co-location depreciation, partly offset by lower bonuses, licensing costs, and litigation-related expense. The co-location program launched in Q1 and contributed $9.7 million of access and communication revenue.
- Dividend income fell: total dividend income was $6.6 million versus $16.7 million, primarily due to lower income from the BM&FBOVESPA investment. Interest expense declined following repayment of a $420.5 million term loan in January 2011.
Liquidity, debt, outlook and risks
Debt comprised fixed-rate notes with $750 million due in 2013 at 5.40%, $750 million due in 2014 at 5.75%, and $612.5 million due in 2018 at an effective rate of approximately 4.46%. No commercial paper was outstanding. CME Group reported approximately $1.0 billion of unused general-purpose revolving credit capacity and a separate committed clearing-house line of up to $3.0 billion, supported by $4.4 billion of eligible guaranty-fund collateral. The company stated it was in compliance with debt covenants and expected to maintain an investment-grade rating; S&P’s outlook was negative and Moody’s outlook stable.
The filing provides no quantitative earnings or revenue guidance. Management described trading activity as sensitive to volatility, market and economic conditions, regulation, competition, and customer activity. Risks also include technology and cybersecurity, clearing-member credit exposure, the implementation of Dodd-Frank requirements, and the ability to adjust costs if revenue declines. Management reported no material change in market-risk exposure since year-end and stated disclosure controls were effective.
- Contingencies: CME provided a $550 million guarantee to the MF Global bankruptcy trustee related to specified customer distributions. Management considered payment remote and the estimated guarantee liability immaterial. CME also had $161 million of letters of credit contingent to Singapore Exchange under a mutual-offset agreement.
- Legal matters: CME faces MF Global-related suits seeking unspecified damages, including treble and punitive damages; it said it could not estimate a reasonably possible loss. The company also described patent disputes and stated it intended to defend itself; certain patent claims had been rejected by the USPTO, subject to possible replies or appeals. Accrued legal and regulatory matters were $12.8 million.
- Subsequent events: In April 2012, CME sold two Chicago buildings and leased back part of the property under a 15-year lease. It also established a fund that may provide up to $100 million to qualifying family farmers and ranchers if future customer losses result from an insolvency.
- Planned transaction: CME expected its Index Services contribution and sale of Credit Market Analysis to McGraw-Hill to close in Q2 or Q3 2012, subject to regulatory approval and customary conditions.
Investor verification priorities
- Assess how persistent the 11% contract-volume decline may be and whether activity and volatility recovered after the quarter.
- Separate underlying earnings trends from the unusually low Q1 2011 tax rate when comparing year-over-year profit.
- Review dividend sustainability against operating cash flow, debt maturities, and the company’s substantial quarterly dividend payment.
- Confirm the terms, expected proceeds, and accounting impact of the April building sale-leaseback and the status of the McGraw-Hill transaction.
- Monitor potential exposure from MF Global-related claims, the $550 million guarantee, patent litigation, and clearing-house guarantees.